Bankrupt Sub's Claim Against General Contractor Is a Non-Core Proceeding and Must Be Arbitrated, U.S. Court Holds

Jessica Singh
April 1, 2009 — 1,319 views  

The U.S. Court of Appeals for the 11th Circuit has ruled that an adversary proceeding by a debtor subcontractor against a general contractor was a noncore proceeding under the Bankruptcy Code and that the adversary proceeding was subject to the parties’ arbitration agreement.

The Court of Appeals further held that even if the adversary proceeding were found to be a core proceeding, the Bankruptcy Court would not have the discretion to deny enforcement of the arbitration agreement unless it found that enforcing the arbitration agreement would inherently conflict with the Bankruptcy Code. Whiting-Turner Contracting Co. v. Electric Machinery Enterprises, Inc. (In re Electric Machinery Enterprises, Inc.), 479 F.3d 791 (11th Cir. 2007). It concluded there would be no such conflict.

Whiting-Turner was general contractor for construction of improvements at Universal City Development Partners’ Seuss Landing theme park. Electric Machinery Enterprises, Inc. subcontracted with Whiting-Turner to provide electrical work on the project.

During the project, both Whiting-Turner and the subcontractor incurred acceleration costs when they incurred delays and the owner refused to grant schedule extensions. Whiting-Turner submitted an acceleration claim to the project owner totaling approximately $21 million, which included a pass-through claim of just over $6.1 million for the subcontractor’s acceleration and extra work claims. While Whiting-Turner pursued these claims against the owner, Whiting-Turner and the subcontractor entered into a tolling agreement, which included an arbitration clause providing for arbitration of any issues, claims or defenses between Whiting-Turner and the subcontractor.

Later, in May 2003, the subcontractor filed for Chapter 11 bankruptcy in Florida. Then, in June 2004, Whiting-Turner and the owner settled the claims for $9.6 million. After the settlement, Whiting-Turner told the subcontractor that it considered the subcontract paid in full and refused to pay any portion of the settlement proceeds to the subcontractor. Whiting-Turner noted that it had paid the subcontractor more than $1.8 million before and during the time the tolling agreement was in effect.

The sub then filed an adversary proceeding in Bankruptcy Court against Whiting-Turner for more than $5 million plus more than $2 million in interest. The subcontractor also alleged that it was owed a proportionate share of the $9.6 million that the owner paid in settlement to Whiting-Turner.

In the Bankruptcy Court, the subcontractor moved for summary judgment seeking turnover of its claimed share of the settlement, and Whiting-Turner moved to compel arbitration. Whiting-Turner also asserted that the subcontractor’s claims were overstated and not supported by job cost records. The Bankruptcy Court denied the subcontractor’s motion, holding that the case presented a construction trust situation and that the amount of the res of the constructive trust was a factual issue. The Bankruptcy Court also denied Whiting-Turner’s motion to compel arbitration, holding that determination of the amount of res in the constructive trust was a core bankruptcy proceeding and, therefore, was not appropriate for an arbitration. The District Court affirmed, and Whiting-Turner appealed.

The appeals court considered: (1) whether determination of the res of the constructive trust was a core proceeding, and if so (2) whether enforcement of the arbitration agreement could be denied.

The Court of Appeals held that subcontractor’s adversary proceeding was a noncore proceeding. The appeals court explained that a proceeding is a core proceeding if it involves a right created by the federal bankruptcy law or if the proceeding is one that would arise only in bankruptcy.

A noncore proceeding does not invoke a substantive right created by federal bankruptcy law and is one that could exist outside bankruptcy.

The appeals court held that the Bankruptcy Court erred in finding that determination of the res of the constructive trust was a core proceeding. The Court of Appeals explained that determination of whether Whiting-Turner owed the subcontractor money under their contract was a noncore proceeding because it did not involve a right created by federal bankruptcy law and it was not a proceeding that would arise only in bankruptcy. The subcontractor could have brought its claim against Whiting-Turner regardless of whether the sub had filed for bankruptcy. The dispute did not involve a claim by a creditor against a debtor in bankruptcy.

The Court of Appeals then held that the subcontractor’s adversary proceeding was subject to its arbitration agreement with Whiting-Turner. In considering this issue, the appeals court explained that a valid arbitration agreement is enforceable unless the party opposing arbitration can demonstrate a clear congressional intent to preclude arbitration of a statutory claim. The appeals court added that a Bankruptcy Court must analyze the congressional intent regardless of whether a proceeding is a core or noncore proceeding.

The appeals court applied the McMahon test to determine Congress’ intent: (1) the text of the statute, (2) its legislative intent and (3) whether “an inherent conflict between arbitration and the underlying purposes [of the statute] exists.” Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987). It noted the McMahon case established a federal policy favoring arbitration.

Applying the McMahon factors, the Court of Appeals found there was no evidence in the statutory text or legislative history that Congress intended to create an exception to the FAA in the Bankruptcy Code. It also found that arbitration of the subcontractor’s claim against Whiting-Turner would not inherently conflict with the underlying purposes of the Bankruptcy Code, even if it were a core proceeding. The Court of Appeals explained that the subcontractor’s claim against Whiting-Turner did not involve the traditional purpose of the Bankruptcy Court, modifying the rights of creditors who make claims against the bankruptcy debtor’s estate. While determination of whether Whiting-Turner actually owed the subcontractor part of the settlement proceeds that Whiting-Turner received from the owner could affect the sub’s bankruptcy estate, the sub’s adversary proceeding was merely related to the bankruptcy case and was a noncore proceeding. Accordingly, the Court of Appeals held, the dispute was arbitrable.

For more information about the issues covered in this report, please contact Jessica Singh in our New York office at 212-895-2808 or at [email protected] or contact your Thelen attorney. For more information about Thelen’s Construction and Government Contracts Department, click here.

Jessica Singh

Thelen Reid Brown Raysman & Steiner LLP