The U.S. Court of Appeals for the Fifth Circuit recently affirmed a bankruptcy court order denying a bank’s motion to compel arbitration, holding that when a debtor seeks to enforce a discharge injunction, a bankruptcy court may decline to compel arbitration because it implicates a bankruptcy court’s ability to enforce its own orders.

A copy of the opinion in Henry v. Educational Financial Service is available at: Link to Opinion.

A borrower took out a student loan and subsequently filed for Chapter 13 bankruptcy. The bankruptcy court confirmed the plan. The borrower made the payments to her creditors, including her student loan owner (“bank”), and received a discharge.

The borrower initiated an adversary action in bankruptcy court alleging that the discharge included her student loan. The bank disagreed and moved to compel arbitration.

The loan agreement contained the following arbitration provision:

“Any controversy or claim arising out of or related to this Note, or an alleged breach of this Note, shall be settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association. Judgment upon the arbitration award may be entered in any court having jurisdiction.”

The bankruptcy court denied the motion to compel arbitration, and certified its order for interlocutory review. This appeal followed.

The Fifth Circuit began its analysis by noting that under the Federal Arbitration Act courts must enforce “covered arbitration agreements according to their terms.”

However, “a contrary congressional command” may override this mandate. Shearson v. McMahon, 482 U.S. 220, 226 (1987). A party arguing that it is not possible to reconcile the two statutes, “and that one displaces the other, bears the heavy burden of showing a clearly expressed congressional intention that such a result should follow.” Epic Systems Corp. v. Lewis, 138 S. Ct. 1612, 1624 (2018).

The Fifth Circuit observed that it has applied McMahon to hold “that bankruptcy courts may decline to enforce arbitration clauses when two requirements are met.” To do so, “the proceeding must adjudicate statutory rights conferred by the Bankruptcy Code and not the debtor’s prepetition legal or equitable rights.” In re Nat’l Gypsum Co., 118 F.3d 1059, 1069 (5th Cir. 1997).

Further, a bankruptcy court may only decline to enforce arbitration agreements when compelling arbitration “would conflict with the purposes of the Bankruptcy Code.” The Bankruptcy Code’s purposes include “centralized resolution of purely bankruptcy issues, the need to protect creditors and reorganizing debtors from piecemeal litigation, and the undisputed power of a bankruptcy court to enforce its own orders.”

Thus, in National Gypsum, the Fifth Circuit “held that bankruptcy courts need not enforce agreements to arbitrate whether a creditor’s efforts to collect a debt violated a discharge order.” 11 U.S.C. § 524(a). This is because an action to enforce a debtor’s right to be free from collections efforts on a discharged debt implicates a bankruptcy court’s ability to enforce its own orders. It “would be inconsistent with the Bankruptcy Code” to require arbitration in this situation.

The bank argued that the Fifth Circuit’s holding in National Gypsum — that bankruptcy courts may refuse to compel arbitration when a debtor seeks to enforce a discharge injunction — is no longer good law after the Supreme Court’s decision in Epic Systems. The Fifth Circuit rejected this argument finding that Epic Systems actually supports National Gypsum’s “doctrinal foundation, i.e., McMahon, remains sound.”

Initially, the Court noted, Epic Systems cites McMahon for support. Further, although there is a difference of tone, McMahon and Epic Systems apply a nearly identical test to determine if a statute overrides the FAA’s requirement “to enforce arbitration agreements according to their terms.”

The Fifth Circuit reasoned that the only difference is that Epic Systems indicates that the party arguing that two statutes cannot be harmonized bears the heavy burden to show a “clearly expressed” congressional intention mandating this result whereas McMahon requires the moving party to show a “deducible” congressional intent. This slight difference in emphasis “is not an unequivocal direction to overrule our precedent.”

Moreover, the Court continued, even if the legislative history discussion in Epic Systems partially overrules McMahon to require a “clearly expressed” congressional intent instead of a “deducible” congressional intent, that would not affect National Gypsum’s validity because National Gypsum did not rely on congressional intent. Instead, National Gypsum looked to the Bankruptcy Code’s purpose, which “remains a valid tool for determining whether a given statute displaces the FAA.” Consequently, the Fifth Circuit determined “that National Gypsum’s application of McMahon remains good law following Epic Systems.”

Therefore, the Fifth Circuit affirmed the bankruptcy court’s order denying the bank’s motion to compel arbitration.