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An Eastern District of Pennsylvania federal judge has ruled that bankruptcy courts may refuse to compel arbitration in a case where the outcome of arbitration could adversely affect administration of the bankrupt estate. In such cases, the bankruptcy court’s power to decide bankruptcy issues trumps the statutory preference for arbitration expressed in the Federal Arbitration Act, District Judge Mary McLaughlin concluded last week in Matter of Mintze. Ethel M. Mintze, 58, a North Philadelphia homemaker, challenged a $44,700 mortgage issue by American General Consumer Discount Co. in her bankruptcy petition. Mintze’s lawyer, Irv Ackelsberg of Community Legal Services, argued that the mortgage was “abusive [and] should be subject to legal challenge.” When Mintze was looking to finance a $3,800 heater installation in 2000, she was referred to American General, according to the opinion. Mintze alleged that the financing company required she borrow $44,700 as a condition of financing the heating project — a loan that would refinance her current mortgage and consolidate her credit card debt at a 13.44 percent annual percentage rate, according to the opinion. But there was an arbitration provision of the contract, and when Mintze filed to undo the loan under the federal Truth In Lending Act, alleging predatory lending, American General asked to remove the case from bankruptcy court and moved to compel arbitration, McLaughlin wrote. The bankruptcy court refused to dismiss the case and did not enforce the arbitration provision. It noted that, if the arbitration provision of the contract were enforced, it could adversely affect important purposes of the Bankruptcy Code. Those purposes include the preservation of an estate’s assets, protection of all creditors’ interests and the restructuring of the debtor-creditor relationship — all of which “are at stake in situations like this case,” McLaughlin wrote, explaining the Bankruptcy Court’s opinion. In the opinion, McLaughlin examined two 3rd U.S. Circuit Court of Appeals decisions, Zimmerman v. Continental Airlines in 1983 and Hays & Co. v. Merrill Lynch in 1989. In both decisions, courts balanced the preference for arbitration in the Federal Arbitration Act with the language of the Bankruptcy Code, which grants bankruptcy court judges jurisdiction over bankruptcy matters (including the power to refuse to compel arbitration). The two opinions also distinguished between proceedings involving “core” issues under the Bankruptcy Code, which may be resolved only by the bankruptcy court, and “non-core” issues. The Zimmerman court held that “arbitration is generally not on the same level of importance as bankruptcy, because bankruptcy proceedings are essential ‘to the smooth functioning of the nation’s commercial activities,’” McLaughlin wrote. A bankruptcy court must exercise its “sound discretion” in deciding whether the enforcement of the arbitration clause would adversely affect the purposes of the Bankruptcy Code, the Zimmerman court explained. Lawyers for American General had argued that the holding in Hays requires the court to dismiss Mintze’s petition. In Hays, the 3rd Circuit reversed a district court’s decision not to compel arbitration because the conflict between the purposes of the FAA and the Bankruptcy Code was insufficient to deny arbitration in a non-core proceeding. This holding “clarified that the bankruptcy courts must enforce arbitration clauses in non-core proceedings,” McLaughlin wrote. She said American General’s interpretation of Hays was incorrect because the Mintze case involves a core proceeding, a fact recognized by both parties, and Hays applies to non-core proceedings. The Hays court also said bankruptcy courts have discretion to not enforce arbitration provisions even in non-core proceedings if the Bankruptcy Code conflicts with the enforcement of an arbitration clause, McLaughlin noted. Interpreting Zimmerman and Hays together, McLaughlin concluded that the Bankruptcy Code gives bankruptcy courts discretion to refuse to compel arbitration, but that the discretion is “severely limited when the proceeding is non-core.” The 2nd Circuit, in a 1999 decision captioned U.S. Lines v. American S.S. Owners Mutual Protection and Indemnity Association, indicated the criteria for the court’s exercise of discretion in core proceedings, McLaughlin said. In U.S. Lines, insurance companies were seeking arbitration to decide the issue of insurance coverage for a client. The district court had refused to enforce an arbitration provision because the purposes of the Bankruptcy Code would have been adversely affected by the arbitration. The 2nd Circuit, reviewing Hays, ruled that a bankruptcy court could properly deny enforcement if the arbitration would significantly and adversely affect the administration of the bankruptcy case. McLaughlin adopted the U.S. Lines standard. McLaughlin observed that Mintze’s bankruptcy petition would be seriously affected if her challenge to the American General loan proves to be valid. Under the original refinanced mortgage Mintze had with American General, she was required to pay $551 a month for 15 years. Because she cannot afford to pay the monthly $551, she is instead paying $275 a month to the financing company and $10 a month to a trustee for her unsecured creditors, according to the opinion. If Mintze’s efforts to rescind the loan are successful, she would owe less money each month, and the $285 she now pays could be divided up among her remaining creditors, McLaughlin explained. “The determination of the validity of the rescission would affect the rights of other creditors,” as well as affect the success of Mintze’s financial reorganization plan and whether she is able to keep her home, McLaughlin wrote. Thus, the bankruptcy court was justified in deciding it was the best forum to resolve the matter, she said. “The stakes here are huge — we’re talking about someone’s house,” Ackelsberg said. “This is one of the more egregious examples of this very frightening trend in the law whereby companies are able to include mandatory arbitration provisions in consumer contracts.” Ackelsberg said he is disappointed with courts that have enforced arbitration clauses that deny consumers the right to resolve a contract dispute in court. “For those of us trying to get justice for these people, we have to come up with a way to keep these people in court,” Ackelsberg said. “This is one of the ways it might work — filing the case within a Chapter 13 filing.” Ackelsberg said that he doubted his client, who has poor vision because of her diabetes, was able to easily read the fine print on her mortgage contract that detailed the arbitration provision. Hank Reichner of Reed Smith, who represented American General, declined to comment Monday.

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