Court Holds Plan Does Not Trump Arbitration Clause In Parties’ Agreement

by Cadwalader, Wickersham & Taft LLP

Pursuant to its prepackaged plan of reorganization, which the bankruptcy court confirmed on December 8, 2009, CIT Group, Inc. rejected a tax agreement it had entered into with its former indirect parent company, Tyco International Ltd.  Tyco filed a proof of claim asserting rejection damages and demanded arbitration proceedings, relying on an arbitration clause in the tax agreement.  CIT then commenced an adversary proceeding, seeking to stay arbitration pending the bankruptcy court’s decision on whether to subordinate Tyco’s claim under section 510(b) of the Bankruptcy Code, as neither party disputed that if the court subordinated Tyco’s claim Tyco would receive no distribution under CIT’s plan of reorganization.  The bankruptcy court granted summary judgment to Tyco on the subordination issue, and CIT appealed directly to the Second Circuit as permitted under 28 U.S.C. § 158(d)(2)(A)(i) and (iii), circumventing an appeal to the district court.  Tyco responded with a motion to compel arbitration of its claim.  The bankruptcy court had to consider whether Tyco’s claim should be arbitrated, and if it should, whether to stay arbitration pending the Second Circuit’s decision.

CIT conceded that the arbitration clause in the tax agreement covered Tyco’s claim and also acknowledged that CIT’s rejection of the tax agreement did not constitute rejection of the arbitration clause.  CIT argued, however, that Tyco’s claim should not be arbitrated because of a clause in CIT’s plan of reorganization that stated that the bankruptcy court retained “exclusive jurisdiction . . . to the fullest extent permitted by law” to “determine all matters with respect to the assumption or rejection of any executory contract.”  Tyco countered by pointing to a contradictory clause in CIT’s plan that stated that the resolution of all claims must be determined “in the manner in which such claim would have been determined, resolved or adjudicated if the chapter 11 cases had not been commenced.”

The court determined that, even if the plan provision granting the bankruptcy court exclusive jurisdiction controlled, in light of the “strong federal policy favoring arbitration agreements,” it would refuse to compel arbitration only if arbitration would “necessarily jeopardize” the goals of the Bankruptcy Code.  CIT argued that permitting arbitration would “necessarily jeopardize” the objectives of the Bankruptcy Code because Tyco’s claim was “uniquely a creature of the Bankruptcy Code.”  The court rejected CIT’s argument, however, noting that unlike the issue of subordination, the determination of Tyco’s damages would not require consideration of bankruptcy law issues.  Furthermore, liquidation of Tyco’s claim would not delay consummation of CIT’s plan because the plan became effective several years ago.

Having decided that Tyco’s claim should be arbitrated, the court turned to the issue of whether to enjoin the arbitration pending a final decision on Tyco’s appeal to the Second Circuit on the subordination question.  The court noted that a stay pending appeal will be entered only when the movant demonstrates “(1) that irreparable harm is likely absent an injunction and (2) either (a) a likelihood of success on the merits or (b) sufficiently serious questions going to the merits of the case to make it a fair ground for litigation plus a balance of hardships tipping decidedly in [its] favor.”  CIT asserted that it would suffer irreparable harm because it would waste time and money arbitrating a claim that would have no value if CIT won on the subordination issue.  Although the court rejected this argument, noting that the incurrence of litigation costs does not ordinarily constitute irreparable harm, it nevertheless stayed the matter for a sufficient period to allow the Second Circuit to decide whether to grant CIT’s further stay motion.

In re CIT Group Inc. reaffirms the notion that a bankruptcy court may defer to another tribunal when considering issues that do not conflict with the goals of the Bankruptcy Code.  Further, language in the debtor’s plan with respect to the bankruptcy court’s jurisdiction will not be able to exceed the scope of the law.  The case also reiterates that rejection of a contract does not function to reject an arbitration clause.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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