Bankr. E.D.N.C.- In re JSmith- Arbitration in Bankruptcy

Summary:

In this post-confirmation Chapter 11 dispute, the Bankruptcy Court for the Eastern District of North Carolina granted a motion by Fourth Elm Construction, LLC to compel arbitration and stay the adversary proceeding brought by the debtor, JSmith Civil, LLC. The adversary complaint asserted state-law claims for breach of contract and quantum meruit arising from a terminated subcontracting agreement. Fourth Elm relied on the contract’s Article 24 arbitration clause, invoking Section 3 of the Federal Arbitration Act (FAA).

JSmith Civil resisted arbitration, arguing first that the contract’s damage-limiting clause (Article 22) rendered the arbitration agreement void under Lischwe v. Clearone Advantage (In re Erwin), a case involving impermissible waivers of claims under North Carolina’s UDTPA. Judge Callaway distinguished Erwin, finding that no such statutory or fraud claims were actually alleged—only garden-variety breach and quasi-contract. JSmith’s second argument—that compelling arbitration would impair bankruptcy case administration—also failed, as the claims did not arise under the Bankruptcy Code and were not core proceedings.

The Court compelled arbitration but explicitly warned Fourth Elm that it could not file any counterclaims or assert a §553 setoff in the arbitration without first obtaining stay relief. Fourth Elm, through counsel, disavowed any intent to seek such relief, and the Court noted it would enforce that commitment under pain of sanctions.

Commentary:

This decision highlights the entrenched enforceability of arbitration clauses in bankruptcy, particularly when the debtor brings state-law claims post-confirmation and the dispute lacks any core bankruptcy component. Judge Callaway’s ruling reflects a straightforward application of the Federal Arbitration Act (FAA), even in the Chapter 11 context, and follows the familiar maxim that “[a]ny doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration.”

But what about in the consumer Chapter 13 context, where debtors frequently interact with contracts that contain arbitration clauses—credit card agreements, auto loans, rent-to-own contracts, and debt relief services? Unlike in business cases, a unique opportunity may exist for consumer debtors to proactively address arbitration in their Chapter 13 plan.

Specifically, a nonstandard Chapter 13 plan provision may be used to expressly reject or eliminate arbitration clauses in executory contracts or to declare that the debtor does not consent to arbitration of any disputes related to a given agreement. Because Chapter 13 plans function as binding contracts between the debtor, creditors, and the trustee upon confirmation, and because 11 U.S.C. § 1322(b)(2), (b)(6), and (b)(11) permit substantial flexibility in how a debtor restructures obligations and provides for treatment of claims, courts may allow debtors to include such provisions.

While not all courts will enforce such plan terms (and some creditors may object), there is a growing recognition that plan provisions may alter dispute resolution rights where the arbitration clause is part of a contract the debtor is assuming, modifying, or curing under the plan. In this way, the plan operates as both shield and sword, binding creditors who fail to object and thus creating a limited window to neutralize otherwise enforceable arbitration rights.

Moreover, if a creditor fails to timely object to confirmation, courts may hold it bound by the plan under §1327(a), and therefore estopped from later enforcing arbitration provisions in an attempt to derail claims administration or fair debt relief remedies under the Code.

Practice Tip for Consumer Debtors:

Practitioners should consider whether their standard Chapter 13 plan templates adequately address arbitration—and if not, propose a nonstandard provision rejecting arbitration clauses in applicable agreements. For example:

“Any arbitration provision in any prepetition agreement between the Debtor and any creditor is expressly rejected and shall be of no force or effect with respect to any dispute arising during the pendency of this bankruptcy case or relating to any claim provided for under this Plan."

This may be particularly valuable where the debtor has viable claims under state consumer protection laws (e.g., UDTPA, FDCPA) or disputes related to vehicle repossession or predatory lending. It also reduces the risk of post-confirmation motion practice or removed arbitrations that sap the estate’s resources.