Salander-O'Reilly Galleries LLC

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UNITED STATES BANKRUPTCY COURT 	FOR PUBLICATION
SOUTHERN DISTRICT OF NEW YORK
POUGHKEEPSIE DIVISION
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Case No. 07-30005
In re Salander O’Reilly Galleries, 	Chapter 11
Debtor.
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OPINION DENYING MOTION FOR RELIEF FROM STAY
Appearances:
Ilan Scharf
Pachulski Stang Ziehl & Jones, LLP
780 Third Ave., 36th Floor
New York, New York
Attorneys for Alan M. Jacobs, Liquidation Trustee, SOG Liquidation Trust
Petra von Ziegesar and David Faust
Faust Oppenheim, LLP
488 Madison Ave., 17th Floor
New York, New York
Attorneys for Kraken Investment, Ltd.
CECELIA G. MORRIS
UNITED STATES BANKRUPTCY JUDGE
Kraken Investment, Ltd. (“Kraken”) moves for relief from the automatic
stay, and for an order of this Court stating that Jersey (Channel Islands) law
controls the determination of whether a work of art, “Madonna and Child, by
Sandro Botticelli (the “Botticelli”) is part of the Debtor’s estate, and that such
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determination shall be made in arbitration in Jersey (Channel Islands).1 Kraken
seeks to enforce an arbitration clause in a pre-petition consignment contract
entered with Debtor’s former principal, which states that all disputes between the
parties shall be determined by arbitration in Jersey under the law of Jersey, and that
the agreement shall be governed by Jersey law. Kraken’s motion is denied. The
Trust’s rights were created through chapter 5 of the Bankruptcy Code, which
governs creditors, the debtor and the estate, and were assigned to the Trust by
Debtor’s prepetition secured lender. The Court does not find that cause exists to lift
the stay, where a party seeks to enforce an arbitration clause against an entity that
asserts rights derived from the Bankruptcy Code and as assignee of a third-party
creditor. The presumption of enforceability of arbitration clauses must yield to the
policies of the Bankruptcy Code, where the matter to be arbitrated is substantively
core. Kraken has not made a persuasive argument that the arbitration and choice of
law clause is valid in light of N.Y. U.C.C. § 105(2), which states that N.Y. U.C.C.
§§ 9-301 through 9-307 specify the law governing perfection, the effect of non-
perfection, 	and 	the 	priority 	of 	security 	interests, 	which 	are 	at 	the 	heart 	of
determining whether the Trust may liquidate the work of art for the benefit of
creditors.
1 Hereafter, Jersey (Channel Islands) shall be referred to as “Jersey.”
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BACKGROUND
Before the bankruptcy case was commenced, the Debtor was an art gallery
in Manhattan. It obtained financing from the predecessor-in-interest of Bank of
America, N.A. (the “Bank”), which allegedly was secured by a blanket lien on all
the Debtor’s assets. 2 At the time the bankruptcy case was commenced, the
aggregate outstanding principal balance owed to the Bank was $25.317 million.
See Final Order Pursuant to 11 U.S.C. §§ 361, 362, 363, 364 and 105 and Fed. R.
Bankr. P. 4001 and 6004 Granting Final Approval of Debtor in Possession
Financing and Use of Cash Collateral, entered Jan. 3, 2008 (“Final DIP Order”);
Disclosure Statement with respect to Third Amended Plan of Liquidation for
Salander O’Reilly Galleries, LLC, p. 12.3 A blanket lien on the artwork in favor of
the Bank was referenced in the Final DIP Order, in which the Court approved
debtor-in-possession financing.
On May 3, 2006, about a year and a half before the bankruptcy case was
commenced, Kraken and the Debtor entered into an agreement characterized as a
consignment agreement, which provided for the consignment of a painting called
“Madonna and Child,” by Botticelli. The sale price was set at $9.5 million. The
2 Ownership of this loan changed repeatedly over the course of this case. During the greater part
of the bankruptcy, the secured creditor was First Republic Bank, and the parties refer to First
Republic Bank in their motion papers. The alleged lien on the Botticelli was assigned to the
Trust by Bank of America.
3 The Court takes judicial notice of the documents filed in this case, and cites to these documents
for the uncontroverted factual history of the case.
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agreement contained a clause that states:
11. 	Any 	disputes 	between 	the 	parties, 	including 	any 	disputes
regarding this agreement, will be referred to arbitration. The sole
arbitrator to be appointed will be a former Judge of the Royal Court of
Jersey, 	Channel 	Islands, 	or 	another 	suitably 	qualified 	person.
Arbitration will take place in Jersey, Channel Islands, with the only
competent Court to be the Royal Court of Jersey, Channel Islands.
Jersey, Channel Islands law will apply to this agreement, including the
Arbitration (Jersey) Law 1998.
(the “Jersey Law Clause”). According to the Trust, the consignment agreement
expired in June 2007.
Before the bankruptcy was commenced, a creditor, Lennox, obtained a state-
court injunction barring the transfer of any artwork. Six days before the bankruptcy
was filed, Kraken commenced its own lawsuit in the New York Supreme Court to
recover the Botticelli; the lawsuit was stayed by the bankruptcy filing.
Procedural history of the bankruptcy case
On November 1, 2007 (the “Petition Date”), three creditors of the Debtor
commenced an involuntary case against the Debtor under chapter 7 the Bankruptcy
Code. On November 9, 2007, the Debtor’s involuntary case was converted to a
voluntary case under chapter 11 of the Bankruptcy Code. After conversion of the
case, the Debtor’s business was managed by a chief restructuring officer appointed
by the Court.
On November 20, 2007, the United States Trustee appointed the Official
Committee of Unsecured Creditors (the “Committee”). By stipulation entered
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February 4, 2008, the Debtor and the Committee agreed that the Debtor would
assign certain responsibilities with respect to the investigation and prosecution of
certain 	estate 	claims 	to 	the 	Committee 	(the 	“Stipulation”). 	Pursuant 	to 	the
Stipulation, the Committee was authorized to prosecute certain claims on behalf of
the Debtor’s estate, including any claims pursuant to sections 544 through 552 of
the Bankruptcy Code, and section 541 of the Bankruptcy Code.
By order entered March 11, 2008, the Court approved the Art Claims
Protocol, a procedure designed to streamline the resolution of competing claims to
the artwork (the “Protocol”). Pursuant to the Protocol, art claimants would file
claims 	of 	ownership 	with 	respect 	to 	the 	artwork, 	and 	engage 	in 	mediation
regarding disputed claims. Disclosure Statement, pp. 21-22.
Kraken filed an art claim pursuant to the Art Protocol on or about May 28,
2008, asserting claims to the Botticelli, among other artwork, and engaged in an
unsuccessful mediation regarding the Botticelli pursuant to the Art Protocol.
Kraken filed a proof of claim on July 17, 2008, for $9.5 million for “consigned
artwork,” 	and 	annexed 	a 	copy 	of 	the 	art 	claim, 	apparently 	as 	supporting
documents.
On January 20, 2010, the Court entered its Order (A) confirming the third
amended joint plan of liquidation proposed by Debtor, the Committee and the
Bank (the “Plan”) and (B) approving a settlement between Debtor, the Committee,
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and four other entities (the “Settlement”) (together, the “Confirmation Order”).
Pursuant to the confirmed plan, a liquidation trust was established (the “Trust”),
and the rights and powers under sections 544 through 552 of the Bankruptcy Code
passed from the Committee to the Trust. Disclosure Statement, p. 47. The Bank
assigned its interest in the Botticelli to the Trust. Objection of the Liquidation
Trustee to Motion of Kraken Investments Limited for Relief from the Automatic
Stay, Exhibit D, Docket No. 951.
The lift-stay motion
On January 19, 2011, Kraken filed a motion for relief from stay, with
supporting affidavits and memorandum of law. Case No. 07-30005, Docket Nos.
937-943. The Trust filed an objection to the motion on February 22, 2011. Docket
Nos. 951-952. A hearing was held to consider the motion on March 1, 2011. The
Court held a subsequent hearing in May 9, 2011, and assigned additional briefing.
Kraken and the Trust filed the supplemental briefs and corresponding replies.
Kraken seeks relief from the stay, to enforce the Jersey Law Clause and
pursue arbitration against the Liquidation Trustee of the Trust in Jersey. Kraken’s
request in pursuing arbitration is to determine whether the Botticelli was property
of the Debtor prior to the commencement of the bankruptcy proceeding and
whether, the Botticelli is now part of the bankruptcy estate. Kraken asks that Jersey
law control that determination.
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Kraken argues that the question is whether the Botticelli is part of the
bankruptcy 	estate, 	and 	such 	question 	turns 	on 	state 	law 	— 	the 	Uniform
Commercial 	Code. 	The 	Uniform 	Commercial 	Code 	controls 	two 	important
questions: whether the arbitration clause should be enforced, and the effect of
Kraken’s failure to file a financing statement. At oral argument, counsel to Kraken
framed the issues as: 1. whether the Botticelli was property of the Debtor before
the bankruptcy case was commenced; and 2. where the first question should be
decided. According to Kraken, N.Y. U.C.C. 1-105(1) provides that choice of law
provisions must be respected where the choice is of a jurisdiction that bears a
“reasonable relation” to the transaction. Kraken argues that the Court should
enforce the provision in the consignment agreement that sets Jersey law as the law
that should control whether the Botticelli is part of the estate. Kraken does not
address the effect of N.Y. U.C.C. § 1-105(2), other than as an exception allegedly
not relevant to the matter at bar. As discussed herein, N.Y. U.C.C. § 1-105(2)
appears on its face to suggest that the Uniform Commercial Code pre-empts the
Jersey Law Clause with respect to the effect of non-perfection of a security
interest, and is highly relevant to deciding whether Kraken may be granted relief
from the stay.
The Trust opposes the lift-stay motion, pointing out that a U.C.C. financing
statement was not filed with respect to the artwork and arguing that Kraken must
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prove that the consignment was a “true consignment.” The Trust alleges the
consignment agreement expired before the chapter 11 bankruptcy was commenced,
and Kraken consented to a continued consignment. As proof that the Debtor
continued in possession of the Botticelli after the consignment agreement expired,
counsel to the Trust proffers an excerpt of a catalogue featuring the Botticelli in an
exhibition scheduled to run from October 17, 2007, to February 1, 2008. The Trust
alleges 	that 	the 	Bank’s 	lien 	survived 	Kraken’s 	attempt 	to 	terminate 	the
consignment agreement before the commencement of the bankruptcy, resulting in a
valid transfer of the Bank’s interest to the Trust.
The Trust argues that the proceeding is a core proceeding: 1. Kraken filed a
proof of claim, the allowance of which will require a conclusive determination of
the Trust’s interest pursuant to 11 U.S.C. § 544 and 28 U.S.C. § 157(b)(2)(B); 2.
the Trust acquired the Bank’s lien, and the determination of the validity, extent or
priority of the Bank and Kraken’s competing liens is a core proceeding pursuant to
28 U.S.C. § 157(b)(2)(K); and 3. the determination of the Trust’s interest in the
Botticelli affects the liquidation of the assets of the Debtor’s estate and the debtor-
creditor relationship between the Debtor and Kraken, rendering the matter core
pursuant to 28 U.S.C. § 157(b)(2)(O).
The Trust argues that its rights are superior to Kraken’s under two theories:
1. as successor-in-interest to the Debtor as debtor-in-possession, it holds the rights
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of a hypothetical judicial lien creditor under Bankruptcy Code §§ 544(a) and
1107(a), 	which 	may 	have 	priority 	over 	creditors 	with 	unperfected 	security
interests; and 2. it has a superior right as the assignee of the Bank. The Trust
alleges that its rights arise by operation of Bankruptcy Code § 544 or assignment
by the Bank under the U.C.C.; it is not a party to the Consignment Agreement and
is not bound by the choice of law clause. According to the Trust, its rights are not
actually derivative of the Debtor, and the Trust does not stand in the shoes of the
Debtor with respect to this matter.
The Trust argues that the Court acknowledged the Bank’s perfected liens on
all the Debtor’s goods in an order entered January 3, 2008. See Final Order
Pursuant to 11 U.S.C. §§ 361, 362, 363, 364 and 105 and Fed. R. Bankr. P. 4001
and 6004 Granting Final Approval of Debtor In Possession Financing and Use of
Cash Collateral Docket No. 22 . The Bank’s lien on the Botticelli was transferred
to the Trust pursuant to the confirmed chapter 11 plan, which was approved by
order entered January 20, 2010. See Objection of the Liquidation Trustee to Motion
of Kraken Investments Limited for Relief from the Automatic Stay, Exhibit D,
Docket No. 951 (“Pursuant to Article IV.D of the Plan or any other applicable
authority, 	the 	Bank 	hereby 	assigns, 	transfers 	and 	conveys 	outright 	and
unconditionally to the Liquidation Trustee on behalf of the Trust, and their
respective successors and assigns, all of the Bank’s rights, title and interest in or to
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the Painting, including without limitation the Bank’s lien against or in the Painting
…”).
The Trust argues that a determination that a proceeding is non-core shall not
be made solely on the basis that its resolution may be affected by state law, as
stated in 28 U.S.C. § 157(b)(3).4
4 In its opposition to Kraken’s motion for relief from the stay, the Trust offers a substantive
argument in support of the priority of its liens on the Botticelli. The Trust argues that the
transactions between Kraken and the Debtor fit the definition of a consignment pursuant to § 9-
102(a)(20) of the Uniform Commercial Code. Allegedly, Kraken failed to perfect its interest by
failing to file a financing statement, allegedly required by N.Y. U.C.C. § 9-102(a)(20). The Trust
argues that, pursuant to N.Y. U.C.C. § 9-319 and Bankruptcy Code § 544, it may attach the
consigned goods (the Botticelli) as if the consignee (the Debtor) actually had title to the goods.
The Trust argues that since Kraken did not file a U.C.C. financing statement, it will have to
prove that a majority of the Debtor’s creditors were aware that the Debtor was substantially
engaged in selling the goods of others, a burden that allegedly is impossibly for Kraken to meet.
The Court notes the statutes cited by the Trust, and does not reach the merits of whether they
may support the Trust having a superior interest in the Botticelli — the question before the Court
is whether Kraken has demonstrated cause for relief from the stay so that it may pursue
arbitration pursuant to the Jersey Law Clause, not whether the Trust has a superior interest in the
Botticelli.
N.Y. U.C.C. § 9-102(a)(20) states:
[A “consignment” is defined as] a transaction, regardless of its form, in which a
person delivers goods to a merchant for the purpose of sale and:
(A) the merchant:
(i) deals in goods of that kind under a name other than the name of the
person making delivery;
(ii) is not an auctioneer; and
(iii) is not generally known by its creditors to be substantially engaged in
selling the goods of others;
(B) with respect to each delivery, the aggregate value of the goods is $1,000
or more at the time of delivery;
(C) the goods are not consumer goods immediately before delivery; and
(D) the transaction does not create a security interest 	that secures an
obligation.
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STATEMENT OF JURISDICTION
This Court has subject matter jurisdiction pursuant to 28 U.S.C. § 1334(a)
and (e), 28 U.S.C. § 157(a), and the Standing Order of Reference signed by Acting
Chief Judge Robert J. Ward dated July 10, 1984 (the “Order of Reference”).
Determination 	of 	the 	lift-stay 	motion 	is 	a 	core 	proceeding. 	28 	U.S.C. 	§
157(b)(2)(G). As discussed herein, the relief Kraken seeks in its motion directly
implicates the allowance of its claims against the estate and the determination of
the validity of liens, which are core proceedings pursuant to 28 U.S.C. §§
157(b)(2)(B) and (K), respectively.
By virtue of the Order of Reference, the bankruptcy court has exclusive
jurisdiction 	of 	all 	bankruptcy 	cases, 	as 	well 	as 	original 	but 	not 	exclusive
jurisdiction of all civil proceedings arising under the Bankruptcy Code, or arising
in or related to cases under the Bankruptcy Code. See 28 U.S.C. §§ 157(a) and (b),
and 1334(a) and (b). The Court has exclusive jurisdiction over all property of the
N.Y. U.C.C. § 9-319 states:
a. Consignee has consignor’s rights. Except as otherwise provided in subsection
(b), for purposes of determining the rights of creditors of, and purchasers for
value of goods from, a consignee, while the goods are in the possession of the
consignee, the consignee is deemed to have rights and title to the goods identical
to those the consignor had or had power to transfer.
b. Applicability of other law. For purposes of determining the rights of a creditor
of a consignee, law other than this article determines the rights and title of a
consignee while goods are in the consignee’s possession if, under this part, a
perfected security interest held by the consignor would have priority over the
rights of the creditor.
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debtor as of the commencement of the case, as well as property of the estate,
regardless of where the property is located. See 28 U.S.C. § 1334(e).
“Matters that ‘arise under’ the Bankruptcy Code are those that come before
the court by virtue of a provision of the Bankruptcy Code.” Alan N. Resnick, The
Enforceability of Arbitration Clauses in Bankruptcy, 15 Am. Bankr. Inst. L. Rev.
183, 193 (2007) (emphasis added). “Matters that ‘arise in’ a case under the
Bankruptcy Code are those based on a right created by the Bankruptcy Code and
that, by their nature, can only be brought in a case under the Bankruptcy Code.” Id.
“Bankruptcy judges may hear and determine all cases under title 11 and all
core proceedings arising under title 11, or arising in a case under title 11, referred
[to the bankruptcy court by the district court].” 28 U.S.C. § 157(b)(1) (emphasis
added). “Core” proceedings are those that directly relate to a bankruptcy court’s
central functions. If a proceeding is core, the bankruptcy judge may determine the
matter. See In re McLean Industries, Inc., 76 B.R. 328, 337-338 (Bankr. S.D.N.Y.
1987) (denying motion for relief from stay where creditor wished to seek relief in
admiralty court; noting the validity of liens is a core matter within the jurisdiction
of bankruptcy courts); e.g., 28 U.S.C. §§ 157(b)(2)(B) (allowance of claims), (K)
(determination 	of 	validity 	and 	priority 	of 	liens) 	and 	(O) 	(other 	proceedings
affecting liquidation of assets).
“[M]atters that are only ‘related to’ the bankruptcy do not have their roots in
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the Bankruptcy Code, and would be brought in an alternative forum were the
debtor not before the bankruptcy court.” Resnick, supra at 193. A related to matter
is one that could conceivably have any effect on the estate being administered in
bankruptcy. Id. A related to matter is a “non-core” proceeding, and the bankruptcy
judge may preside over the matter to the extent of submitting proposed findings of
fact and conclusions of law to the district court. Id. at 194.
“The bankruptcy judge shall determine, on the judge’s own motion or on
timely motion of a party, whether a proceeding is a core proceeding under this
subsection or is a proceeding that is otherwise related to a case under title 11.” 28
U.S.C. § 157(b)(3). “A determination that a proceeding is not a core proceeding
shall not be made solely on the basis that its resolution may be affected by State
law.” Id. (emphasis added).
A claim is a right to payment, whether or not such right is reduced to
judgment, 	liquidated, 	unliquidated, 	fixed, 	contingent, 	matured, 	unmatured,
disputed, 	undisputed, 	legal, 	equitable, 	secured, 	or 	unsecured. 	11 	U.S.C. 	§
101(5)(a). If proof of a claim is filed, the claim is deemed allowed, unless a party
in interest objects. 11 U.S.C. § 502(a). As discussed herein, whether a proof of
claim 	may 	be 	allowed 	is 	an 	important part 	of 	the 	analysis 	of 	whether 	the
bankruptcy court has jurisdiction to decide a matter.
Kraken filed a proof of claim, and an art claim pursuant to the Art Protocol
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specially adopted in this case. The Liquidating Trustee has expressed its intent to
seek to avoid Kraken’s interest as consignor in the Botticelli pursuant to 11 U.S.C.
§ 544(a), on account of Kraken’s failure to file a financing statement, and to assert
a superior interest as assignee of the Bank’s lien. The matter that Kraken seeks to
arbitrate in Jersey — whether the Botticelli was property of the debtor at the time
the case was commenced — is an essential and inseparable element of an action
under Bankruptcy Code § 544(a). Resolution of the § 544 matter will go to the
heart of whether Kraken’s claim will be allowed. Kraken’s requested relief is
inextricably bound up with the resolution of the art claim and proof of claim it filed
in this case, and falls squarely within the jurisdiction of the bankruptcy court.
In Stern v. Marshall, 2011 WL 2472792 	(June 23, 2011), the United States
Supreme Court held that a bankruptcy court “lacked the constitutional authority to
enter final judgment on a state law counterclaim that is not resolved in the process
of ruling on a creditor’s proof of claim.” Id. at *27. The thrust of Stern is that
Congress’ 	designation 	of 	all 	counterclaims 	as 	“core” 	cannot 	supersede 	the
Constitution’s designation of judicial power in Article III courts, whose judges are
protected from improper influence of the other branches by life tenure and
established salaries. In Stern, the Court considered a compulsory counterclaim in
which the debtor asserted a claim of tortious interference with a gift and requested
punitive 	damages. 	The 	creditor 	had 	filed 	a 	claim 	for 	defamation, 	and 	the
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bankruptcy court would have had to make determinations regarding whether debtor
could 	prevail 	on 	the 	counterclaim 	and 	demand 	for 	punitive 	damages 	—
determinations that are beyond what would have been required to determine
whether to allow the claim for defamation. 5 See id. at *23. “There thus was never
reason to believe that the process of ruling on Pierce’s proof of claim would
necessarily result in the resolution of Vickie’s counterclaim.” Id.
Stern is replete with language emphasizing that the ruling should be limited
to the unique circumstances of that case, and the ruling does not remove from the
bankruptcy court its jurisdiction over matters directly related to the estate that can
be finally decided in connection with restructuring debtor and creditor relations:
[T]he debtors’ claims in the cases on which [Vickie Marshall] relies
were themselves federal claims under bankruptcy law, which would be
completely 	resolved 	in 	the 	bankruptcy 	process 	of 	allowing 	or
disallowing 	claims. 	Here 	Vickie’s 	claim 	is 	a 	state 	law 	action
independent 	of 	the 	federal 	bankruptcy 	law 	and 	not 	necessarily
resolvable by a ruling on the creditor’s proof of claim in bankruptcy.
Id. at *16 (emphasis added); e.g., at *20 (“The ‘experts’ in the federal system at
resolving common law counterclaims such as Vickie’s are the Article III courts”)
(emphasis added); id. at *21 (“Given the extent to which this case is so markedly
distinct from the agency cases discussing the public rights exception in the context
of [a substantive regulatory scheme], however, we do not in this opinion express
5 It appears that the creditor filed a proof of claim for defamation, and an adversary proceeding to
except the debt from discharge. It appears that the debtor filed the counterclaim in response to
the complaint in the adversary proceeding.
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any view on how the doctrine might apply in that different context”); id. at *22
(“There was no question [in Katchen] that the bankruptcy referee could decide
whether there had been a voidable preference in determining whether and to what
extent to allow the creditor’s claim”); id. at *22 (a preferential transfer claim can
be heard in bankruptcy when the allegedly favored creditor has filed a claim,
because then ‘the ensuing preference action by the trustee become[s] integral to the
restructuring of the debtor-creditor relationship) (discussing Langenkamp); id. at
*23 (citing brief for the United States as amicus curiae) (“[In Stern,] the question
presented concerns authority of a bankruptcy court to enter final judgment on a
compulsory 	counterclaim 	‘when 	adjudication 	of 	the 	counterclaim 	requires
resolution of issues that are not implicated by the claim against the estate’”); id. at
*24 (“Congress may not bypass Article III simply because a proceeding may have
some bearing on a bankruptcy case; the question is whether the action at issue
stems from the bankruptcy itself or would necessarily be resolved in the claims
allowance process”) (emphasis added); id. at *26 (“We do not think the removal of
counterclaims such as Vickie’s from core bankruptcy jurisdiction meaningfully
changes the division of labor in the current statute; we agree with the United States
that the question presented here is a ‘narrow’ one”); id. at *27 (“We conclude
today that Congress, in one isolated respect, exceeded [the limitations of Article
III] in the Bankruptcy Act of 1984”).
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In finding that the bankruptcy court could not constitutionally determine the
state-law counterclaim, the Stern majority relied in part upon the plurality opinion
in N. Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50 (1982)
(“Marathon”). In that case, the debtor sued a company for purely state-law causes
of action, which existed independent of the bankruptcy: breaches of contract and
warranty, as well as for alleged misrepresentation, coercion and duress. Id. at 56.
The only relationship these legal claims had to the bankruptcy was the potential
that they would yield damages that would add value to the bankruptcy estate. The
causes of action themselves were not at all derived from the Bankruptcy Code, and
did not implicate a proof of claim. In a plurality opinion, Justice Brennan noted,
“[T]he restructuring of debtor-creditor relations, which is at the core of the federal
bankruptcy power, must be distinguished from the adjudication of state-created
private rights, such as the right to recover contract damages that is at issue in this
case.” Id. at 71. Similarly, in Granfinanciera, S.A. v. Nordberg, 492 U.S. 33
(1989), the Court considered whether a defendant had a right to a jury trial in an
action by a trustee to recover an allegedly fraudulent transfer, from a party that had
not filed a proof of claim. Id. at 36. The Court held that such a person is entitled to
a jury trial, notwithstanding Congress’ designation of fraudulent conveyance
actions as “core proceedings.” Id.
Nowhere in Marathon, Granfinanciera, or Stern does the Supreme Court
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rule that the bankruptcy court may not rule with respect to state law when
determining a proof of claim in the bankruptcy, or when deciding a matter directly
and conclusively related to the bankruptcy. As noted, Stern repeatedly emphasizes
that it addresses only the constitutionality of the bankruptcy court making a final
ruling on a state-law counterclaim that would not be finally resolved in the process
of allowing or disallowing a proof of claim. The Granfinanciera Court interpreted
previous cases as holding that the creditor’s right to a jury trial turned on whether it
submitted 	a 	claim 	against 	the 	estate. 	Granfinanciera, 	492 	U.S. 	at 	59. 	The
Marathon plurality emphasized the difference between restructuring of debtor-
creditor relations and enforcement of a purely private right. Marathon, 458 U.S. at
71. The thread that binds these cases is the concept that when the jurisdiction of the
bankruptcy court is at issue, the adjudication of a proof of claim — a request for
payment from the estate — is of paramount concern.
“[The 	Congress 	shall 	have 	Power] 	To 	establish 	an 	uniform 	Rule 	of
Naturalization, and uniform Laws on the subject of Bankruptcies throughout the
United States.” U.S. Const. art. I, § 8, cl. 4. Congress created the Bankruptcy Code
that governs today with the Bankruptcy Reform Act of 1978. Pub. L. No. 95-598,
92 State. 2549 (1978). This law creates an estate, made up of all the debtor’s
interests in property at the time the case is commenced. 11 U.S.C. § 541(a). It
creates a trustee, the representative of the estate. 11 U.S.C. §§ 321-323. Chapter 11
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of the Bankruptcy Code creates the debtor-in-possession, a legal entity distinct
from the debtor, which may exercise many of the powers of the trustee. 11 U.S.C.
§§ 	1101, 	1107. 	The 	Bankruptcy 	Code 	establishes 	a 	system 	of 	priorities 	to
determine the order in which creditors are paid. 11 U.S.C. § 507. The Bankruptcy
Code creates an automatic stay, which prevents collection of most debts from
property 	of 	the 	estate 	while 	the 	debtor 	reorganizes. 	11 	U.S.C. 	§ 	362. 	The
Bankruptcy Code creates a discharge, which may prevent the collection of a debt
forever. See 11 U.S.C. § 1141(d) (confirmation of a plan discharges the debtor
from any debt that arose before the date of such confirmation).
The automatic stay, the estate and the discharge were created by Congress
pursuant to its Article I power to enact a bankruptcy law. Together, they prevent
the creditor from collecting the debt, no matter where it would like to sue — state
court, district court, or bankruptcy court. As a result, in most circumstances, the
right of the unsecured creditor to be paid from the bankruptcy estate depends upon
the claims allowance process. In a chapter 11 case, an unsecured creditor should
file a proof of claim if its claim is not scheduled by the debtor, or if it is scheduled
as disputed, contingent, or unliquidated, or if the creditor disagrees with the
debtor’s characterization of the amount or status of the claim. Fed. R. Bankr. P.
3003(c); 9 Collier on Bankruptcy ¶ 3003.03[3] (Alan N. Resnick & Henry J.
Sommer eds., 16th ed.). In the case of the chapter 11 debtor, the claims allowance
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process may affect how the creditor influences the debtor’s reorganization. See 11
U.S.C. § 1126(c) (class accepts plan if at least two-thirds in amount and more than
one-half in number of the allowed, voting claims of the class accept the plan).
It is clear from the foregoing that the Bankruptcy Court is empowered to
apply state law when so doing would finally resolve a claim. In the matter at bar,
Kraken nominally seeks relief from the automatic stay, but the substance of its
requested relief will have a dramatic effect on the resolution of its proof of claim.
Kraken characterizes its motion as one for relief from the stay, seeking to enforce
an arbitration clause and a choice of law clause in a pre-petition consignment
agreement with the Debtor, which might constitute a private right if not for the
bankruptcy filing. Kraken seeks this relief after filing two proofs of claim. If the
Court were to grant Kraken relief from the stay, and allow arbitration to proceed in
Jersey and the law of Jersey to apply, then Kraken’s claim would be decided by an
adjudicator other than the Bankruptcy Court. This may not be done — allowance
of claims is indisputably the realm of the bankruptcy court. Cf. 28 U.S.C. §
1334(e)(1) (district court shall have exclusive jurisdiction of all the property,
wherever located, of the debtor as of the commencement of a bankruptcy case, and
of property of the estate).
In the matter at bar, upon the papers filed and authority cited by the parties
with respect to this matter, there are two foreseeable outcomes with respect to the
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art claim and proof of claim filed by Kraken: The Trust will avoid Kraken’s
interest as consignor pursuant to Bankruptcy Code § 544 or as assignee of the
Bank and liquidate the Botticelli for the benefit of creditors, paying Kraken its
dividend as a general unsecured creditor; or Kraken will recover the Botticelli and
exit this case with its painting in hand. In either scenario, the Bankruptcy Court’s
ruling will finally determine Kraken’s art claim and proof of claim. The present
motion for relief from the stay, which implicates the adjudication of the proof of
claim, is within the jurisdiction of this Court.
DISCUSSION
In seeking relief from the automatic stay, Kraken prays for the following
relief:
1. that the stay be terminated;
2. that the issue of whether the Botticelli was part of the estate of the debtor
be determined under Jersey law, including the Arbitration (Jersey) Law
1998; by a retired judge of the Royal Court of Jersey; in an arbitration in
Jersey; and
3. that Kraken be permitted to commence arbitration under Jersey Law,
including the Arbitration (Jersey) Law 1998, by a retired judge of the
Royal Court of Jersey, in an arbitration against the Trustee.
11 U.S.C. § 362(a)(1) provides that a bankruptcy petition operates as a stay,
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applicable to all entities, of the commencement or continuation, including the
issuance or employment of process, of a judicial, administrative, or other action or
proceeding against the debtor that was or could have been commenced before the
commencement of the bankruptcy case, or to recover a claim against the debtor
that arose before the commencement of the bankruptcy case. The stay prevents any
act to obtain possession of property of the estate or of property from the estate or to
exercise control over property of the estate. 11 U.S.C. § 362(a)(3). The stay
prevents any act to create, perfect or enforce any lien against property of the estate,
and any act to create, perfect or enforce against property of the debtor any lien to
the extent that the lien secures a claim that arose before the commencement of the
bankruptcy case. 11 U.S.C. § 362(a)(3).
On request of a party in interest and after notice and a hearing, the
court shall grant relief from the stay …
(1) for cause, including the lack of adequate protection of an interest
in property of such party in interest;
(2) with respect to a stay of an act against property under subsection
(a) of this section, if –
(A) the debtor does not have equity in such property; and
(B) such property is not necessary to an effective reorganization.
Bankruptcy Code § 362(d). When a bankruptcy court lifts the stay, it must find
cause. See 11 U.S.C. § 362(d); In re Sonnax Indus., 907 F.2d 1280 (2d Cir. 1990)
(describing twelve factors for court to consider when deciding whether cause exists
to lift the stay, including lack of any connection with or interference with the
bankruptcy case; whether litigation in another forum would prejudice the interests
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of other creditors; the interests of judicial economy and the expeditious and
economical resolution of litigation; and the impact of the stay on the parties and
the balance of harms). The movant must make an initial showing of cause for relief
from the stay. See Sonnax, 907 F.2d at 1285. “If the movant fails to make an initial
showing of cause, however, the court should deny relief without requiring any
showing from the debtor that it is entitled to continued protection.” Id.
In seeking arbitration with the Trustee, it appears that Kraken seeks to
determine whether its interest in the Botticelli may be avoided by the Trustee. 11
U.S.C. § 544(a) states that the trustee has the avoidance powers of a hypothetical
judicial lien creditor.6 In practice, this provision allows the trustee to avoid security
6 11 U.S.C. § 544 states:
(a) The trustee shall have, as of the commencement of the case, and without
regard to any knowledge of the trustee or of any creditor, the rights and powers
of, or may avoid any transfer of property of the debtor or any obligation incurred
by the debtor that is voidable by—
(1) 	a 	creditor 	that 	extends 	credit 	to 	the 	debtor 	at 	the 	time 	of 	the
commencement of the case, and that obtains, at such time and with respect to
such credit, a judicial lien on all property on which a creditor on a simple
contract could have obtained such a judicial lien, whether or not such a
creditor exists;
(2) 	a 	creditor 	that 	extends 	credit 	to 	the 	debtor 	at 	the 	time 	of 	the
commencement of the case, and obtains, at such time and with respect to such
credit, an execution against the debtor that is returned unsatisfied at such time,
whether or not such a creditor exists; or
(3) a bona fide purchaser of real property, other than fixtures, from the debtor,
against whom applicable law permits such transfer to be perfected, that
obtains the status of a bona fide purchaser and has perfected such transfer at
the time of the commencement of the case, whether or not such a purchaser
exists.
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interests 	that 	are 	not 	perfected, 	rendering 	a 	high-priority 	secured 	creditor
unsecured, and increasing the amount and value of property that can be distributed
to creditors. “The trustee hypothetically extends credit to the debtor at the time of
filing and, at that moment, obtains a judicial lien on all property in which the
debtor has any interest that could be reached by a creditor. The advantage of this
status derives not from the Bankruptcy Code but, rather, from the relevant state law
defining creditor rights.” Musso v. Otashko, 468 F.3d 99, 104 (2d Cir. 2006)
(emphasis added).
Where 	goods 	are 	consigned 	to 	the 	debtor 	prepetition, 	they 	might 	be
liquidated for the benefit of other creditors pursuant to the trustee’s power under §
544(a). See In re Tristar Automotive Group, Inc., 141 B.R. 41 (Bankr. S.D.N.Y.
1992) (“[A debtor-in-possession under § 1107] may assert the so-called strong-arm
avoiding powers under 11 U.S.C. § 544(a) and set aside an unperfected security
interest. … The fact that [the creditor] retained the title documents for the
automobiles in question did not prevent the vehicles from becoming property of
the estate within the meaning of 11 U.S.C. § 541.”); Valley Media, 279 B.R. at 132
(“No knowledge of the pre-petition debtor regarding the consignments is imputed
(b) (1) Except as provided in paragraph (2) [concerning charitable contributions],
the trustee may avoid any transfer of an interest of the debtor in property or any
obligation incurred by the debtor that is voidable under applicable law by a
creditor holding an unsecured claim that is allowable under section 502 of this
title or that is not allowable only under section 502 (e) of this title. ***
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to the Debtor in Possession. … [A] consignor will not prevail over a trustee
exercising its powers pursuant to 11 U.S.C. § 544(a).”); In re Morgansen’s LTD,
302 B.R. 784 (Bankr. E.D.N.Y. 2003) (“If a person takes goods to one who is
considered a consignee (a ‘buyer’ for resale) and that buyer files for bankruptcy
relief, the buyer/debtor’s trustee will take the goods as property of the debtor’s
estate. Under section 544(a) of the Bankruptcy Code, these goods may be sold by
debtor’s trustee.”). A chapter 11 debtor that remains in control of its bankruptcy
case is called a debtor-in-possession, which may exercise a trustee’s avoidance
powers under § 544. See 11 U.S.C. §§ 1101, 1107.
In the matter at bar, the Court must determine whether to order the Trust to
arbitration with Kraken pursuant to the Jersey Law Clause. The Court denies
Kraken’s motion. The bankruptcy court is the proper forum to determine whether
the Botticelli is property of the estate, as one element of an action to avoid an
unperfected security interest, which is a core proceeding. The Trust is not a party
to the consignment agreement and is not bound by the Jersey Law Clause, because
it asserts rights derived as a hypothetical judicial lien creditor, which stems from
the Bankruptcy Code, and as assignee of the Bank. With respect to arbitration, a
bankruptcy court may decline to enforce an arbitration clause when the matter to
be determined is substantively core, and when the parties did not agree to
arbitration.
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Kraken has failed to establish cause for relief from the stay for the following
reasons: 1. Arbitration of whether the Botticelli was property of the debtor or
property of the estate would improperly sever an element of the § 544 action; and
2. Other creditors — the Trust as hypothetical judicial lien creditor and as assignee
of the Bank —were not parties to the consignment agreement and thus are not
bound by the Jersey Law Clause, either with respect to arbitration or the choice of
Jersey law.
Bankruptcy courts may apply state law in resolving core matters.
Kraken argues that the determination of whether the Botticelli is property of
the estate is governed by issues of state law, rendering it a non-core proceeding. In
support of this argument, Kraken cites Interconnect Tel. Services, Inc., 59 B.R. 397
(S.D.N.Y. 1986), in which the district court granted the defendants’ motion to
withdraw the order of reference to the bankruptcy court. In Interconnect, the debtor
commenced an adversary proceeding against former employees and the company
they 	started, 	alleging 	causes 	of 	action 	under 	state 	law, 	independent 	of 	and
antecedent of the bankruptcy case, including conspiring to defraud the debtor by
creating a competitor, continuing to receive salaries and bonuses from the debtor,
and misappropriating trade secrets. Interconnect is not binding on this court, and
the Court declines to follow it for the proposition that the need for the bankruptcy
court to apply state law renders a proceeding non-core. 	Interconnect 	is less
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persuasive than In re Valley Media, discussed herein, and did not concern a
trustee’s avoidance powers under § 544. Interconnect concerned state-law claims
independent of the bankruptcy, of the kind that the Supreme Court in Marathon
found to elude the jurisdiction of the bankruptcy court. 	Interconnect did not
concern a right the stems from the Bankruptcy Code, such as is at stake in the
matter at bar. The Court declines to follow Interconnect for the proposition that it
should not determine whether the Botticelli was property of the debtor or property
of the estate.
The jurisdiction of the bankruptcy court depends on whether the issue to be
decided arises in or under the Bankruptcy Code, such as whether a claim will be
allowed, not whether state law is implicated. As previously noted, Stern did not
eliminate the distinction between core and non-core matters; that case’s holding
only removed from the bankruptcy court’s jurisdiction state-law counterclaims that
cannot be fully resolved in the claims allowance process.
Kraken cites Butner v. U.S., 440 U.S. 48 (1979) for the proposition that
whether an asset is property of the estate is a matter of state law. In Butner, a case
under the Bankruptcy Act of 1898, a junior mortgagee claimed a security interest
in rents and profits. The Court considered whether a security interest in rents and
profits should be determined under state law, which might not allow such an
interest to arise automatically, or pursuant to a federal rule of equity that would
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extend a security interest automatically. The Court concluded that state law should
control the question of whether the mortgagee had a security interest in the rents
and profits. The Court stated the rule:
Property interests are created and defined by state law. Unless some
federal interest requires a different result, there is no reason why such
interests should be analyzed differently simply because an interested
party is involved in a bankruptcy proceeding. Uniform treatment of
property interests by both state and federal courts within a State serves
to reduce uncertainty, to discourage forum shopping, and to prevent a
party from receiving “a windfall merely by reason of the happenstance
of bankruptcy.”
Id. at 55. See also In re Dreier LLP, 429 B.R. 112, 125 (Bankr. S.D.N.Y. 2010)
(stating state law or other applicable non-bankruptcy law normally determines the
extent of the debtor’s interest in property, absent an overriding federal policy;
bankruptcy law determines whether that interest is property of the estate).
Butner does not support Kraken’s suggestion that the need to apply state law
— the New York Uniform Commercial Code — deprives the Court of jurisdiction.
Butner merely resolved a split among the circuits regarding whether state law
should 	govern 	security 	interests 	in 	rents 	and 	profits. 	As 	noted 	above, 	“[a]
determination that a proceeding is not a core proceeding shall not be made solely
on the basis that its resolution may be affected by State law.” 28 U.S.C. §
157(b)(3). 	Allowance 	of 	claims 	and 	order 	of 	priorities 	of 	interests 	may 	be
fundamentally concerned with state law, and they are expressly denominated as
core proceedings, over which the Court has original jurisdiction. See 28 U.S.C. §
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157(b)(2)(B), (K). In fact, in In re Valley Media, 279 B.R. 105, 125, 133 (Bankr.
D. Del. 2002), a Delaware bankruptcy court construed past and present versions of
the California Uniform Commercial Code, as well as the California law of
corporations and federal patent law, to find that a debtor-in-possession could
auction consigned goods and avoid the security interests of the consignors pursuant
to Bankruptcy Code §§ 544(a) and 1107(a) ( “Under [U.C.C. §§ 9-102(a)(20) and
9-319(a)], the court is not concerned with the rights between the consignor and
consignee, but rather solely with the rights of the third party creditors of the
consignee”).
Whether the Botticelli is property of the Debtor is an element of a lien avoidance
action that is properly determined by the bankruptcy court.
In support of its argument that a threshold determination must be made that
the Botticelli was property of the Debtor, Kraken cites In re Koreag, Controle et
Revision S.A., 961 F.2d 341 (2d Cir. 1992), in which the Second Circuit required
the bankruptcy court to make such a determination in the context of a motion for
turnover of assets alleged to be part of a foreign bankruptcy case. In Koreag,
Mebco, a Swiss bank, was in bankruptcy liquidation pursuant to Swiss law; Koreag
was appointed liquidator of Mebco. Id. at 345. Refco was a New York corporation
that engaged in commodity and currency transactions around the world, and traded
foreign currency with Mebco for U.S. dollars. Id. at 344. The parties had an
agreement to wire the currencies and dollars to an account at the New York branch
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of a Swiss Bank. Id. When Mebco went into liquidation, payments were not
allowed to go out of that account. Id. at 345. Refco, unaware of the liquidation,
continued wiring funds into the account. Id. Other funds in which Refco claimed
an interest were ensnared in Mebco bank accounts. Id. Refco sued Mebco in
district court to recover the funds, and Koreag petitioned the bankruptcy court for
relief ancillary to a foreign proceeding pursuant to § 304.7 Id. at 346.
The Second Circuit required the bankruptcy court to make a threshold
determination of whether the property at issue was property of the estate of the
entity in a foreign insolvency proceeding pursuant to § 304, before turnover of the
funds could be ordered. Id. at 350. The appellate court noted that in a domestic
bankruptcy, “although federal bankruptcy law determines the outer boundary of
what may constitute property of the estate, state law determines the ‘nature of a
debtor’s interest’ in a given item.” Id. at 349. The Second Circuit stated,
Koreag, as liquidator, has asked a United States bankruptcy court to
require 	the 	turnover 	of 	disputed 	assets 	to 	a 	foreign 	insolvency
proceeding. The power of the court extends to ‘property of [the]
estate.’ § 304(b)(2). Once a plausible challenge is presented as to
whether particular property falls within the statutory definition, the
bankruptcy court whose authority is invoked must determine the
legitimacy 	of 	that 	invocation. 	The 	nature 	of 	this 	determination
demands that it be made prior to the turnover of the property.
7 11 U.S.C. § 304 was repealed by the Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005, and replaced by chapter 15 of the Bankruptcy Code, “Ancillary and Other Cross-
Border Cases, 11 U.S.C. § 1501 et seq. Jurisprudence that was developed under 11 U.S.C. § 304
is preserved in the context of new § 1507.
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Id. at 349. 8
Read in its entirety, Koreag supports the bankruptcy court’s retention of
jurisdiction to decide whether the Botticelli is part of Debtor’s estate when it
determines the extent of the Trust’s liens on the Botticelli. The courts in Koreag
considered whether funds should be turned over to the Swiss liquidator, and the
Second Circuit required the bankruptcy court to make a determination of whether
the funds were property of the estate, as part of the turnover motion. Id. at 349,
350. Similarly, in the case at bar, the Court will have to determine whether the
Debtor and the estate had an interest in the Botticelli, as part of determining the
order of the priorities of the competing interests in the work of art, as well as
8 Having found that the bankruptcy court was required to make a threshold determination of
whether the funds were property of the estate, the Koreag court went on to consider whether
New York or Swiss law should apply to that determination. The court stated the rule: “Federal
courts 	sitting 	in 	diversity 	jurisdiction 	are 	required 	by 	Klaxon 	Co. 	v. 	Stentor 	Electric
Manufacturing Co., 313 U.S. 487, 496, 85 L. Ed. 1477 , 61 S. Ct. 1020 (1941), to apply the
choice-of-law doctrines of the forum state. Many bankruptcy courts have read Klaxon as
imposing 	the 	forum 	state’s 	choice-of-law 	rules 	on 	bankruptcy 	adjudications 	where 	the
underlying rights and obligations are defined by state law. In contrast, federal principles should
guide our consideration of which jurisdiction's substantive law applies in cases arising out of
federal law.” In re Koreag, Controle et Revision S.A., 961 F.2d 341, 350 (2d Cir. 1992). The
court found that the federal and New York choice-of-law standards were similar, requiring the
court to apply the law of the jurisdiction having the greatest interest in the litigation. The court
examined the interests of Switzerland and New York, and concluded that New York had a
greater interest: “New York’s concerns relate to the underlying property claims at stake, the
corresponding contract rights of the parties, and the conduct giving rise to this particular property
dispute. These relationships are ordinarily regulated under New York law, and New York is
concerned with how this law operates as to a New York corporation with its principal place of
business in New York. Switzerland’s interests, on the other hand, focus less upon the ownership
of particular property than upon the fair and organized administration of the debtor's estate, once
defined.” Id. at 351.
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whether Kraken’s claim may be allowed. 	Koreag 	does not support Kraken’s
argument that the question of whether the Botticelli is property of the estate can be
severed from the larger question of the priority of the competing interests and
decided in another forum. In fact, Koreag supports the opposite outcome —
determination of whether the debtor had an interest in the work of art should be
made by the bankruptcy court as a necessary element of an avoidance action
created by the Bankruptcy Code. 	Id. 	at 350 (“[P]articular property must be
determined to be ‘of the estate’ before it may be turned over pursuant to §
304(b)(2).”); see also In re Halabi, 184 F.3d 1335 (11th Cir. 1999) (affirming
summary judgment for banks; trustee could not avoid assignment of properly
perfected mortgage using § 544; debtor had no interest in that property and it was
not property of the debtor); In re Rector, 14 B.R. 1008 (Bankr. D. Tenn. 1981)
(denying summary judgment for trustee seeking to recover funds paid to debtor’s
lawyers under § 547(b); funds were paid by debtor’s ex-husband and earmarked
for payees by court order, and thus were not property of the debtor).
The Court holds that it has jurisdiction to determine the priority of interests
in the Botticelli, a core matter pursuant to 28 U.S.C. §§ 157(b)(2)(B), (K) and (O).
Bankruptcy 	courts 	may 	apply 	state 	law 	as 	part 	of 	the 	resolution 	of 	core
proceedings. Determination of whether property was property of the debtor is more
efficiently determined as one element of an action by the trustee to avoid an
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unperfected security interest pursuant to 11 U.S.C. § 544(a). Judicial economy is
better served by letting the bankruptcy court determine whether Debtor had a pre-
petition interest in the Botticelli, as part of a single legal proceeding — the
determination of whether the Trust may avoid any unperfected security interest of
Kraken. Kraken’s interest in the Botticelli will be determined irrespective of the
stay, as part of the § 544(a) action and allowance of its claim, which are both core
proceedings in the domain of the bankruptcy court.
The bankruptcy court may deny arbitration of a substantively core matter.
“The Federal Arbitration Act (“FAA”), see 9 U.S.C. §§ 1 et seq., requires a
federal 	court 	to 	enforce 	an 	arbitration 	agreement 	and 	stay 	litigation 	that
contravenes it.” Kittay v. Landegger (In re Hagerstown Fiber Ltd. P’ship), 277
B.R. 181, 197 (Bankr. S.D.N.Y. 2002). “The FAA signifies a congressional
declaration of a liberal federal policy favoring arbitration agreements, and any
doubts concerning the scope of arbitrable issues should be resolved in favor of
arbitration.” Id. (citation omitted). “The policy favoring arbitration is so strong that
an arbitration agreement must be enforced notwithstanding the presence of other
persons who are parties to the underlying dispute but not to the arbitration
agreement.” Id. (citation omitted). “[By] its terms, the Act leaves no place for the
exercise of discretion by a district court, but instead mandates that district courts
shall direct the parties to proceed to arbitration on issues as to which an arbitration
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agreement has been signed.” Genesco, Inc. v. Kakiuchi & Co., 815 F.2d 840, 844
(2d Cir. 1987).
Where a court is asked to stay proceedings pending arbitration in a case
covered by the FAA, four determinations that must be made by the court: 1.
whether the parties agreed to arbitrate; 2. the scope of that agreement; 3. if federal
statutory claims are asserted; and 4. if some claims are arbitrable, whether to stay
the balance of the proceedings pending arbitration. Id.; see also Kittay, 277 B.R. at
198. “In determining whether a particular claim falls within the scope of the
parties’ arbitration agreement, we focus on the factual allegations in the complaint
rather than the legal causes of action asserted.” Genesco, 815 F.2d at 846; see also
Maross Constr., Inc. v. Central New York Regional Transp. Authority, 66 N.Y.2d
341, 345 (N.Y. 1985) (“Where the parties have expressly agreed to arbitrate their
disputes, it remains to be determined whether the subject matter of the dispute is
one that may be submitted to arbitration without violation of any law or public
policy and, if so, whether it falls within the scope of the arbitration agreement.”).
The FAA supports enforcement of arbitration clauses in contracts, while the
Bankruptcy Code supports consolidation of reorganization and the attendant legal
activities in a single forum, the bankruptcy court. “In the bankruptcy setting,
congressional 	intent 	to 	permit 	a 	bankruptcy 	court 	to 	enjoin 	arbitration 	is
sufficiently clear to override even international arbitration agreements.” In re
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United States Lines, 197 F.3d 631, 639 (2d Cir. 1999). The bankruptcy court’s
equity powers under § 105(a), the broad effect of the automatic stay described in §
362(a), and the centralization of disputes and efficient reorganization are evidence
of a congressional mandate that requires the policy in favor of arbitration to yield
to the integrity of the reorganization process in the bankruptcy court in certain
circumstances. See id. at 639-41. A bankruptcy court turns to the distinction
between core and non-core proceedings when determining whether it should
exercise its discretion to enforce an arbitration clause, or require the matter to be
resolved in bankruptcy court.
[Some bankruptcy] proceedings are core for substantive reasons; they
are not based on the parties’ pre-petition relationship, and involve
rights created under the Bankruptcy Code. Such disputes will often
fail the preliminary question of arbitrability because the parties did not
agree to arbitrate them. Nevertheless, even if they are covered by the
arbitration clause, it is more likely that arbitration will conflict with
the policy of the Bankruptcy Code that created the right in dispute.
Kittay v. Landegger (In re Hagerstown Fiber Ltd. P’ship), 277 B.R. 181, 202-03
(Bankr. S.D.N.Y. 2002) (denying arbitration of fraudulent conveyance litigation).
An early case discussing the apparent conflict between enforcement of
arbitration clauses and administration of bankruptcy cases in the single forum of
the bankruptcy court is Hays and Co. v. Merrill Lynch, 885 F.2d 1149 (3d Cir.
1989). In Hays, debtor entered an agreement with its brokerage firm that included a
requirement to arbitrate controversies arising out of the brokerage relationship. Id.
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at 1150. Allegedly, Merrill Lynch invested the money in speculative securities
contrary to debtor’s directions, and commingled funds in personal and corporate
accounts. 	Id. 	After 	the 	debtor 	filed 	for 	bankruptcy, 	the 	chapter 	11 	trustee
commenced a lawsuit against Merrill Lynch, pleading claims under common law,
as well as federal, Pennsylvania and New Jersey law, and under § 544 of the
Bankruptcy Code. Id. 	Merrill Lynch moved to compel arbitration, and the court
denied the motion. Id. at 1151.
The Third Circuit held that the trustee-plaintiff stands in the shoes of the
debtor and is bound by the arbitration clause to the same extent as would be the
debtor, and that § 544(b) claims are not derivative of the debtor and are not
arbitrable. Id. at 1153. The court included arbitration clauses as encompassed by
the general rule that trustees are bound by pre-petition, non-executory contracts,
noting the strong federal policy favoring arbitration and the Arbitration Act. Id. at
1153-54. The court found that the claims under § 544(b) were not arbitrable — the
trustee’s rights were created by the Bankruptcy Code, and were not derived from
the debtor: “[T]here is no justification for binding creditors to an arbitration clause
with respect to claims that are not derivative from one who was a party to it.” Id. at
1155.9
9 The appellate court in Hays concluded its discussion by deciding whether the bankruptcy court
had discretion to decline to enforce the arbitration clause, and concluded that it did not. This
portion of the Hays decision concerned a non-core proceeding.
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In bankruptcy cases, the enforceability of arbitration clauses is governed by
whether the matter to be arbitrated is substantively core. The Second Circuit
discussed arbitration clauses in bankruptcy in In re United States Lines, Inc., 197
F.3d 631 (2d Cir. 1999), in which a reorganization trust, successor to the debtors,
sought a declaratory judgment regarding its rights under insurance contracts. In
United States Lines, about 18,000 claims were filed regarding asbestos-related
injuries, and more were expected. The insurance proceeds were likely to be the
only source of recovery for these creditors.
The Second Circuit noted the Supreme Court’s statement in 	Northern
Pipeline Construction Co. v. Marathon Pipe Line. Co., 458 U.S. 50 (1982)
(“Marathon”), 	the 	decision 	that 	prompted 	Congress 	to 	create 	the 	distinction
between core and non-core proceedings: “[T]he restructuring of debtor-creditor
relations, 	which 	is 	at 	the 	core 	of 	the 	federal 	bankruptcy 	power, 	must 	be
distinguished from the adjudication of state-created private rights, such as the right
to recover contract damages.” United States Lines, 197 F.3d at 636 (quoting
Marathon). The Second Circuit noted that it has held that “ ‘core proceedings’
should 	be 	given 	a 	broad 	interpretation 	that 	is 	close 	to 	or 	congruent 	with
constitutional limits as set forth in Marathon, and that Marathon is to be construed
narrowly.” United States Lines, 197 F.3d at 637. The appellate court stated the
rule, “[u]nder Marathon, whether a contract proceeding is core depends on (1)
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whether the contract is antecedent to the reorganization petition; and (2) the degree
to which the proceeding is independent of the reorganization. The latter inquiry
hinges on the nature of the proceeding.” Proceedings can be core by virtue of their
nature if either (1) the type of proceeding is unique to or uniquely affected by the
bankruptcy proceedings, or (2) the proceedings directly affect a core bankruptcy
function. Id. (citations omitted). “Core bankruptcy functions of particular import to
the instant proceedings include fixing the order of priority of creditor claims
against a debtor, placing the property of the bankrupt, wherever found, under the
control of the court, for equal distribution among the creditors, and administering
all property in the bankrupt’s possession.” Id. (citations omitted).
The United States Lines judges were in agreement that the contract and
breach under consideration presented a core proceeding.10 Having established that
10 The United Lines opinion was written by Judge Walker. Judge Walker determined that the
bankruptcy court had core jurisdiction over the proceeding for the declaratory judgment, due to
the impact the contracts would have on other core bankruptcy functions. He noted that the
insurance contracts could be the most important asset of the estate, and a “pay-first” provision in
the contracts necessitated declaratory relief to make sure the trust would be indemnified for
money it would have to pay the claimants. Judge Newman concurred in all aspects except for
Judge Walker’s statement that whether a post-petition breach of a pre-petition contract was core
depended on the impact the contract had on core bankruptcy functions. Judge Newman proposed
a bright-line rule that all suits alleging post-petition breaches of pre-petition contracts should be
core. Similarly, Judge Calabresi concurred in all parts of Judge Walker’s opinion, except for the
statement that whether a post-petition breach of a pre-petition contract is core depends on the
impact the contract has on core bankruptcy functions, and found that the narrow question of how
to determine whether a post-petition breach of a pre-petition contract was core was not before the
court. The three judges were in agreement that this particular contract and breach presented a
core proceeding.
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the proceeding was core, the United States Lines court considered whether the
bankruptcy court properly annulled the arbitration clause, and stated the standard
of review: “Where the bankruptcy court has properly considered the conflicting
policies in accordance with law, we acknowledge its exercise of discretion and
show due deference to its determination that arbitration will seriously jeopardize a
particular core bankruptcy proceeding.” Id. at 641. The Second Circuit found that
the bankruptcy court had properly exercised its discretion to refuse to send the core
proceedings to arbitration: 1. the declaratory judgment proceedings were integral to
the court’s ability to preserve and equitably distribute the trust’s assets; 2. the
bankruptcy court was the preferable venue in which to handle mass tort actions
against an insolvent debtor; and 3. the factual scenario was complex, involving
multiple claims, policies and insurers.
Kraken relies on MBNA America Bank, N.A. v. Hill, 436 F.3d 104 (2d Cir.
2006), for the proposition that bankruptcy courts favor arbitration. In Hill, debtor
attempted to bring a class action suit in the bankruptcy court as an adversary
proceeding, alleging that MBNA had violated the stay by continuing to deduct
monthly payments from her bank account. See id. at 106. In response to the
complaint, MBNA moved to enforce an arbitration clause in the agreement
between the parties, which stated that any claim or dispute arising from or relating
in any way to the agreement or the account would be resolved by binding
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arbitration. Id. The Second Circuit noted that bankruptcy courts generally do not
have discretion to refuse to compel arbitration of “non-core” bankruptcy matters,
or matters that are simply “related to” bankruptcy cases. Id. at 108. With respect to
core proceedings, “the bankruptcy court will not have discretion to override an
arbitration agreement unless it finds that the proceedings are based on provisions
of the Bankruptcy Code that inherently conflict with the Arbitration Act or that
arbitration 	of 	the 	claim 	would 	necessarily 	jeopardize 	the 	objectives 	of 	the
Bankruptcy 	Code.” 	Id. 	(citation 	omitted). 	“This 	determination 	requires 	a
particularized inquiry into the nature of the claim and the facts of the specific
bankruptcy. The objectives of the Bankruptcy Code relevant to this inquiry include
the goal of centralized resolution of purely bankruptcy issues, the need to protect
creditors and reorganizing debtors from piecemeal litigation, and the undisputed
power of a bankruptcy court to enforce its own orders.” Id. (citation omitted).
The Second Circuit reversed and remanded the lower courts’ decisions to
refuse arbitration, even though the matter was core. First, the Second Circuit stated
that the debtor, an individual in a no-asset chapter 7 case, had received her
discharge and the case was fully administered. Second, “as a purported class
action, [debtor’s] claims lack the direct connection to her own bankruptcy case that
would weigh in favor of refusing to compel arbitration.” Id. at 109. Third, the stay
is not so closely related to an injunction that it could only be enforced by the
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bankruptcy court.
In Hill, the Second Circuit distinguished the facts and legal questions under
consideration from those presented by United States Lines. The Hill court noted
that the question in United States Lines implicated core insurance claims that were
integral to the bankruptcy court’s ability to preserve and equitably distribute assets
of the estate, where the debtor faced mass tort actions. The Hill court cited Gandy
v. Gandy (In re Gandy), 299 F.3d 489 (5th Cir. 2002), in which the circuit court
affirmed that a complaint in which the debtor primarily sought to recover transfers
pursuant to Bankruptcy Code §§ 544(b), 548 and 550 would not be sent to
arbitration, where the claims represented nearly the entirety of the estate, the
claims concerned the equitable distribution of the assets among creditors and one
of the remedies sought was not available in arbitration; and Phillips v. Congelton,
LLC (In re White Mt. Mining Co., LLC.), 403 F.3d 164 (4th Cir. 2005) (affirming
denial of arbitration of disputes between owners of debtor; arbitration would have
made it difficult to attract funding, undermined creditor confidence, undermined
confidence of parties doing business with the debtor, and imposed additional costs
on the estate).
In the matter at bar, Kraken seeks relief from the stay to pursue arbitration in
Jersey pursuant to a prepetition consignment agreement with the Debtor. Kraken’s
motion is denied. The Trust, asserting rights derived from the Bankruptcy Code
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and the Bank, is not a party to the consignment agreement and is not bound by the
Jersey Law Clause. The dispute between the Trust and Kraken is a substantively
core matter, and it is not subject to arbitration.
The Court considers the Marathon factors discussed in United States Lines
to determine whether the consignment agreement is core: 1. the consignment
agreement that contains the Jersey Law Clause was entered by Debtor and Kraken
on May 3, 2006, about a year and a half before the bankruptcy case was filed; and
2. the proceeding to determine the validity of the liens is totally dependent on the
reorganization, implicating the powers of the Trust under § 544 that are created by
the Bankruptcy Code and unique to the Bankruptcy Code. Determination of the
Trust’s interest in the Botticelli concerns whether a substantial claim will be
allowed, 	which 	is 	unique 	to 	the 	bankruptcy 	proceedings; 	and 	represents 	a
potentially significant source for creditor recovery. According to the agreement
between Debtor and Kraken, the Botticelli was to be sold for $9.5 million, which
suggests to the Court that the work of art is quite valuable. If the Trust’s interest is
superior to Kraken’s, then liquidation of the painting may cause the creditors to
receive a greater distribution than they would receive without the Botticelli.
The matter at bar bears striking similarities to the matter under consideration
in United States Lines. In that case, the Second Circuit noted that it was confronted
with core bankruptcy functions including fixing the order of priority of creditor
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claims against a debtor, placing the property of the debtor, wherever found, under
the 	control 	of 	the 	court, 	for 	equal 	distribution 	among 	the 	creditors, 	and
administering all property in the bankrupt’s possession. United States Lines, 197
F.3d at 637. These are exactly the same core bankruptcy functions presented by the
question of who has the superior interest in the Botticelli. Competing interests are
asserted by three parties, Kraken, the Trust as a judicial lien creditor under § 544,
and the Trust as assignee of the Bank, and the priority of these interests must be
determined. The Botticelli is in the control of the Court, and has been subject to the
Court-ordered Art Protocol; and the interests in the Botticelli must be adjudicated
so that it can be either liquidated for the benefit of creditors in the bankruptcy or
returned to Kraken or other rightful owner.
With respect to the four-factor test federal courts apply when determining
whether to enforce an arbitration clause, Kraken fails to satisfy the first prong: that
the parties agreed to arbitrate. It seeks to enforce an arbitration clause and a choice
of law clause against parties that were not parties to its agreement with the Debtor,
regarding rights that are not contemplated by the agreement. The consignment
agreement provides for consignment by Kraken to Debtor for one year; for $8.5
million of sale proceeds to Kraken; for insurance; for presentment of the painting
to experts; for exhibition in a separate room; for Debtor to use best efforts to sell
the painting; Kraken warrants ownership of the painting; asking price of $9.5
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million; and for sale proceeds to be remitted to Kraken upon receipt or within
thirty days. The arbitration clause provides, “[a]ny disputes between the parties,
including any disputes regarding this agreement, will be referred to arbitration. . .
.” 	(emphasis 	added). 	The 	consignment 	agreement 	makes 	no 	reference 	to
bankruptcy.
The Trust is not a party to the consignment agreement. The Trust acquired
its alleged right to avoid Kraken’s unperfected security interest from Bankruptcy
Code § 544(a) — a right that flows from the Bankruptcy Code, not the Debtor. If
the Trust argues that it comes by its rights as assignee of the Bank, which was not a
party to the consignment agreement, then the Trust cannot be said to be a party to
the consignment agreement.
Kraken argues that whether the Botticelli was property of the Debtor at the
time the case was commenced is a distinct, arbitrable issue, but, as noted above, it
is really part of the prima facie case that the Trust must make if it attacks Kraken’s
claim using its powers under § 544(a). See Koreag. The determination of whether
property was property of the Debtor cannot be severed from the other issues
involved in a § 544 action and sent to arbitration. Rights under chapter 5 of the
Bankruptcy Code, including lien avoidance under § 544, recovery of preferential
transfers under § 547 and recovering fraudulent transfers under § 548, are not
derived from the Debtor. Allowing part of a § 544 action to be resolved by
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arbitration pursuant to a pre-petition arbitration agreement would improperly
subject the trustee to an arbitration clause to which it was not a party, in
contravention of established authority that § 544 rights are not derived from the
Debtor. Whether the Botticelli was property of the Debtor may determine the
priority of the Trust’s lien against the Botticelli pursuant to § 544, and must be
decided by the bankruptcy court. To bifurcate the § 544 claim in the manner
demanded by Kraken would be to abandon the jurisprudence established by Hays
and United States Lines. Arbitrating part of the § 544 claim in Jersey, then
litigating 	the 	other 	part 	of 	the 	claim 	in 	bankruptcy 	court 	would 	lead 	to 	a
multiplicity 	of 	proceedings, 	undermine 	judicial 	economy, 	and 	decentralize
disputes, all of which militate against finding cause for relief from the stay. See In
re Sonnax Indus., Inc., 907 F.2d 1280, 1286 (2d Cir. 1990).
Upon 	the 	foregoing, 	Kraken’s 	dispute 	with 	the 	Liquidation 	Trust 	is
unquestionably a core matter. The dispute at bar falls squarely within the rules
stated by the Second Circuit in United States Lines. It appears that one of the
questions to be arbitrated is the effect of Kraken’s failure to file a U.C.C. financing
statement with respect to the Botticelli, which is the question that will determine
the priority of the Trust’s interest in the work of art. This question is fundamentally
concerned with whether the Trust may claim the superior lien on the work of art
pursuant to § 544 or as a result of the assignment of the Bank’s lien. The priority of
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the liens will determine whether Kraken’s claim will be allowed.
The Court considers the policies that support enforcement of arbitration
clauses: Kraken is a foreign entity that wished to protect itself from unknown laws,
and purposefully required the Jersey Law Clause. See Affidavit of Ronald Fuhrer,
Docket No. 941. Enforcement of arbitration clauses may facilitate commerce and
may reinforce the integrity of contracts. In New York City, a commercial hub and
the location of Debtor’s gallery, an arbitration clause might be negotiated by the
parties as a necessary part of their business relationship. However, the present case
presents a classic example of the compelling policy in support of a uniform
Bankruptcy Code, to facilitate reorganization of debt and assets, allow repayment
of creditors, and centralize disputes in a single forum.
At the time the bankruptcy case was commenced, Debtor’s books and
records had been impounded and art sales enjoined pursuant to orders issued by
New York state courts. At least nineteen lawsuits were pending against the Debtor.
See Docket No. 459, Statement of Financial Affairs. The Debtor and its principal
eventually 	were 	charged 	with 	several 	crimes, 	including 	grand 	larceny 	and
scheming 	to 	defraud 	investors. 	Disclosure 	Statement, 	at 	13. 	Collectors
unexpectedly found strangers asserting claims to their artwork, without their
knowledge or permission. Commercial creditors cannot be paid from proceeds of
sales of the artwork until the competing claims are resolved. Amid this legal chaos,
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the only hope for fair creditor recovery lies in the efficient administration of estate
assets in a single forum, the bankruptcy court. The very law that Kraken seeks to
avoid is meant to protect the interests of parties that were unaware of the
relationship 	between 	Debtor 	and 	Kraken, 	and 	who 	were 	not 	parties 	to 	the
consignment agreement. Binding these third parties — the trustee in bankruptcy
and a commercial lender — to arbitration would be grotesquely unfair, and would
undermine state law and policies that require the perfection of security interests by
filing public financing statements.
Kraken’s dispute over priority of interests in the Botticelli is hardly an
isolated prepetition lawsuit; rather, it is intertwined with the fundamental goals of
this case: the distribution of a gallery crammed with art of unknown value, and
payment of collectors and trade creditors who became mired in a fraud. The
resolution of the competing claims to the body of artwork in the possession of the
Debtor at the time the case was commenced is the primary purpose of this
bankruptcy case. The Debtor has spent significant money on cataloguing and
storing the artwork. The Court approved a special protocol designed to facilitate
the resolution of the claims to the art, which was established by order. The Court
approved a plan by order entered on January 20, 2010, which provides for the
continuing resolution of the competing claims to the art. Sale of the works of art in
which the Trust has the superior interest is the most significant source of creditor
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recovery in this case.
Kraken has failed to persuade the Court that the consequence of its failure to file
a financing statement may be governed by Jersey law.
In addition to the foregoing conclusions, the Court holds that Kraken has
failed to present a legal analysis of choice of law principles sufficient to persuade
the Court that the Jersey Law Clause survives the limitation on contractual choice
of law provisions set forth in N.Y. U.C.C. § 1-105(2).11 Kraken has not established
that it has a colorable right to enforce the Jersey Law Clause against the Trust,
which is not a party to the consignment agreement, in a matter that concerns
Kraken’s failure to file a financing statement. “If the movant fails to make an
initial showing of cause . . . the court should deny relief without requiring any
showing from the debtor that it is entitled to continued protection.” In re Sonnax
Industries, Inc., 907 F.2d 1280, 1285 (2d Cir. 1990). Kraken argues that whether
11 N.Y. U.C.C. § 1-105 states:
Territorial Application of the Act; Parties' Power to Choose Applicable Law
(1) Except as provided hereafter in this section, when a transaction bears a
reasonable relation to this state and also to another state or nation the parties may
agree that the law either of this state or of such other state or nation shall govern
their rights and duties. Failing such agreement this Act applies to transactions
bearing an appropriate relation to this state.
(2) Where one of the following provisions of this Act specifies the applicable law,
that provision governs and a contrary agreement is effective only to the extent
permitted by the law (including the conflict of laws rules) so specified:
*** Law governing perfection, the effect of perfection or non-perfection, and the
priority of security interests and agricultural liens. Sections 9-301 through 9-307.
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property is property of the estate is a question of state law, and state law,
specifically N.Y. U.C.C. § 1-105(1), states that choice of law provisions should be
upheld where the chosen law and forum bears a reasonable relation to the
transaction.12
Even assuming that it is the New York Uniform Commercial Code that
governs whether the choice-of-law aspect of the Arbitration Clause should be
enforced, Kraken fails to address U.C.C. § 1-105(2), which states, “Where [U.C.C.
sections 9-301 through 9-307, among others] specifies the applicable law, that
provision 	governs 	and 	a 	contrary 	agreement 	is 	effective 	only 	to 	the 	extent
permitted by the law (including the conflict of laws rules) so specified[.]” N.Y.
U.C.C. §§ 9-301 through 9-307 address the law governing perfection and priority
of security interests. Section 9-301 states that, with exceptions, while a debtor or
collateral is located in a jurisdiction, the local law of that jurisdiction governs
perfection, the effect of perfection or nonperfection, and the priority of a security
12 “In most instances bankruptcy courts rely on the rule observed by federal district courts
hearing diversity cases and use the choice of law rules of the forum state.” In re Eagle
Enterprises, Inc., 223 B.R. 290, 292 (Bankr. E.D. Pa. 1998). New York applies an “interest
analysis” to choice of law problems. Hong Kong and Shanghai Banking Corp., Ltd. v. HFH USA
Corp., 805 F. Supp. 133, 140 n.3 (W.D.N.Y. 1992). In HSBC, the court noted that New York law
would apply under the interest analysis. The goods were located in New York, the financing
statements were filed with New York, and application of New York law would further the goals
of New York’s Article 9: predictability of transactions and the provision of notice to prospective
creditors. These factors showed the importance of the contacts that the transactions had with
New York.
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interest in collateral. 13 By failing to address N.Y. U.C.C. § 105(2), which suggests
that choice of law clauses yield to local law in the determination of questions
regarding perfection, Kraken has failed to demonstrate to the Court that it is
entitled to enforce the Jersey Law Clause.
The Court cannot overlook the apparent inconsistency between Kraken’s
argument that N.Y. U.C.C. § 1-105(2) is an irrelevant exception to the “reasonable
relation” rule, and the plain text of N.Y. U.C.C. § 1-105(2) that suggests that a
choice-of-law clause should not be enforced with respect to perfection. Parties to a
contract are not allowed to opt out of the rules regarding perfection. The rules are
meant to protect third parties that might extend credit, by providing notice of the
secured party’s interest in collateral in such a manner that other creditors can find
it. See In re Eagle Enterprises, Inc., 223 B.R. 290, 293 (Bankr. E.D. Pa. 1998)
(holding that German choice of law clause did not apply to perfection of security
interests, according to Pennsylvania law substantially similar to N.Y. U.C.C. § 1-
13 N.Y. U.C.C. § 9-301 states:
Law Governing Perfection and Priority of Security Interests
Except as otherwise provided in Sections 9-303 through 9-306, the following
rules determine the law governing perfection, the effect of perfection or
nonperfection, and the priority of a security interest in collateral:
(a) Except as otherwise provided in this section, while a debtor is located in a
jurisdiction, the local law of that jurisdiction governs perfection, the effect of
perfection or nonperfection, and the priority of a security interest in collateral.
(b) While collateral is located in a jurisdiction, the local law of that jurisdiction
governs perfection, the effect of perfection or nonperfection, and the priority of a
possessory security interest in that collateral.***
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105(2); 	“the 	[chapter 	7] 	Trustee 	stands 	in 	the 	role 	of 	a 	third 	party 	as 	a
representative of all creditors, and is specifically given the powers of a judicial lien
creditor under 11 U.S.C. § 544. The Trustee, thus, is a third party whose rights
cannot be governed by [the creditor’s] contract with the Debtor.”); Hong Kong and
Shanghai Banking Corp., Ltd. v. HFH USA Corp., 805 F. Supp. 133 (W.D.N.Y.
1992) (holding German law did not apply, according to previous version of N.Y.
U.C.C. § 1-105; “[T]he parties’ stipulation will not be regarded where it would
operate to the detriment of strangers to the agreement, such as creditors or
lienholders.”); Manufacturers Hanover Trust Co. v. Frymire, 1991 WL 274972, at
*7 (N.D. Ill. 1991) (“U.C.C. § 1-105(2) mentions five exceptions, all involving
third party rights, where a choice of law clause in the contract will not prevail; but
the Code does not limit the exceptions to those five examples. The general tenor of
the Code indicates that third parties should not be bound by a choice of law
clause.”). In light of the plain reading of N.Y. U.C.C. § 1-105(2), Kraken has failed
to present a colorable argument that it is entitled to enforce the choice-of-law
provision of the Jersey Law Clause against the Trust, because the rights it intends
to assert flow from the Bankruptcy Code and as assignee of the Bank’s alleged
lien. As such, it cannot be said, for purposes of determining whether Kraken’s
motion may be granted, that the Trust is a party to the consignment agreement and
bound by the clause setting Jersey law as the applicable choice of law.
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CONCLUSION
Kraken’s motion for relief from the stay is DENIED in all aspects. The
Court exercises its discretion to deny the enforcement of the arbitration provision
of the Jersey Law Clause. The determination of the Trust’s interest in the Botticelli
is a core proceeding that may implicate its powers under § 544 of the Bankruptcy
Code. 	The 	Trust, 	allegedly 	having 	come 	by 	its 	rights 	by 	operation 	of 	the
Bankruptcy Code and by assignment from the Bank, is not a party to the
consignment agreement and did not agree to arbitrate the priority of its liens or the
question of whether Debtor had an interest in the Botticelli at the time the
bankruptcy case was commenced. Kraken failed to persuade the Court that the
choice of law provision of the Jersey Law Clause is not pre-empted by N.Y.
U.C.C. §§ 1-105(2) and 9-301 through 9-307. Given these deficiencies in its
argument, Kraken has failed to establish cause for relief from the stay. Kraken’s
motion is denied.
Counsel to the Trust shall submit an order consistent with this decision.
Dated: 	July 18, 2011
Poughkeepsie, New York
/s/ Cecelia G. Morris
The Hon. Cecelia. G. Morris
United States Bankruptcy Judge
07-30005-cgm Doc 988 Filed 07/18/11 Entered 07/18/11 16:51:24 Main Document
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