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Do Legal Arbitration Clauses Hold Up in Bankruptcy Court?

Wednesday, May, 23, 2012

On major question that businesses and individuals have when filing bankruptcy is if legal arbitration clauses still apply in bankruptcy court. While by and large, bankruptcy judges will drop all references to arbitration when seeing a bankruptcy case, it is ultimately their choice, and it’s entirely possible that the failing business or individual may still have to own up to the contract arbitration clauses.

Financial Arbitration Clauses in Bankruptcy Court


The common point where arbitration can usually be struck down is in “core issues,” but it tends to stick in “non-core issues.” That is, the issues that are not resolvable outside of bankruptcy court can be kept under the umbrella of the bankruptcy, whereas the issues that are not central to the problem of bankruptcy are outside the reach of the bankruptcy.


There are also forms of debt that cannot be admitted to bankruptcy anyway. Financial issues such as defaulted student loans, for example, are legally not admissible to bankruptcy court. In this case, arbitration or litigation are the more appropriate ways to resolve these debts.

How This Relates to the Federal Arbitration Act


The Federal Arbitration Act would seem to be absolute in the case of arbitration clauses, but it has only a limited reach when it comes to bankruptcy according to the 9th Circuit Court of Appeals. Normally, the FAA loses its authority in a given case when it comes into conflict with congressional intent. Bankruptcy Code is not under that category.


How the Bankruptcy Code can trump the FAA is in core issues of a bankruptcy case where the FAA and the Bankruptcy Code come into conflict. By and large, the decision to determine whether or not the FAA and the BC are in conflict in any given case is up to the judge.