Second Circuit Holds Violation of Bankruptcy Discharge Injunction May Nullify Mandatory Arbitration Requirement Under Federal Arbitration Act

by John P. Schneider

In In re Anderson v. Credit One Bank, N.A., 884 F.3d 382 (2d Cir. 2018), the Second Circuit held that it is within a bankruptcy court’s discretion to deny arbitration of disputes involving a violation of the bankruptcy discharge injunction.  In doing so, it found that despite the strong congressional preference for arbitration generally, the importance of the Bankruptcy Code’s fresh start, and the bankruptcy court’s powers to enforce the discharge injunction, prevailed.

Orrin Anderson (the “Debtor”) was the holder of a consumer credit card account with Credit One Bank, N.A. (“Credit One”).   In March 2012, Credit One “charged off” the Debtor’s delinquent debt, sold it to a third-party purchaser, and reported these changes to each of the nation’s leading credit reporting agencies.  The Debtor subsequently filed a voluntary Chapter 7 bankruptcy petition and was granted a discharge in May 2014.

The Debtor’s claim arose after Credit One refused his request to remove the charge-off from his credit report.  The Debtor contended that Credit One’s refusal violated the discharge injunction by attempting to coerce him into paying a discharged debt, knowing that debtors would be more inclined to pay charged-off (rather than “discharged”) debt to clear their credit report.

In December 2014, the bankruptcy court permitted the Debtor to reopen the bankruptcy case to file a class action seeking damages against Credit One for violating Bankruptcy Code section 524’s discharge injunction.  In response, Credit One moved to stay the proceedings and to initiate arbitration of the dispute in accordance with an arbitration clause contained in the Debtor’s cardholder agreement.  The bankruptcy court denied Credit One’s motion and held that because the Debtor’s claim was a core bankruptcy proceeding which “went to the heart of the fresh start guaranteed to debtors” under the Bankruptcy Code, it was not subject to arbitration.[1]

As was its right under the Federal Arbitration Act (the “FAA”), Credit One filed an interlocutory appeal of the bankruptcy court’s denial of its motion to compel arbitration in June 2015.  The District Court for the Southern District of New York affirmed the bankruptcy court’s decision in June 2016.  Credit One then  appealed to the Second Circuit.

Reviewing the bankruptcy court’s decision under an abuse of discretion standard, the Second Circuit initially stated that although the FAA establishes a federal policy favoring arbitration, “[t]his preference . . . is not absolute[]” and its mandates may be overridden by a contrary congressional command.  Therefore, given the presence of the Bankruptcy Code’s discharge provisions, the ultimate issue was whether Congress intended those provisions to preclude enforcement of arbitration agreements under the FAA.

Keenly aware that the discharge is the foundation upon which the Bankruptcy Code is built and of Congressional intent to afford the “honest but unfortunate debtors an opportunity to reorder their financial affairs and get a fresh start,” the Second Circuit recognized that this would only be possible if discharge injunctions were fully heeded by creditors.  Violations of the discharge order “damage the foundation on which the debtor’s fresh start is built.”[2]  Not surprisingly, the court determined that requiring arbitration to enforce the bankruptcy court’s discharge injunction would seriously jeopardize the effectiveness of the discharge, because: (i) the discharge injunction is integral to the bankruptcy court’s ability to provide debtors with the fresh start at the very foundation of the Bankruptcy Code; (ii) the Debtor’s claim against Credit One related to an ongoing bankruptcy matter requiring bankruptcy court supervision; and (iii) the equitable powers of the bankruptcy court to enforce its own injunctions are central to the structure of the Bankruptcy Code.[3]

Moreover, because the power to enforce a bankruptcy discharge injunction complements the duty to obey the injunction, only the bankruptcy court would have the power to enforce the injunction under section 524 of the Bankruptcy Code.  Arbitration of the claim, the Second Circuit found, would present an inherent conflict with the Bankruptcy Code.

Because the Second Circuit determined that there was an inherent conflict between arbitration of the Debtor’s claim against Credit One and the Bankruptcy Code, the court concluded that the bankruptcy court “properly considered the conflicting policies in accordance with the law” and acted within its discretion to deny Credit One’s motion to compel arbitration.[4]

 

[1] Id. at 385.

[2] Id.

[3] Id. at 389-90 (internal citation omitted).

[4] Id. at 392 (internal citation omitted).