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THE USE OF
ALTERNATIVE DISPUTE RESOLUTION (ADR) IN THE BANKRUPTCY ARENA
INTRODUCTION:
Any person in
business has at one time or another received the dreaded notice from the
Bankruptcy Court that a debtor or customer has filed for bankruptcy and
that what was previously a business relationship that can offer some
benefit is now not only defunct, but the odds of recovery are probably
nil. As described in our article on
Bankruptcy,
once bankruptcy is filed the Federal Bankruptcy Court assumes full
jurisdiction as to all economic matters effecting the bankrupting party,
all pending or possible legal actions or remedies are stayed, and,
indeed, the creditor can face severe sanctions from the court if relief
is sought outside the jurisdiction of the Bankruptcy Court. Existing
obligations may be entirely nullified by the court with creditors often
paid pennies on the dollar. A common reaction of the creditors was to
simply throw the notice in the waste basket and write off the debt.
Which can be a
mistake. It is becoming an increasingly common tactic for viable
businesses to utilize bankruptcy to “restructure” debt load to remain in
business and simply filing a bankruptcy no longer implies that the
bankrupt is without resources. More and more intelligent business people
now take the time (and money) to participate in the Federal Court
proceedings to determine what part of the original obligation can be
saved and whether it is worth while to continue to pursue the debt in
that forum.
Some Creditors, such
as those in construction or with Deeds of Trust, must proceed to
Bankruptcy Court to obtain relief from the bankruptcy stay and foreclose
on their various security. See our articles on
Mechanics Liens
and
Real Estate Transactions.
But even unsecured creditors have found that an active and intelligent
participation in the bankruptcy proceeding can yield important results.
As one client put it, filing bankruptcy no longer stops all efforts to
collect…merely changes the forum of collection.
Obviously a rigid
cost benefit analysis must be conducted to determine the possible net
recovery but, at the least, the creditor is well advised to investigate
the matter with alacrity and obtain both legal and tax advice as to the
potential upside and downside of pursuing the claim.
And this leads to
the question of whether the various cost saving business/legal tools the
wise business person has adopted can still be utilized in bankruptcy.
The Bankruptcy Courts are jealous of their powers and not inclined to
allow the intricate safeguards any good business attorney builds into
contracts to interfere with the plans the Court may develop to “save” or
protect the bankrupt business. However, a new spirit is developing in
the Bankruptcy Courts and the creditors are no longer necessarily seen
as third parties whose only interest is to avoid the valid laws of
bankruptcy. As more and more cases are filed in which solvent companies
are using the Bankruptcy Courts to revamp obligations, the Bankruptcy
Courts are seeing themselves as applying equitable principles to ensure
the fair allocation of obligations and responsibilities and to
concentrate increasingly on protecting the rights of the creditors as
well.
Nowhere is this more
clear than in the attitude of the Courts to use of arbitration. As the
reader can determine by reviewing our articles on
Arbitration
and on
Arbitration and Mediation,
this mode of recovery allows parties to efficiently and rapidly
determine rights and duties without the great expense of court trials.
Quite often, a party facing a dire consequence during an arbitration, or
knowing that another party is about to commence proceedings in
arbitration, will leap into the Bankruptcy Courts and hope that the
greater expense of a trial in that forum will cause the other party to
give up the claim.
But the Bankruptcy
Courts are rethinking their approach to the enforceability of
arbitration and mediation clauses in Bankruptcy and that is the theme of
this article.
ADR IN THE BANKRUPTCY COURTS
If a claim of a
creditor is contested by the Trustee in bankruptcy, the resulting trial
is normally termed an “adversary proceeding.” As the number of
bankruptcy filings has increased and the size and complexity of cases,
adversary proceedings and contested matters have grown, ADR has assumed
a more prominent role in bankruptcy disputes. Discussions of the topic
have fallen into two broad areas.
1.
The
first intersection between bankruptcy and ADR has not concerned the use
of alternative resolution methods for specifically bankruptcy problems,
but rather whether arbitration provisions in pre-petition contract
between the debtor and a third party are enforceable.
Early cases were generally hostile to enforcing pre-petition arbitration
agreements on the ground that Congress had intended to concentrate all
debtor-related adjudication before the Bankruptcy Court. Subsequent
legislative and judicial changes undermined the basis for this position.
It now appears to be clearly established that a Bankruptcy Court has no
discretion but to uphold otherwise valid arbitration clauses in noncore
or "related to" matters. In core proceedings, the growing judicial
consensus appears to be that a Bankruptcy Court has discretion to deny
the enforcement of a pre-petition arbitration clause if, but only if,
the dispute involves a substantive right created by the Bankruptcy Code
itself, or if the rights of the pre-petition debtor are not at issue.
2.
The
second general area of concern has been the use of court-annexed ADR as
part
of the
bankruptcy process itself. Proceedings
under the Bankruptcy Code, particularly the reorganization chapters,
are themselves a form of collective alternative dispute resolution, and
it is surprising that the use of court-annexed ADR is relatively new to
bankruptcy. Starting with the creative use of ADR on an ad hoc basis in
cases involving mass claims and with pilot programs in certain
districts, the use of nonbinding ADR as a means of reaching agreement
now has a firm foundation both in statutes and in procedural rules. Some
Bankruptcy Courts have their own local rules dealing with mediation as a
means of achieving settlement, and other Bankruptcy Courts employ the
local ADR rules of the district court. For mediation to work, however,
confidentiality is required. Just how this should be achieved has been
the subject of some dispute. Furthermore, the parties must mediate in
good faith. Just what constitutes "bad faith mediation" and how it
should be dealt with deserves attention. Settlements achieved through
ADR require Bankruptcy Court approval. Once approved, a compromise
achieved by mediation is almost
unassailable.
PRACTICAL STEPS TO TAKE
With the useful
business litigation tools of arbitration and mediation being available,
and with a viable alternative to relatively expensive court trials under
the jurisdiction of the Bankruptcy Court, an entirely new cost benefit
analysis is applicable. Even the more complex bankruptcies, involving
dozens or even hundreds of creditors, are no longer necessarily destined
for the endless expensive mass hearings that were once the hallmark of
major bankruptcy filings, since the Court is often inclined to require
professional mediators to assume all or part of the burden of resolving
and settling contested issues, be they claims denied by the debtor or
competing claims of creditors.
A very wise old
business man once told the author that the difference between someone
adequate in business and someone who is good in business is adjusting to
new circumstances before the competition. “Anyone…even a dolt…can
eventually learn how to do almost any kind of business. But it takes
brains to see the changes in business practices that must be mastered to
stay in business and stay healthy.”
That is true in
analyzing legal remedies and the changes in both the laws of bankruptcy
and the ethos of the Bankruptcy Courts should be considered by the
business person seeking to protect the interests of the business.
In short, don’t just
throw the notice away. That may be what the competitors are doing, to
their detriment. Check out the remedies and be ready to aggressively
pursue them.
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