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ADR in Bankruptcy: Expanding Opportunities (BNA Insights/Bloomberg)

By Andrew J. Olejnik & Olivier P. André

Download a PDF of this article here.

Reproduced with permission from BNA’s Bankruptcy Law Reporter, 25 BBLR 299, 02/28/2013. Copyright © 2013 by The Bureau of National Affairs, Inc. (800-372-1033)


During the past several years, the financial crisis has provided opportunities for bankruptcy courts and parties to continue to make use of alternative dispute resolution (ADR) tools in their cases.1 This is an evolution that is positive for the bankruptcy system, so long as judges, lawyers, and clients understand how ADR can be used  effectively and its limitations. Used properly, ADR in bankruptcy cases can improve the process and produce better results for creditors and other stakeholders. Identifying what works and what doesn’t work can be a challenge, however, because ADR processes are often confidential and ADR-related disputes in bankruptcy are seldom litigated.

In October 2009, the American Bankruptcy Institute Law Review held a conference to explore the relationship between alternative dispute resolution and bankruptcy—‘‘ADR Meets Bankruptcy: Cross-Purposes
or Cross-Pollination.’’2 The conference brought together experts from the ADR and bankruptcy worlds to assess the similarities and differences in their two areas, focusing on both arbitration and mediation in bankruptcy.

Since then, many large, complex cases increasingly have turned to ADR tools as a means to resolve disputes. Those tools can offer to parties advantages that are not otherwise available through bankruptcy litigation. For example, a mediation process can be designed to assist multi-party negotiations that might otherwise face roadblocks and high litigation costs due to the complex web of parties’ rights, interests, and positions. Confidential ADR procedures can allow a debtor to resolve disputed issues outside of court in a manner that preserves business interests. Other dispute resolution systems can be designed to handle large numbers of similar claims that might otherwise clog and slow down the bankruptcy case. And, a consensual arbitration process could be used to resolve cross-border disputes that might otherwise face enforcement and recognition hurdles.

Although bankruptcy judges, practitioners, and clients already are quite adept at negotiating resolutions and streamlining procedures, they nevertheless should know and understand what ADR tools are available and how they are being used in order to achieve the best
possible outcome for an insolvent or distressed company (or municipality) and their stakeholders.

As part of its mission to help global businesses and their lawyers resolve complex commercial disputes more cost effectively and efficiently, the International Institute for Conflict Prevention & Resolution (CPR), through its Banking & Financial Services Committee, monitors and analyzes the latest developments involving ADR in bankruptcy. CPR also maintains a panel of highly skilled arbitrators and mediators specialized in bankruptcy and financial matters and has recently created a separate panel of mediators specifically focused on municipal bankruptcy in light of the financial distress many municipalities face. In this article, we high-light a few recent prominent cases impacting and illustrating the use of ADR in bankruptcy cases.

Enforceability of Arbitration Clauses in Bankruptcy

The United States Supreme Court has recognized that Congress established a ‘‘liberal federal policy favoring arbitration agreements’’ in the Federal Arbitration Act.3 That Act provides that agreements to arbitrate ‘‘shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.’’4 That mandate, however, may be overridden by Congressional intent, which is ‘‘deducible from [a] statute’s text or legislative history, or from an inherent conflict between arbitration and [a] statute’s underlying purposes.’’5

Because neither the Bankruptcy Code’s text nor its legislative history indicate an intent to override the arbitration mandate, bankruptcy courts will analyze whether there is an inherent conflict between the Bankruptcy Code’s purposes, on the one hand, and arbitration, on the other hand, when asked to compel arbitration. Several circuit courts have held that in non-core bankruptcy matters, ‘‘the bankruptcy court generally does not have discretion to deny enforcement of a valid prepetition arbitration agreement.’’6 In core bankruptcy matters, however, circuit courts have held that the bankruptcy court has discretion to deny enforcement of an arbitration provision ‘‘only if arbitration would conflict with the underlying purposes of the Bankruptcy Code.’’7 In a given case, it is therefore crucial to determine whether the matter being adjudicated is ‘‘core.’’8 In its January 2012 decision in Continental Ins. Co. v. Thorpe Insulation Co., the United States Court of Appeals for the Ninth Circuit explained that ‘‘the purposes of the Bankruptcy Code include ‘[c]entralization of disputes concerning a debtor’s legal obligations’ and ‘protect[ing] creditors and reorganizing debtors from piecemeal litigation.’ ’’9 In that case, the Ninth Circuit affirmed the denial of Continental’s motion to compel arbitration of a dispute arising under a pre-petition settlement agreement with the debtor, Thorpe.10 The Ninth Circuit expressed concern that the arbitration of a creditor’s claim could interfere with these purposes, fracture the plan confirmation process, and take away the bankruptcy court’s control of the process.11

The holding in that case, however, is limited by its facts. Continental’s claim was based on the debtor’s efforts to seek for itself and third parties the protections of § 524(g) of the Bankruptcy Code, a mechanism allowing a company to channel present and future asbestos claims to a trust. The court held that Continental’s claim ‘‘implicates and tests the efficacy of [§ 524(g)’s] underlying policies,’’ and that only the bankruptcy court should decide whether the debtor’s conduct breached the contract because Congress intended bankruptcy courts to oversee all aspects of a § 524(g) reorganization.12 The Ninth Circuit concluded ‘‘[a]rbitration in this case would conflict with congressional intent.’’13 Although the Ninth Circuit identified broad purposes of the Bankruptcy Code that might be interpreted to trump the use of arbitration in core bankruptcy matters, the facts of the Thorpe decision limit its broad application. This may be why the U.S. Supreme Court denied Continental’s petition for a writ of certiorari in October 2012.14

Mediation in Bankruptcy

Although there are limitations on the enforceability of arbitration clauses in bankruptcy cases, bankruptcy courts have been much more inclined to authorize or direct parties to mediate disputes. In 1986, the Southern District of California established the first mediation program for bankruptcy cases. Since then, more than 50 bankruptcy courts have explicitly authorized mediation by local rule or order.15 More recently, bankruptcy courts and parties have been utilizing those rules and orders to implement alternative dispute resolution procedures in innovative ways. Consistent with this growing trend of utilizing ADR procedures in bankruptcy cases, the California legislature enacted legislation that requires municipalities to go through a mediation-like process (the legislation calls it a ‘‘neutral evaluation process’’) before the municipality is eligible to file for Chapter 9 bankruptcy relief.

These directives from courts and lawmakers permit parties to employ flexible, creative, and constructive approaches to resolving disputes – something that CPR has pioneered for the resolution of complex commercial disputes with its ADR pledges signed by thousands of companies and law firms to foster the appropriate use of face-to-face negotiation, interest-based bargaining, mediation, and other approaches.16

The following three cases illustrate how mediation has been implemented in complex restructuring matters. As noted above, it is often difficult to analyze why a mediation was or was not successful because of the confidentiality of the process. Nonetheless, a few general observations can be drawn from these cases.

First, although mediation may not resolve all issues and disputes, it can reduce substantially the number of disputes to be litigated, and therefore reduce litigation costs. Second, the increasing involvement of the government and government officials in restructurings adds unique, public interests into the mix, which may be addressed more effectively through mediation. Third, mediation creates a structured process in which multiple parties can participate, though absent consensus, bankruptcy litigation may threaten to undo agreements reached by some of the parties in the mediation. Fourth, mediation takes time, but it may be preferred if the bankruptcy process cannot produce a more expeditious result.

Lehman Brothers’ ADR Procedures for Derivatives Disputes

When Lehman Brothers filed for bankruptcy in September 2008, it was a party to approximately 1.2 million derivative transactions with approximately 6,500 counter-parties. Lehman used these contracts to hedge against the risks of its business, to speculate in the changes of market rates or prices, and for financing. Lehman’s bankruptcy filing constituted an ‘‘event of default’’ under the contracts, and the vast majority of its counter-parties terminated the transactions, accelerated amounts owed, and exercised rights of setoff against collateral. The safe harbor provisions of the Bankruptcy Code generally permitted these actions.

Other counter-parties, however, did not exercise their termination rights because doing so would have resulted in a net payment to Lehman. These ‘‘in the money’’ derivatives contracts constituted significant assets of Lehman’s estate. After obtaining authorization from the bankruptcy court to assume and assign these contracts when possible, Lehman also requested and obtained ADR procedures to streamline the process of capturing the value of these contracts and to promote judicial efficiency.17 Without the procedures, Lehman likely would have been forced to commence and prosecute hundreds of adversary proceedings or contested matters that, in their most basic form, were collection actions.

The legal bases for the ADR procedures were § 105(a) of the Bankruptcy Code and the Southern District of New York’s Standing Order for ADR (General Order M-390). Several parties filed objections to the proposed procedures. Parties objected to certain mechanics of the mediation procedures, the court’s jurisdiction to order procedures for claims which must be heard by an Article III judge, and the inconsistency with a centralized decision making process that bankruptcy usually entails, among other things. The court overruled the objections, and approved the procedures.

The success rate of the process suggests that the procedures significantly benefited the estate. According to a February 2013 report filed with the bankruptcy court, Lehman had achieved settlements in 242 ADR matters involving 335 counter-parties and resulting in over $1.39 billion for its bankruptcy estate. Of the 98 ADR matters that reached the mediation stage and were concluded, 93 were settled.

Although the confidentiality and individualized nature of the process may be seen as contrary to the collective and public nature of  bankruptcy proceedings, these results demonstrate that ADR procedures in bankruptcy cases can be used to streamline and limit bankruptcy litigation to benefit the bankrupt’s estate.

Stockton, California

On June 28, 2012, the city of Stockton, California became the largest city to file for bankruptcy protection. Stockton also was the first municipality to undergo a state-required ‘‘neutral evaluation process’’ before becoming eligible to file for bankruptcy. As of Jan. 1, 2012, municipalities in California are required to participate in a mediation- like process before they can avail themselves of the protections afforded by Chapter 9 of the Bankruptcy Code, unless they declare a fiscal emergency.18 The purpose of the statute is to facilitate restructuring and avoid bankruptcy filings. To that end, the legislation requires municipalities to meet with interested parties for at least 60 days, but no more than 90, after which the municipality may file a Chapter 9 petition, subject to applicable federal bankruptcy law. In light of the number of interested parties involved and the information to be exchanged, however, two to three months likely is—and in this case, was—an insufficient time to achieve a consensual restructuring.

In Stockton’s case, the city met and reached agreements with several of its large creditor constituencies. However, other interested parties—bond insurers of debt issued by the city—have challenged the city’s eligibility to obtain Chapter 9 bankruptcy relief. According to the objectors, the city officials failed to seek concessions from its largest creditor—the California Public Employees Retirement System—because of political reasons, failed to negotiate in good faith with all interested parties (which may have been a consequence of the limited time available for mediation), and were unwilling to make difficult political choices, opting instead for the cover of a court approved restructuring.

Stockton’s eligibility to file for federal bankruptcy protection is a threshold issue, which, if successfully challenged, will prevent the city from imposing restructured terms on creditors. The issue, however, still has not been resolved—more than a year after the pre- bankruptcy mediation process began. In the meantime, the bankruptcy court has appointed Bankruptcy Judge Elizabeth Perris to serve as a judicial mediator in the case. Because the issues involving the city’s eligibility to file bankruptcy are not easily resolved, are complicated by the confidentiality of the pre-bankruptcy mediation, and are likely subject to appeals, the mediation process may have the time necessary to produce a consensual restructuring.

Ambac Financial Group

Ambac Financial Group (AFG) is an insurance holding company and the parent company of Wisconsin-based monoline insurer Ambac Assurance Company (AAC).19 In November 2010, AFG filed a Chapter 11 bankruptcy petition in the Southern District of New York— approximately eight months after AAC commenced a partial insurance rehabilitation in Wisconsin state court. On March 24, 2010, AAC and the Wisconsin Commission of Insurance had divided AAC’s insurance exposure into a General Account and a Segregated Account and placed the Segregated Account into rehabilitation.20

On March 2, 2011, the bankruptcy court approved a mediation process pursuant to the court’s General Order M-390, authorizing alternative dispute resolution procedures in bankruptcy cases. The order established a process for the debtor (AFG), the United States government (the IRS), and the AFG creditors’ committee (principally AFG bondholders) to mediate certain tax disputes involving a $700 million tax refund and more than $7 billion of net operating loss carry forwards. The mediation was extended to include representatives of AAC, as well as representatives of the Wisconsin Commissioner of Insurance on behalf of AAC’s Segregated Account in state court rehabilitation proceedings. Those parties were necessary because AFG had transferred the tax refund to AAC and, as a member of the AFG consolidated tax group, AAC could make use of the net operating losses. In fact, AAC’s operations, not AFG, generated the losses, some of which were used to obtain the tax refund.

In September 2011, the parties other than the IRS reached an agreement with respect to claims and the on-going relationship between AFG and AAC. That agreement formed the basis for AFG’s Chapter 11 plan of reorganization, which was confirmed by the bankruptcy court in March 2012. The plan is conditioned on the United States’ approval of a proposed settlement of the tax disputes, and that approval process has required several levels of government review, including final approval by the Congressional Joint Committee on Taxation. By reaching an agreement, the parties avoided litigating complex inter-company and tax disputes, as well as whether the Bankruptcy Code preempts the McCarran-Ferguson Act, which exempts the business of insurance from federal regulation. Even after the tax disputes are resolved, however, disputes remain in the AAC rehabilitation case which could unravel the parties’ overall  restructuring efforts. Several trustees and parties holding securities insured by AAC have challenged AAC’s and the Wisconsin Insurance Commissioner’s attempt to treat AAC’s performing and non-performing policies differently, to restructure payment only for the policies with material losses, and to settle with AAC’s parent company and its creditors on the terms agreed to, among other things.21 In contrast to the bankruptcy court, the Wisconsin rehabilitation court did not establish a mediation process which might have otherwise reduced litigation and led to a consensual restructuring.


In sum, the use of ADR tools in complex bankruptcy cases is increasing, and stakeholders should understand best practices in ADR to attain the best results. To assist businesses and their lawyers effectively resolve disputes, CPR and its Banking & Financial Services Committee continue to monitor and analyze developments in this area.

SIDE BAR: Andrew J. Olejnik is a partner at Jenner & Block LLP ( and a member of its bankruptcy & restructuring group. He was a member of the legal team that represented Anton R. Valukas, the court-appointed Examiner in the Lehman Brothers bankruptcy case. He also represents certain insured parties in the Ambac insurance rehabilitation case. He can be reached at Olivier P. André is Special Counsel and Director of Dispute Resolution Services at the International Institute for Conflict Prevention & Resolution (CPR), He can be reached at Mr. Olejnik is a member of, and Mr. Andre´ is the CPR Liaison to, the CPR Banking & Financial Services Committee.

The views and opinions expressed in this article are those of
Mr. Olejnik’s and Mr. André’s and do not necessarily reflect those of Jenner & Block LLP or CPR.


1 Some examples of ADR tools include mediation (evaluative or facilitative), arbitration, med/arb, and early neutral evaluation. See Elizabeth S. Strong, Some Reflections from the Bench on Alternative Dispute Resolution in Business Bankruptcy Cases, Arbitration, 17 AM. BANKR. INST. L. REV. 387 (2009).
2 Symposium, ADR Meets Bankruptcy: Cross-Purposes or Cross-Pollination?, 17 AM. BANKR. INST. L. REV. 385 (2009).
3 Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983) (citing Section 2 of the Federal Arbitration Act, 9 U.S.C. § 1 et seq.).
4 Federal Arbitration Act, 9 U.S.C. § 2.
5 In re Thorpe Insulation Co., 671 F.3d 1011, 1020 (9th Cir. 2012)(24 BBLR 175, 2/9/12)(citing Shearson/Am. Express Inc. v. McMahon, 482 U.S. 220, 227 (1987) (alternation, citation, and internal quotation marks omitted)).
6 Id. at 1021 (citing several cases).
7 Id. (citing several cases). For an analysis of how the Federal Arbitration Act and the Bankruptcy Code can be reconciled, see Paul F. Kirgis, Arbitration, Bankruptcy, and Public Policy: A Contractarian Analysis, 17 AM. BANKR. INST. L. REV. 503 (2009); see also Alan N. Resnick, The Enforceability of Arbitration Clauses in Bankruptcy, 15 AM. BANKR. INST. L. REV. 183 (2007) (suggesting that a clear line be drawn between non-core and core matters).
8 Core matters generally are those that exist because of the bankruptcy case, whereas non-core matters generally are those that would exist independent of the bankruptcy case. See 28 U.S.C. § 157 (listing types of core proceedings).
9 671 F.3d at 1022 (citations omitted).
10 Continental provided insurance to Thorpe that covered asbestos claims, and in 2003, the parties entered into a settlement agreement regarding the insurance policies and coverage. In its claim,  Continental alleged that actions taken by Thorpe to orchestrate a plan of reorganization with a § 524(g) channeling injunction violated that pre-petition settlement agreement. Among other things, that agreement prohibited Thorpe from assigning certain rights and assisting anyone in establishing any claims against Continental.
11 Id. at 1023. The Ninth Circuit did note that if Continental had presented a claim relating solely to Thorpe’s encouragement of direct action claims, ‘‘that claim likely should have been arbitrated.’’ 671 F.3d at 1024, n. 10.
12 Id. at 1022.
13 Id.
14 In a July 2012 decision, the Ninth Circuit relied on its Thorpe decision and affirmed the denial of a motion to compel arbitration because the issues to be decided by the arbitrator were closely intertwined with dischargeability and ‘‘would conflict with the underlying purposes of the Bankruptcy Code.’’ In re Eber, 687 F.3d 1123, 1130-31 (9th Cir. 2012).
15 Ralph Peeples, The Use of Mediation in Chapter 11 Cases, 17 AM. BANKR. INST. L. REV. 401, 407 (2009).
16 Over 30 years ago, CPR launched the CPR Corporate Policy Statement on Alternatives to Litigation and the CPR Law Firm Policy Statement on Alternatives to Litigation. These pledges have been instrumental in fostering the use of mediation and other creative and constructive techniques to resolve disputes among the more than 4,000 operating companies and 1,500 law firms that have committed to them. In order to reflect the evolving needs of ADR practitioners and to assist corporations in creating sustainable domestic and international dispute resolution processes, CPR has now promulgated
a 21st Century Corporate ADR Pledge. This new Pledge which incorporates the lessons learned from the past 30 years of ADR practice already has been signed by 21 multinational corporations.
17 Lehman also obtained streamlined procedures for certain ‘‘Tier 2’’ contracts involving disputes less than $1 million and specialized procedures for disputes involving special purpose vehicle counter-parties.
18 In August 2012, the city of San Bernadino, California skipped the neutral evaluation process and filed for Chapter 9 bankruptcy after declaring a fiscal emergency on July 18, 2012. San Bernadino’s bankruptcy filing is being contested.
19 AAC wrote financial guaranty insurance for municipal bonds and structured financial products such as residential mortgage-backed securities and student loan securitizations.
20 Insurance companies are ineligible to file for federal bankruptcy protection. See 11 U.S.C. § 109 (identifying who may be a debtor). Instead, insurance rehabilitations and liquidations are governed by state law.
21 Those challenges are pending in the Wisconsin Court of Appeals.