Project Restore LLC

U.S. Bankruptcy Judge Rea

Dated: 10/7/2022

IN THE UNITED STATES BANKRUPTCY COURT

MIDDLE DISTRICT OF TENNESSEE

IN RE: )

Project Restore, LLC, Case No. 3:22-bk-01897

) Chapter 7

Debtor. ) Judge Randal S. Mashburn

ORDER AND MEMORANDUM OPINION DENYING MOTION TO DISMISS

INVOLUNTARY PETITION OR, IN THE ALTERNATIVE,

TO ABSTAIN BASED ON ARBITRATION AGREEMENTS,

WITHOUT PREJUDICE TO OTHER ARGUMENTS

The putative debtor in this involuntary bankruptcy, Project Restore, LLC

(“Debtor”), has sought dismissal of the case based on the impact of arbitration clauses

in contracts signed by the three petitioning creditors. Alternatively, Debtor has

requested that the Court abstain from hearing the involuntary bankruptcy case in

deference to allowing the disputed claims of the petitioning creditors to first be

resolved by arbitration.

Although there generally is a strong preference for enforcing arbitration

agreements even in some bankruptcy matters, Debtor’s position of requiring

arbitration as a prerequisite to an involuntary petition would unduly thwart the

rights of petitioning creditors and create a result at odds with the Bankruptcy Code.

The critical initial issue in any involuntary bankruptcy is whether petitioning

creditors’ claims are subject to a bona fide dispute — not the actual allowance,

disallowance, or liquidation of those claims. Determination of the validity of the

petition and whether to enter an order for relief are matters over which this Court

has exclusive jurisdiction and not something that can be punted to an arbitrator

simply because the parties have an agreement to arbitrate their contract disputes.

BACKGROUND

Involuntary Petition and Response

On June 16, 2022, Christopher M. Todd (“Todd”), Brian and Amy Maas

(together as “Maas”), and R. Kenneth Barnes (“Barnes”) (collectively, “Petitioning

Creditors”), filed an involuntary petition against Debtor under Chapter 7 of the

Bankruptcy Code. Each Petitioning Creditor claims to be owed an amount in excess

of the statutory minimum of $18,600 relating to defaulted construction contracts.

Debtor responded with a Motion to Dismiss, disputing any liability as well as the

amount of the alleged debts, and requesting the Court dismiss the petition or abstain

in favor of arbitration.

Arbitration Provisions

The construction contracts between Debtor and each of the Petitioning

Creditors contain arbitration provisions. The provision from the Todd and Barnes

contracts states:

Should any dispute arise relative to the performance of this contract that the

parties cannot satisfactorily resolve, then the parties agree that the dispute

shall be resolved by binding arbitration conducted by the American Arbitration

Association. The party demanding arbitration shall give written notice to the

opposite party and the American Arbitration Association promptly after the

matter in dispute arises. In no event, however, shall a written notice of demand

for arbitration be given after the date on which a legal action concerning the

matter in dispute would be barred by the appropriate statute of limitations.

The provision from the Maas contract is virtually identical but selects a different

arbitration service than the one identified in the other two contracts. It states:

Should any dispute arise relative to the performance of this contract that the

parties cannot satisfactorily resolve, then the parties agree that the dispute

shall be resolved by binding arbitration conducted by a single arbitrator,

through JAMS. The party demanding arbitration shall give written notice to

the opposite party and the JAMS promptly after the matter in dispute arises.

In no event, however, shall a written notice of demand for arbitration be given

after the date on which legal action concerning the matter in dispute would be

barred by the appropriate statute of limitations.

Procedural Status

The parties agreed to bifurcate the hearing on Debtor’s motion to dismiss the

involuntary petition. By consent, they set up a briefing and hearing schedule

designed to carve out the legal issue on arbitration before moving forward with an

evidentiary hearing on the factual questions that arise in an involuntary bankruptcy,

such as whether the Petitioning Creditors’ claims are subject to bona fide dispute and

whether the Debtor is generally paying its debts as they become due.

The Court conducted a hearing on October 4, 2022, limited to the narrow issue

of whether the stipulated existence of standard arbitration clauses in the pertinent

contracts would mandate that the claims first be decided by an arbitrator before the

involuntary bankruptcy could proceed. Alternatively, the Court was asked to

determine whether the role of the arbitration clauses created a sufficient justification

for the Court to exercise its discretion to abstain from the matter in deference to

arbitration. For purposes of the hearing on October 4, 2022, it was stipulated that

the contracts containing the arbitration provisions are authentic and admissible into

evidence.

The agreed upon process was for the Court first to decide the arbitration issue

and then, only if it declined to dismiss the case or abstain, proceed with an evidentiary

hearing scheduled for November 3, 2022.

DISCUSSION

The Bona Fide Dispute Factor in Involuntary Bankruptcies

In deciding the efficacy of an involuntary bankruptcy, the Court must

determine, among other things, whether each petitioner has a claim for at least

$18,600 that is “not contingent as to liability or the subject of a bona fide dispute as

to liability or amount.” 11 U.S.C. § 303(b)(1). A bona fide dispute exists “[i]f there is

either a genuine issue of material fact that bears upon the debtor's liability, or a

meritorious contention as to the application of law to undisputed facts . . . .” Riverview

Trenton Railroad Co. v. DCS, Ltd. (In re DSC, Ltd.), 486 F.3d 940, 944–45 (6th Cir.

2007) (quoting Booher Enterprises v. Eastown Auto Co. (In re Eastown Auto Co.), 215

B.R. 960, 965 (B.A.P. 6th Cir. 1998) (quoting In re Lough, 57 B.R. 993, 997 (Bankr.

E.D. Mich. 1986))). The Sixth Circuit has stated that, “[i]mportantly, the court need

not resolve any genuine issues of fact or law; it only must determine that such issues

exist.” In re DSC, Ltd., 486 F.3d at 944–45.

Even though the Court will not actually resolve any genuinely disputed issue

in connection with ruling on the involuntary petition, it is Debtor’s position that the

Court should dismiss the case or abstain from ruling on the petition because the Court

cannot avoid deciding what Debtor argues to be non-core, arbitrable issues in the

process of ruling on the petition. This is the fatal flaw in Debtor’s reasoning. While

it is true that it is impossible to avoid hearing evidence about the claims in

determining whether they are subject to a bona fide dispute, it is not necessary to

liquidate the claims or decide the ultimate allowance or disallowance of any claim.

One aspect of Debtor’s argument relates to its view of the interpretation of

section 303(b)(1). Debtor contends that the reference to “bona fide dispute as to

liability or amount” means that any dispute whatsoever as to the precise amount

renders a petitioning creditor ineligible. Under Debtor’s approach, a bona fide

dispute over whether a debt is $50,000 or $50,001 keeps the creditor from being an

eligible petitioner. Petitioning Creditors take the position that the pertinent question

is whether there is no bona fide dispute as to an amount of at least $18,600 and it is

irrelevant whether there might be a legitimate debate about the exact dollar figure

above that threshold amount.

Although the Court has not ruled on that interpretation question, it has

indicated to the parties that it leans toward the view that a creditor can be a valid

petitioner in an involuntary case as long as there is no bona fide dispute as to a

minimum debt of $18,600. In doing so, it has generally accepted the rationale

articulated in In re Miller, 489 B.R. 74, 81-83 (Bankr. E.D. Tenn. 2013).

Debtor has argued that, given the Court’s view on how to interpret the statute

regarding disputes over amounts, it would be impossible for the Court to enter an

order for relief without deciding that there is a valid claim in a minimum amount of

$18,600 per Petitioning Creditor. Thus, Debtor argues, the Court would have to

decide the merits of various defenses and even possible counterclaims that might be

asserted by Debtor in making a ruling. In short, under Debtor’s analysis, while the

Court may not necessarily fully liquidate a claim in the involuntary bankruptcy

decision process, it would effectively destroy any ability of Debtor to take advantage

of the parties’ agreed upon arbitration mechanism for resolving disputes about their

contracts.

It is true that this Court would be required to hear some evidence relating to

both liability and claim amount to rule on the involuntary petition. But it is not

accurate to say that any ruling would be dispositive of the ultimate claim

determination or preclude later arbitration on the claims. A similar scenario plays

out frequently in the summary judgment context. A court might deny summary

judgment because of a genuine issue as to material fact and later rule in favor of the

same movant regarding the merits of the lawsuit. Likewise, a ruling on whether

there is a bona fide dispute regarding a claim for the limited purpose of whether to

enter an order for relief does not necessarily have any preclusive effect on the

resolution of a specific claim. Indeed, it is possible to envision a scenario where an

order for relief is entered but then the claim determination matter is still sent to an

arbitrator who should have a clean slate in determining both liability and amount.

Arbitration and Its Role in Bankruptcy

The Federal Arbitration Act (“FAA”) provides, in relevant part, that an

arbitration agreement “shall be valid, irrevocable, and enforceable, save upon such

grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. §§

2–3. “The [FAA] … provides that a court must stay its proceedings if it is satisfied

that an issue before it is arbitrable under the agreement, § 3; and it authorizes a

federal district court to issue an order compelling arbitration if there has been a

‘failure, neglect, or refusal’ to comply with the arbitration agreement, § 4.”

Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220, 226 (1987). “The [FAA] thus

establishes a ‘federal policy favoring arbitration,’ requiring that ‘[courts] rigorously

enforce agreements to arbitrate.’” Id. (citations omitted).

“At the same time, however, ‘Congress intended to grant comprehensive

jurisdiction to bankruptcy courts so that they might deal efficiently and expeditiously

with all matters connected with the bankruptcy estate.’” Moses v. CashCall, Inc., 781

F.3d 63, 71 (4th Cir. 2015) (quoting Celotex Corp. v. Edwards, 514 U.S. 300, 308

(1995) (additional internal quotation marks and citation omitted)). Disputes

involving the Bankruptcy Code and the FAA often “present[ ] a conflict of near polar

extremes: bankruptcy policy exerts an inexorable pull towards centralization while

arbitration policy advocates a decentralized approach towards dispute resolution.”

United States Lines, Inc. v. Am. Steamship Owners Mutual Prot. and Indem. Ass’n,

Inc. (In re United States Lines, Inc.), 197 F.3d 631, 640 (2nd Cir. 1999) (citation

omitted).

Notwithstanding the FAA’s enforcement requirements, “[l]ike any statutory

directive, the [FAA]'s mandate may be overridden by a contrary congressional

command.” McMahon, 482 U.S. at 226. When there is a tension between the FAA

and another federal statute, courts must determine whether there is a contrary

congressional command which may be deduced from (i) the text of the statute, (ii) the

statute's legislative history, or (iii) an inherent conflict between arbitration and the

statute's underlying purposes. Moses, 781 F.3d at 71 (citing McMahon, 482 U.S. at

227 (additional citation omitted)). The party seeking to prevent enforcement of the

arbitration agreement bears the burden. Id.

Although the Sixth Circuit has not weighed in on whether Congress intended

the Bankruptcy Code as a whole to conflict with the FAA under the McMahon

standard, “other circuit courts of appeal have overwhelmingly concluded that neither

the text nor the legislative history of the Bankruptcy Code reflects a congressional

intent to preclude enforcement of agreements to arbitrate in the context of a

bankruptcy case.” In re Patriot Solar Grp., LLC, 569 B.R. 451, 456–59 (Bankr. W.D.

Mich. 2017) (citing cases from the Second, Third, Fourth, Ninth, and Eleventh

Circuits).

In deciding whether an inherent conflict exists, courts typically first determine

whether the dispute that would be subject to arbitration is a core or non-core

proceeding pursuant to 28 U.S.C. § 157(b). In re Patriot Solar Grp., LLC, 569 B.R.

451, 457 (Bankr. W.D. Mich. 2017). If non-core, “a court is generally without

discretion to preclude the enforcement of the arbitration provision and the inquiry

ends.” Id. at 457-58. If core, “the court moves to the next step in the analysis—

whether enforcement of such agreement would inherently conflict with the

underlying purposes of the Bankruptcy Code.” Id. at 458.

Request to Arbitrate in the Context of the Involuntary Petition

Starting with the first question of core or non-core, the determination of the

validity of an involuntary petition is a core proceeding under 28 U.S.C. § 157(b)(2).

See In re Virginia Broadband, LLC, 498 B.R. 90, 93 (Bankr. W.D. Va. 2013) (referring

to a voluntary petition); In re Loe, No. 07-12045-BKC-RBR, 2007 WL 997581, at *1

(Bankr. S.D. Fla. Mar. 29, 2007) (“The determination of whether an order for relief

should be granted in an involuntary case is a core proceeding.” (citing 28 U.S.C. §

157(b)(2)(A) and 11 U.S.C. § 303(h))); In re Fisher Island Invs., Inc., No. 11-17047-

AJC, 2014 WL 1343269, at *3 (Bankr. S.D. Fla. Mar. 28, 2014) (“[T]he determination

of the validity of the alleged debts underlying [involuntary] petitions is a core

proceeding,” since the “validity of those interests ‘will determine[e] whether an order

of relief should be granted.’” (citing In re Loe, 2007 WL 997581, at *1)). But that does

not end the court’s inquiry.

The court must next consider whether there is an inherent conflict between

arbitration and the underlying purposes of the Bankruptcy Code. “[C]ases finding a

McMahon conflict concluded that the claims at the center of the dispute were directly

related to the Bankruptcy Code.” Kiskaden v. LVNV Funding, LLC (In re Kiskaden),

571 B.R. 226, 233 (Bankr. E.D. Ky. 2017) (citing cases from Fourth, Fifth and Ninth

circuit courts of appeal). As it relates to the review of an involuntary petition, it is

clear that there is an inherent conflict between the underlying purposes of the

Bankruptcy Code and arbitration, at least to the extent that arbitration would

preclude a creditor’s right to pursue an involuntary bankruptcy.

First, through referral from district courts pursuant to 28 U.S.C. § 157,

bankruptcy courts have exclusive jurisdiction over bankruptcy cases. See 28 U.S.C.

§ 1334(a) (With exceptions not applicable to the filing of a petition, “the district courts

shall have original and exclusive jurisdiction of all cases under title 11.”); see also In

re Garnett, 303 B.R. 274, 277 (E.D.N.Y. 2003) (“Thus the filing of the petition

commences the case, which has the effect under 28 U.S.C. § 1334(d) of vesting

exclusive jurisdiction over the property of the debtor and of the estate in the district

court, and hence the bankruptcy court, in which the petition is filed.”).

Second, the bankruptcy court is the sole court with which a petition, whether

voluntary or involuntary, may be filed to commence a bankruptcy proceeding. See 11

U.S.C. § 301, 303. A bankruptcy case could not be commenced by filing a petition for

bankruptcy with an arbitrator.

Further, in reviewing a contested involuntary petition, the bankruptcy court

must determine whether the petition satisfies the requirements of section 303 of the

Bankruptcy Code and related Bankruptcy Rules, and then determine whether an

order for relief should be entered, see § 303(h), something that happens

simultaneously with the filing of a voluntary petition, see § 301(b). If the court were

to refer a ruling on the validity of the involuntary petition and the decision as to

whether to enter an order for relief to an arbitrator, the arbitrator could not enter

any such order. The court would be delegating to an arbitrator a question over which

Congress intended that bankruptcy courts have exclusive jurisdiction.

By requiring that bankruptcy cases be commenced by the filing of a petition in

a bankruptcy court, Congress clearly intended bankruptcy courts to have the

exclusive jurisdiction to evaluate and rule on the validity of such a petition. On these

specific matters – whether an involuntary petition is valid based on the eligibility of

Petitioning Creditors and whether an order for relief should be entered – there is an

inherent conflict between arbitration and the Bankruptcy Code.

Debtor seeks to ignore the clear distinction between a contested matter

involving the validity of an involuntary petition, which does not require claim

determination, and litigation over a claim. It would have the Court blend the two

matters together and find that this Court should not decide the first issue because it

is inextricably intertwined with the second issue that is subject to the arbitration

provision.

Admittedly, this Court cannot decide if the petition is valid in terms of having

qualified petitioners without some evidence about whether there is a bona fide

dispute about Petitioning Creditors’ claims, just as it must hear evidence about

whether Debtor is generally paying debts as they become due. See 11 U.S.C. § 303.

But at this stage the Court does not have to make ultimate determinations about

claims any more than it must make ultimate findings about the likelihood of creditors

to be paid from the Debtor’s assets.

The Bankruptcy Code does not require that a petitioning creditor’s claim be

liquidated for it to support an involuntary petition; it just need not be shown by the

debtor to be subject to a bona fide dispute. In re Miller, 489 B.R. at 82. If the Court

accepted Debtor’s approach on arbitration, the practical effect would lead to

inconsistent treatment of petitioning creditors with and without arbitration

agreements and would mean that any creditor who signs a contract with an

arbitration provision has given up a basic right under the Bankruptcy Code. A

creditor without an arbitration clause has the right to be a petitioning creditor

without having a fully adjudicated claim. However, under Debtor’s approach, a

petitioning creditor with a disputed claim subject to an arbitration clause would have

to have to have an arbitration award in order to qualify as a petitioning creditor,

regardless of whether the dispute was bona fide.

Additionally, if the parties’ positions were reversed, it is hard to imagine

anyone seriously arguing that Debtor could be totally deprived of the right to file a

voluntary bankruptcy because its three primary creditors held disputed, arbitrable

claims. From the Court’s standpoint, a creditor cannot contract away its right as a

petitioner in an involuntary case any more than a debtor can contract away its right

to file a voluntary bankruptcy.

Debtor’s counsel stated at oral argument that its request is not about forfeiture

of any right of the creditors but merely enforcement of their agreements to arbitrate.

However, creditors cannot prospectively delegate rights under the Bankruptcy Code

to an arbitrator, so the effect of a dismissal or abstention at this stage would, indeed,

be to deprive the Petitioning Creditors of a right under section 303 of the Bankruptcy

Code without the Court ever hearing any evidence about the normal factors involved

in an involuntary bankruptcy case.

Debtor has also asserted that the involuntary bankruptcy is merely a collection

leverage tool being utilized by three disgruntled customers. That allegation could

potentially go to the issue of whether the petition was filed in good faith. It does not

provide a basis for requiring arbitration of the most fundamental issues involved in

an involuntary petition.

One final point of emphasis should be made. This Court is making no

determination at this time regarding whether arbitration should be used at some

point in resolving disputes over the claims in the event an order for relief is entered.

There are numerous variables that would come into play in making that

determination – some requiring further legal analysis and some based more on

practical considerations. The Court will consider those issues if and when they arise.

For purposes of this ruling, the Court is simply holding that it is this Court, not an

arbitrator, that must decide whether the involuntary petition is valid as it relates to

the eligibility of Petitioning Creditors and whether an order for relief should be

entered. This Court will not refrain from carrying out that obligation based on the

existence of an arbitration agreement.

Debtor’s motion is denied to the extent it seeks dismissal or abstention based

on the arbitration agreements. The denial is without prejudice to any other argument

raised in the motion to dismiss.

IT IS SO ORDERED.