Coase-Sandor Working Paper Series in Law and Economics

Document Type

Working Paper

Publication Date



The United States Bankruptcy Code (the Code)1 and the Federal Arbitration Act (FAA)2 are powerful statutory schemes. Each one demands a broad scope of influence and preempts many other fields of law, state and federal. The capacious nature of these statutes creates a challenging tension when they come into conflict. On the one hand, bankruptcy law is in its very essence a collective multiparty dispute resolution procedure that cannot be waived or altered by private contract. On the other hand, the FAA embodies a general federal policy in favor of allowing parties to contract into private dispute resolution procedures.

This Symposium focuses on resolving that tension. Doing so requires an examination of important questions about the scope and operation of bankruptcy law.3 In our view, the interaction between the FAA and the Code is a version of a familiar and fundamental bankruptcy problem: When, and under what circumstances, should parties be allowed to opt in or out of the “bankruptcy tribunal” for the resolution of bankruptcy and bankruptcy-related matters?

This Article develops a general principle for thinking about that bankruptcy tribunal problem in the corporate bankruptcy context. As a definitional matter, we use “bankruptcy tribunal” to mean a federal court applying the Code and following the procedures commonly associated with bankruptcy cases as opposed to courts in other jurisdictions or in federal courts presiding over cases not brought under the Code. A more formal way to say the same thing is that, in the United States,4 a bankruptcy tribunal is a court exercising jurisdiction under 28 U.S.C. § 1334.5

We consciously avoid the term “bankruptcy court,” which creates a false distinction between a bankruptcy proceeding in a United States Bankruptcy Court and a bankruptcy proceeding in a United States District Court. For our purposes here, the District Court and the Bankruptcy Court are constituent parts of the same bankruptcy tribunal and function in the same role when presiding over bankruptcy matters.6

Our general principle is that the bankruptcy tribunal should be the exclusive tribunal to resolve a dispute if sending that dispute elsewhere would thwart the Code’s purpose of providing a collective forum where parties can coordinate to resolve multiparty disputes that involve distressed firms.7 When a case is brought into the bankruptcy tribunal, bankruptcy rules displace a substantial portion of non-bankruptcy law and private ordering. Because bankruptcy law’s essential function is coordinating a collective muti-party resolution, the displacement of private ordering is predominantly procedural and requires coordination even when that coordination conflicts with the procedures that would exist under non-bankruptcy law.8 To bring the parties toward one global resolution, bankruptcy law brings their substantive claims into the bankruptcy tribunal and subjects them to one set of mandatory procedural rules.

The FAA, on the other hand, has no similarly broad unifying purpose. It embodies a preference for private ordering of procedure. It reflects the view that parties should be able to choose for themselves whether future disputes should be resolved through arbitration. But that is the same private ordering of procedure that bankruptcy law must displace to achieve its collective coordinating purpose. This creates an inherent conflict.9 Subordinating the Code to the FAA allows a two-party option to avoid the bankruptcy tribunal. The purpose of bankruptcy law is to address the collective action problems that arise when a firm is in financial distress. Any two parties could use a private arbitration provision to remove from the bankruptcy tribunal a dispute that affects the rights of other parties. Such a removal would be the equivalent of allowing those two parties to force all other claimants to waive their right to have their claims collectively resolved in the bankruptcy tribunal. That is fundamentally inconsistent with the Code’s purpose of coordinating multilateral behavior. As a result, our analysis suggests that the Code must generally trump the FAA in order to remain effective. An alternative rule would gut the Code of its essential function. But the opposite is not true. The FAA still has effect and covers a large and important sphere of contractual disputes even when subordinated to the Code,

As we move beyond arbitration and look at bankruptcy law more broadly, we suggest that all questions about whether parties can keep certain disputes out of the bankruptcy tribunal—not just those involving arbitration—can and should be resolved by looking to bankruptcy’s essential purpose of providing a forum in to coordinate the resolution of multiparty disputes. This Article examines the bankruptcy tribunal question in its various forms to show the broad relevance of our principle. For example, tribunal choice is at the heart of questions about arbitration,10 forum selection, third-party releases,11 and the use of entity partitions and voting structures (golden shares and director seats). For each of these examples, the question of whether a proceeding should be inside or outside the bankruptcy system is really a question about governing law and procedure and whether certain parties should be able to opt out of the bankruptcy’s mandatory collective procedures. The questions should be resolved by asking how enforcing a contractual agreement to opt out of bankruptcy affects the collective proceedings. If enforcement would implicate only the interests of the parties to the contract, the contractual opt-out should be respected. On the other hand, if enforcement could prevent third parties from availing themselves of the collective proceeding bankruptcy provides, bankruptcy considerations should prevail and the opt-out should be denied.

An additional implication of our framework is that in some situations the law should not only prohibit opt-out but should reach out coercively and bring additional disputes into the bankruptcy tribunal. For example, bankruptcy courts might need the authority to order third-party releases when doing so reduces the opportunism that arises among stakeholder entangled in a distressed debtor’s web of relationships.

This Article proceeds in four parts. Part I presents the debate about bankruptcy law’s purpose and how it relates to questions about the bankruptcy tribunal and identifies areas of general agreement about bankruptcy’s essential collective nature, particularly with regard to coordinating behavior among those with claims against the bankruptcy estate. Part II describes the bankruptcy-tribunal problem in the arbitration context. Part III outlines our general principle and applies it to various other bankruptcy tribunal contexts. Part IV considers the more difficult question of when the bankruptcy purpose test justifies expanding the bankruptcy tribunal’s authority to reach disputes that do not directly involve the debtor.

Included in

Law Commons