Herrington v. Countrywide Home Loans et al

On April 3, 2007, defendant Countrywide was dismissed from this proceeding by1
agreement.
UNITED STATES BANKRUPTCY COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
In re 	: 	Chapter 13
KENNETH HERRINGTON 	:
Debtor 	: 	Bankruptcy No. 06-14433bif
____________________________________
KENNETH HERRINGTON 	:
Plaintiff 	:
v. 	:
WELLS FARGO BANK, MINNESOTA, 	:
N.A., DELTA FUNDING CORPORATION
and COUNTRYWIDE HOME LOANS 	: 	Adversary No. 07-0009
Defendants 	:
____________________________________
.................................................
MEMORANDUM
.................................................
Presently before me are the motions of defendants Delta Funding
Corporation and Wells Fargo Bank, Minnesota, N.A. to compel arbitration as to two
counts of the plaintiff’s amended complaint, Count II, styled “HOEPA Recoupment,”1
and Count III, styled “UDAP.”
“A motion to compel arbitration calls for a two-step inquiry into (1)
whether a valid agreement to arbitrate exists and (2) whether the particular dispute falls
within the scope of that agreement.” Trippe Mfg. Co. v. Niles Audio Corp., 401 F.3d
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529, 532 (3d Cir. 2005). As will be discussed below, the plaintiff opposes defendant’s
motion by arguing that no valid arbitration agreement exists (as it is unconscionable) and
that both counts in this proceeding are non-arbitrable within the express terms of the
agreement. He also asserts that this court should exercise its discretionary authority not to
enforce the arbitration agreement.
For the following reasons, the defendants’ motions will be granted in large
part.
I.
On September 30, 2006, the plaintiff filed a voluntary petition in
bankruptcy under chapter 13. Wells Fargo then filed a secured proof of claim in the
amount of $44,100.97 dated December 14, 2006. This claim is purportedly secured by
real estate located at 1928 West Somerset Street, Philadelphia, Pennsylvania.
On January 12, 2007, the debtor commenced the above-captioned adversary
proceeding. In an amended complaint, the debtor raises claims arising from a loan
transaction of July 24, 2000, wherein he borrowed $19,800 from defendant Delta, secured
by a mortgage on his residence. Wells Fargo is alleged to be Delta’s assignee and current
holder of the note and mortgage.
In Count I of the amended complaint, the debtor contends that the value of
the realty serving as collateral for Wells Fargo’s secured claim does not exceed $22,000.
Amended Complaint, ¶ 18. The debtor further asserts that Delta assigned to Wells Fargo
a security interest in his residence as well as certain of the debtor’s personal property, id.,
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¶ 21, the latter of which deprives the creditor of the “anti-modification” protections of
section 1322(b)(2). Id., ¶ 22. Accordingly, the debtor in Count I seeks to bifurcate Wells
Fargo’s claim into secured and unsecured components by virtue of section 506(a), in
which the secured component does not exceed $22,000. Id., ¶ 23.
In Count II of the amended complaint, the debtor asserts that Delta was
required to provide “the Plaintiff with the specific HOEPA disclosures (‘Section 32
Disclosures’) at least three business days in advance of the July 24, 2000 loan closing, as
required by 15 U.S.C. § 1639(a)(1); 12 C.F.R. § 226.32( c )(1),” Amended Complaint, ¶
42, and that Wells Fargo is liable for this failure by virtue of 15 U.S.C. § 1641(d)(1). Id.,
¶ 44. The debtor requests “recoupment of statutory damages . . . to be offset against the
total amount of the allowed secured claim of Wells Fargo . . . ,” id., “Wherefore clause,” ¶
c, plus reasonable attorney’s fees and costs under 15 U.S.C. § 1640(a)(3). Id., ¶ d.
In Count III of the amended complaint, the debtor avers that “Not providing
Mr. Herrington with the statutorily required HOEPA notice is unfair and deceptive
conduct under 73 P.S. § 201-2(xxi) of the Pennsylvania Unfair Trade Practices
Act (‘UDAP’).” Id., ¶ 50. The debtor was purportedly damaged by the “amount of fees
and costs he paid as a result of entering into this loan transaction.” Id., ¶ 53. He seeks
“recoupment of three times of his actual damages.” Id., “Wherefore clause,” ¶ e.
The July 2000 loan agreement contained an Arbitration Agreement signed
by the debtor. This agreement, a true and correct copy of which is attached to Delta’s
motion to compel arbitration as Exhibit A, contains the following definitions:
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Consistent with the applicability to assigns, a section of the arbitration agreement2
styled Survival, Severability and Primacy states that the agreement survives the sale or transfer of
the loan documents.
4
“We or “US” means Delta Funding Corporation . . . its . . .
successors and assigns. . . . 2
“Credit Transaction” means the loan obligation identified by
the above-referenced Loan Number and any prior loan
obligation which was originated, owned and/or serviced by
us. . . .
“Claim” means any claim, dispute or controversy between you
and us (except for Excluded Claims, defined below) arising
from or relating to the Credit Transaction . . . including the
validity, enforceability or scope of this Agreement. . . . The
term “Claim” is to be given the broadest possible meaning
and includes, by way of example and without limitation, any
claim . . . that arises under or relates to the Truth in Lending
Act, the Home Owners and Equity Protection Act and
Regulation Z . . . state insurance, usury and lending laws . . .
other federal or state consumer protection statutes or
regulations. . . .
“Excluded Claims” means (a) any action to effect a judicial or
non-judicial foreclosure or to establish a deficiency judgment
. . . (d) any action to assert, collect, protect, realize upon or
obtain possession of the collateral for the Credit Transaction
in any bankruptcy proceeding . . . .
Delta’s Motion to Compel Arbitration, Ex. A.
This arbitration agreement further defines non-arbitrable claims:
Notwithstanding the foregoing or any other term in this
Agreement, Excluded Claims, as defined above, are excluded
from arbitration. This means that neither you nor us can
require the other to arbitrate any Excluded Claims.
Participating in a lawsuit or seeking judicial relief with
respect to any Excluded Claims shall not waive a party’s right
to arbitrate any Claims. For example, if we were to
commence a foreclosure action against you in court, that
action and any defenses asserted by you in that action would
be adjudicated in court; however, if you asserted a
counterclaim against us in that action which was covered by
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the scope of this Agreement, we would have the right to
demand that the counterclaim be arbitrated (you would also
have the right to arbitrate the counterclaim rather than
asserting it in court).
Id. In addition, the Arbitration Agreement specifically stated that it was to be governed
by the Federal Arbitration Act (“FAA”). Id.
The arbitration agreement also contained the following provision
concerning costs and fees:
Hearing Location and Arbitration Costs. Any arbitration
hearing that you attend shall take place in the federal judicial
district of your residence. At your written request, we will
consider in good faith making a temporary advance of all or
part of the filing, administrative and/or hearing fees in
connection with any Claim you initiate as to which you or we
seek arbitration. At the conclusion of the arbitration, the
arbitrator will decide who will ultimately be responsible for
paying the filing, administrative and/or hearing fees in
connection with the arbitration. Unless inconsistent with
applicable law, each party shall bear the expense of that party’s
attorneys’, experts’ and witness fees, regardless of which party
prevails in the arbitration.
Finally, the arbitration agreement included a severability clause:
If any portion of this Agreement is deemed invalid or
unenforceable under any law or statute consistent with the
FAA, it shall not invalidate the remaining portions of this
Agreement or the Credit Transaction, each of which shall be
enforceable regardless of such invalidity.
Id.
Based upon the above-quoted definition of an arbitrable claim, both Delta
(as the original lender) and Wells Fargo (as the assignee) contend that the plaintiff’s
HOEPA and UDAP claims against them are expressly made arbitrable. Thus, these
defendants seek to stay the resolution of Counts II and III in this adversary proceeding and
to compel their determination via arbitration. See generally In re Brown, 311 B.R. 702
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The defendants did not contend that the arbitration agreement covered Count I3
(“Lien Stripdown”), which claim is based solely upon the provisions of sections 506 and 1322 of
the Bankruptcy Code. Thus, their request to stay this proceeding pending arbitration does not
include Count I. Given defendants’ position, I issued a prior order severing Count I and
scheduling a trial on that claim, as the facts and issues involved in the “Lien Stripdown” count
are different from those in the other two counts. My courtroom deputy has been informed
recently that Count I has been settled by the parties. Presumably, the parties to such an
agreement—as it involves bifurcation of a secured claim asserted by Wells Fargo—would only
be the debtor and Wells Fargo. Indeed, it is unclear to me that the debtor seeks any relief from
defendant Delta as to Counts II and III, as his amended complaint seeks “recoupment” relief and
Delta has not asserted any claim in this bankruptcy case. That issue though is not before me, as
Delta probably believes it must be raised before an arbitrator.
Also not before me at present, and perhaps also intended by the defendants to be
raised before an arbitrator, is the interplay between the bifurcation relief sought in Count I and
the recoupment relief sought in Counts II and III. Indeed, given the terms of the debtor’s
proposed chapter 13 plan (which has not been confirmed) and given the parties’ resolution of
Count I (the terms of which are not of record), the coordination of relief among the three counts
could render the outcome of the two recoupment claims of little or no significance either to the
debtor or to the defendants, beyond the issue of attorney’s fees.
6
(Bankr. E.D. Pa. 2004). They do not seek to compel arbitration of Count I, the bifurcation
claim. 3
The plaintiff raises three grounds for denying the motion to compel
arbitration. First, he contends that the arbitration clause is both procedurally and
substantively unconscionable. Second, he argues that this proceeding is a response to the
secured proof of claim filed by Wells Fargo and thus is a claim excluded from the scope of
the parties’ arbitration agreement. And third, the plaintiff maintains that this bankruptcy
court has the discretion to deny enforcement of the arbitration agreement and should
exercise its discretion to do so.
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II.
At the outset, I find unpersuasive the plaintiff’s argument that I have the
discretion not to enforce a valid arbitration agreement and stay any resolution of Counts II
and III, which counts assert claims arising from federal and state consumer protection
statutes.
“The FAA provides that arbitration agreements ‘shall be valid, irrevocable,
and enforceable, save upon such grounds as exist at law or in equity for the revocation of
any contract.’ 9 U.S.C. § 2. A court has the power to stay a proceeding if it determines
that an issue falls under an applicable arbitration clause. 9 U.S.C. § 3. If one of the
parties fails to comply with such an agreement, a court may order ‘the parties to proceed to
arbitration in accordance with the terms of the agreement.’ 9 U.S.C. § 4.” In re Mintze,
434 F.3d 222, 229 (3d Cir. 2006). Thus, in general, “[t]he FAA makes agreements to
arbitrate enforceable to the same extent as other contracts.” Harris v. Green Tree Financial
Corp., 183 F.3d 173, 178 (3d Cir. 1999). Indeed, “federal law presumptively favors the
enforcement of arbitration agreements.” Id., at 178.
The duty to enforce arbitration agreements by bankruptcy courts in this
circuit has evolved along with the contours of their subject matter jurisdiction.
After the Supreme Court rendered its decision in Northern Pipeline
Construction Co. v. Marathon Pipeline Co., 458 U.S. 50 (1982), but before Congress
responded with legislation, viz. 28 U.S.C. §§ 157, 1334, giving rise to the current
core/non-core components of bankruptcy court jurisdiction, the Third Circuit expressed
concern in Zimmerman v. Continental Airlines, 712 F.2d 55, 59-60 (3d Cir. 1983), cert.
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denied, 464 U.S. 1038 (1984), that enforcement of a prepetition arbitration provision could
undermine congressional intent found in the Bankruptcy Reform Act of 1978 to have all
issues involving the debtor resolved in one bankruptcy court forum:
The dictates of the Arbitration Act, requiring stays of
proceedings pending arbitration, could result in delays,
expenses, and duplications similar to those previously
experienced in bankruptcy proceedings because of the
dichotomy between plenary and summary jurisdiction. Clearly
a mandatory stay of a bankruptcy proceeding delays that
proceeding. Also, since issues relating to the relationship
between debtor and creditor might well be the subject of both
the bankruptcy and the arbitration proceedings, duplication of
adversarial effort, with a resulting increase in expense, would
likely occur. Therefore, the policies underlying the expansion
of bankruptcy court jurisdiction embodied in the Bankruptcy
Reform Act [of 1978] may be relied on to resolve the conflict
in the instant case.
Id., at 58-59.
Thus, the Third Circuit concluded in Zimmerman that enforcement of
arbitration agreements in bankruptcy cases was discretionary. Id., at 59-60 (“[W]hile a
bankruptcy court would have the power to stay proceedings pending arbitration, the use of
this power is left to the sound discretion of the bankruptcy court.”). See also former 28
U.S.C. § 1471(d). A bankruptcy court could decide whether enforcement of an arbitration
agreement would adversely affect the administration of the bankruptcy case.
After passage of 28 U.S.C. § 157(c), directing that bankruptcy courts could
only issue recommendations in non-core matters unless all parties agreed to the entry of a
final judgment, the congressional policy identified in Zimmerman—that the prompt
administration of a bankruptcy case by having one forum adjudicate all issues involving
the debtor was paramount—was no longer considered valid, at least as to non-core
proceedings. See Hays and Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 885 F.2d
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1149, 1159-60 (3d Cir. 1989). To the extent that Hays could be construed as suggesting
that Zimmerman retained some vitality, with bankruptcy courts having discretion not to
enforce a valid arbitration agreement in core matters, see generally In re FRG, 115 B.R.
72, 73 (E.D. Pa. 1990), the Third Circuit recently instructed otherwise in In re Mintze.
In Mintze, the Circuit Court of Appeals held that “[t]he core/non-core
distinction does not, however, affect whether a bankruptcy court has the discretion to deny
enforcement of an arbitration agreement.” In re Mintze, 434 F.3d at 229. Instead, a
bankruptcy court has no discretion not to enforce an arbitration agreement unless Congress
intended otherwise. The Circuit Court explained:
The FAA’s mandate can, however, be overridden. If a party
opposing arbitration can demonstrate that “Congress intended
to preclude a waiver of judicial remedies for the statutory
rights at issue,” the FAA will not compel courts to enforce an
otherwise applicable arbitration agreement. McMahon, 482
U.S. at 227. . . . To overcome enforcement of arbitration, a
party must establish congressional intent to create an exception
to the FAA’s mandate with respect to the party’s statutory
claims. Congressional intent can be discerned in one of three
ways: (1) the statute’s text, (2) the statute’s legislative history,
or (3) “an inherent conflict between arbitration and the
statute’s underlying purposes.” McMahon, 482 U.S. at 227[.]
Id., at 229; see In re Olympus Healthcare Group, Inc., 352 B.R. 603, 601 (Bankr. D. Del.
2006); see also Green Tree Financial Corp.-Alabama v. Randolph, 531 U.S. 79, 90 (2000)
(“In determining whether statutory claims may be arbitrated, we first ask whether the
parties agreed to submit their claims to arbitration, and then ask whether Congress has
evinced an intention to preclude a waiver of judicial remedies for the statutory rights at
issue.”).
The Court of Appeals found no evidence in either the text or legislative
history of the Bankruptcy Code evincing a congressional intent to preclude arbitration of
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As the plaintiff notes, the court in Mintze did suggest that substantive bankruptcy4
law provisions may not be within the scope of the FAA. Id., at 231-32. Here, both Delta and
Wells Fargo have not sought to arbitrate Count I of this adversary proceeding, involving a claim
under 11 U.S.C. §§ 506 and 1322.
10
disputes arising in bankruptcy cases. In re Mintze, 434 F.3d at 231. Nor did the Third
Circuit find any “inherent conflict”:
The Bankruptcy Court concluded that the ultimate decision on
Mintze's rescission claim will have an effect on the rights of
the other creditors to Mintze's estate. Determining that the
potential effect on the order of priority and the amount of
distribution to Mintze's other creditors was sufficient to create
an inherent conflict between the Bankruptcy Code's underlying
purposes and arbitration, the Bankruptcy Court concluded that
the proceeding was best left in the Bankruptcy Court. The
District Court affirmed the Bankruptcy Court, stating that its
decision was “within the appropriate bounds of discretion. . . .”
We cannot agree with this conclusion. First, to override the
FAA's mandate for enforcement of arbitration, the McMahon
standard requires congressional intent “to preclude a waiver of
judicial remedies for the statutory rights at issue.” McMahon,
482 U.S. at 227, 107 S.Ct. 2332 (emphasis added). The
statutory claims that Mintze has raised are based on TILA and
several federal and state consumer protection laws. Mintze has
failed to raise any statutory claims that were created by the
Bankruptcy Code. With no bankruptcy issue to be decided by
the Bankruptcy Court, we cannot find an inherent conflict
between arbitration of Mintze's federal and state consumer
protection issues and the underlying purposes of the
Bankruptcy Code.
Id., 434 F.3d at 231-32 (footnote omitted). 4
Furthermore, implicit in Mintze is the conclusion that claims arising from
alleged violations of federal or state consumer protection statutes were not intended by
Congress to be outside the scope of the FAA. Id., at 231-32; see In re Cooley, 362 B.R.
514, 518 (Bankr. N.D. Ala. 2007) (“[I]n consumer finance transactions where the parties
have entered into arbitration agreements, TILA claims should be resolved through
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arbitration.”). Congress expressed no intent to preclude arbitration of such claims, if the
parties so agreed.
Therefore, I have no discretionary power to decline to enforce the arbitration
agreement in this proceeding, to the extent it is a valid prepetition agreement.
III.
The plaintiff strenuously argues that the arbitration agreement at issue here is
invalid because it is unconscionable under Pennsylvania law. (The parties do not dispute
that as the loan and arbitration agreements were signed in Pennsylvania, Pennsylvania law
governs. See generally Harris v. Green Tree Financial Corp., 183 F.3d 173 (3d Cir.
1999).) As the plaintiff does not argue that the loan agreement itself was unconscionable,
but only challenges the arbitration provisions, I have the power to determine that
challenge. See Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 126 S. Ct. 1204,
1210 (2006) (“We reaffirm today that, regardless of whether the challenge is brought in
federal or state court, a challenge to the validity of the contract as a whole, and not
specifically to the arbitration clause, must go to the arbitrator.”).
Recently, the Pennsylvania Supreme Court explained the components of its
common law doctrine of unconscionability:
The doctrine of unconscionability has been applied in
Pennsylvania as both a statutory and a common-law defense to
the enforcement of an allegedly unfair contract or contractual
provision. . . . This Court, however, has not frequently
discussed the common-law application. Nevertheless, we
agree with the general formulation which has been applied
fairly consistently in the intermediate appellate courts, and
which borrows from the statutory version and is largely
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consonant with the Second Restatement of Contracts. See
Restatement (Second) of Contracts § 208 (1981).
Under that formulation, a contract or term is unconscionable,
and therefore avoidable, where there was a lack of meaningful
choice in the acceptance of the challenged provision and the
provision unreasonably favors the party asserting it. . . . The
aspects entailing lack of meaningful choice and
unreasonableness have been termed procedural and substantive
unconscionability, respectively. . . . The burden of proof
generally concerning both elements has been allocated to the
party challenging the agreement, and the ultimate
determination of unconscionability is for the courts.
Salley v. Option One Mortgage Corp., 925 A.2d 115, 119-120 (Pa. 2007) (citations and
footnote omitted).
The plaintiff in this proceeding maintains that the particular arbitration
agreement was mandated by the original lender, Delta, and that both procedural and
substantive elements of unconscionability are present. As to both substantive and
procedural unconscionability, he complains that the lender is free to prosecute its claims in
court, while the borrower’s claim must be resolved by arbitration. He argues:
Although the definitions of “claims” and “excluded claims”
appear on their face to apply equally to both parties, in reality
the underlying benefits of the “excluded claims” clause inures
wholly to Delta. As a practical matter, Mr. Herrington cannot,
for example, file a foreclosure action against Delta; or seek a
deficiency judgment against them [sic], or obtain a deed in
lieu. Thus, in reality, the “excluded claims” clause acts to
preserve Delta’s access to the courts, while essentially
precluding the borrower’s judicial access – thus, the “excluded
claims” provision is, in fact, a “reservation of judicial access”
clause which overwhelming favors Delta.
Furthermore, the Agreement also provides that even if Delta
initiates judicial action on an “excluded claim” (for example,
filing a foreclosure or filing a proof of claim in a bankruptcy),
Delta’s choice to use the courts does not waive Delta’s right to
nevertheless force arbitration of any counterclaims filed in
response by the borrower.
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***
In effect, this provision is an “anti-waiver” clause: a one-sided
attempt to avoid any argument that Delta has waived any right
to arbitrate a borrower’s claims even after Delta chooses the
courts over arbitration.
If these three separate sections are parsed carefully and read
together, they effectively (1) mandate arbitration of all
“claims,” but (2) reserve to Delta alone the choice of whether
or not to pursue “excluded claims” in arbitration or in court;
and (3) nevertheless allow Delta to compel arbitration if the
borrower raises counterclaims in response to judicial action
initiated by Delta. See supra. It is clear that, taken together,
the “reservation of judicial access” and “anti-waiver” clauses
overwhelmingly favor Delta by allowing only Delta the ability
to choose whichever forum it thinks is most favorable, and
also allowing Delta the right to ‘change its mind’ and compel
arbitration even after Delta selects the judicial forum. It would
be counterintuitive to believe that Mr. Herrington would
accept such overwhelmingly one-sided access to the courts in
favor of Delta if he was actually aware of these terms or if
another choice existed.
***
Herrington contends that the Agreement is also substantively
unconscionable because the “reservation of judicial access”
clause, together with the “anti-waiver” provision, effectively
reserves access to the courts for Delta only. These two clauses
are clearly so unreasonably onesided that they “unreasonably
favor” Delta and should not be enforced.
Plaintiff’s Reponsive Memorandum to Delta Funding’s Motion, at 7-8, 10.
In responding to Well Fargo’s motion to compel arbitration, the plaintiff
added another reason that the arbitration agreement was unconscionable:
Even if the Court were to find that the “reservation of access”
and “anti-waiver” provisions were not unconscionable per se,
the Agreement still should not be enforced since it imposes
unconscionable costs on Mr. Herrington. Despite the liberal
policy favoring arbitrations, the Supreme Court has made it
clear that arbitration is only an appropriate alternative forum
“so long as the prospective litigant effectively may vindicate
[his or her] statutory cause of action in the arbitral forum,”
Gilmer, 500 U.S. at 28, and has acknowledged that the
existence of large arbitration costs could preclude a litigant . . .
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from effectively vindicating her federal statutory rights in the
arbitral forum.” Green Tree Financial Corp. v. Randolph, 531
U.S. 79, 90 (2000).
Plaintiff’s Responsive Memorandum to Well Fargo’s Motion, at 20-21.
I shall consider both contentions of unconscionability separately.
A.
Plaintiff’s primary position—that an arbitration agreement which exempts
from binding arbitration certain creditor remedies while requiring the submission of
borrower claims to arbitration is unconscionable under Pennsylvania law—was supported
by the Pennsylvania Superior Court decision in Lytle v. CitiFinancial Services, Inc., 810
A.2d 643 (Pa. Super. 2002). The Pennsylvania Supreme Court in Salley v. Option One
Mortgage Corp., however, recently overruled Lytle on that point. Agreeing with the New
Jersey Supreme Court’s decision in Delta Funding Corp. v. Harris, 189 N.J. 28, 912 A.2d
104 (2006), the Salley court noted some justification for the split-forum provisions of
consumer loan arbitration agreements: The foreclosure process, culminating in a sheriff
sale of realty, is inherently judicial; and fee-shifting agreements in consumer protection
statutes ameliorate the expense to borrowers who successfully undertake the arbitration
process.
[T]here is a facially apparent business justification for such an
exception, as the safeguards thereby preserved assure
regularity and consistency for the benefit of both lender and
borrower, and accordingly, there are sound pragmatic and
policy reasons why foreclosure proceedings should be pursued
in a court of law. While there is no question that the
reservation facilitates the split-forum effect highlighted by Mr.
Salley’s amici, again, the federal and state consumer protection
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laws invoked by Mr. Salley mitigate this burden for
meritorious claims properly brought under their provisions.
See, e.g., 15 U.S.C. § 1640(a)(3); 73 P.S. § 201-9.2.
Moreover, the United States Supreme Court has made clear
that parties who agree to arbitrate some claims may exclude
others from the scope of the arbitration agreement. See Dean
Witter Reynolds Inc. v. Byrd, 470 U.S. 213, 221 . . . (1985)
(“The preeminent concern of Congress in passing the [Federal
Arbitration] Act was to enforce private agreements into which
parties had entered, and that concern requires that we enforce
agreements to arbitrate, even if the result is ‘piecemeal’
litigation[.]”); Mitsubishi Motors Corp. v. Soler
Chrysler-Plymouth, Inc., 473 U.S. 614, 628 . . . (1985)
(“Nothing, in the meantime, prevents a party from excluding
statutory claims from the scope of an agreement to arbitrate.”).
As such, the split-forum effect can be viewed as an acceptable
corollary to the general policy favoring arbitration of claims.
Salley v. Option One Mortgage Corp., 925 A.2d at 128.
As a result, the Pennsylvania Supreme Court concluded:
While we believe that Lytle was well intentioned in its effort to
guard against pernicious lending practices, our conclusion here
is that it swept too broadly. Under Pennsylvania law, the
burden of establishing unconscionability lies with the party
seeking to invalidate a contract, including an arbitration
agreement, and there is no presumption of unconscionability
associated with an arbitration agreement merely on the basis
that the agreement reserves judicial remedies associated with
foreclosure.
***
We conclude that the exception from mandatory arbitration for
foreclosure contained within the Option-One/Salley arbitration
agreement, in and of itself, does not render the agreement
presumptively unconscionable under Pennsylvania law.
Salley v. Option One Mortgage Corp., 925 A.2d at 129.
This holding is consistent with the prediction of Pennsylvania law made by
the Third Circuit in Harris v. Green Tree Financial Corporation, 183 F.3d at 183.
Accordingly, the lack of mutuality of forum found in the arbitration agreement does not
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render the agreement so unfair as to be unenforceable. See id., at 180-81; Anderson v.
Delta Funding Corp., 316 F. Supp. 2d 554, 566-67 (N.D. Ohio 2004).
B.
The debtor’s complaint in this proceeding about the potential cost to him of
asserting his consumer protection claims via arbitration was not considered in Salley, 925
A.2d at 121. The issue was analyzed, in the context of an employment dispute, by the
Third Circuit Court of Appeals in Blair v. Scott Specialty Gases, 283 F.3d 595 (3d Cir.
2002):
While this court must be mindful of the “liberal federal policy
favoring arbitration agreements,” Moses H. Cone Memorial
Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24, 103 S. Ct.
927, 74 L. Ed. 2d 765 (1983), the Supreme Court has also
made clear that arbitration is only appropriate “so long as the
prospective litigant effectively may vindicate [his or her]
statutory cause of action in the arbitral forum” allowing the
statute to serve its purposes. Gilmer v. Interstate/Johnson
Lane Corp., 500 U.S. 20, 28, 111 S. Ct. 1647, 114 L. Ed. 2d 26
(1991) (alteration in original) (quoting Mitsubishi Motors
Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 637, 105
S. Ct. 3346, 87 L. Ed. 2d 444 (1985)). Arbitration costs are
directly related to a litigant’s ability to pursue the claim. In
Green Tree Financial Corp.-Alabama v. Randolph, 531 U.S.
79, 121 S. Ct. 513, 148 L. Ed. 2d 373 (2000), the Supreme
Court acknowledged that “the existence of large arbitration
costs could preclude a litigant . . . from effectively vindicating
her federal statutory rights in the arbitral forum.” Id. at 90,
121 S. Ct. 513.
Id., at 605. On remand in Blair v. Scott Specialty Gases, the district court directed the
employer to pay all arbitration costs. See 2002 WL 1838486.
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Later, in Parilla v. IAP Worldwide Services, VI, Inc., 368 F.3d 269, 284 (3d
Cir. 2004), the Third Circuit reviewed its prior holdings on the possible unconscionability
of a provision in an agreement concerning arbitration costs, and stated:
Essentially, we have held that an arbitration provision that
makes the arbitral forum prohibitively expensive for a weaker
party is unconscionable. See Alexander, 341 F.3d at 269-70.
With respect to an employee who is unable to pay the costs of
arbitration, we see little difference between a 100% probability
that the employee will have to pay half the arbitrator’s fees and
expenses on the one hand, and an indeterminate (but less than
100%) probability that the employee would have to pay all of
the arbitrator’s fees and expenses on the other. In either case,
the employee must consider whether arbitration will be so
prohibitively expensive for her that she cannot take advantage
of the arbitral forum. Simply the prospect that the employee
may have to pay the entire amount of the arbitrator’s fees and
expenses may serve to chill her willingness to bring a claim.
Moreover, we see no reason to suspect that providing the
arbitrator with some discretion to direct whether such fees will
ultimately be incurred would have a determinative effect on
the employee’s calculus in deciding whether to seek
arbitration. We therefore conclude that, as long as Parilla
carries her burden to show an inability to pay the anticipated
arbitral costs, the “loser pays” provision is just as unreasonably
favorable to Appellants as would be a “fee splitting” provision.
Accordingly, Parilla must be allowed limited discovery on
remand in order to provide her with the means to show her
inability to pay the anticipated costs of arbitration.
Id., at 284-85.
In both Blair and Parilla, the Court of Appeals placed the burden upon the
party seeking to invalidate the arbitration agreement to demonstrate that it would be
“prohibitively expensive” to pay the agreed upon arbitration costs, thereby nullifying that
party’s ability to seek redress of her claims. The plaintiff in this adversary proceeding
attempts to meet his evidentiary burden by submitting an affidavit disclosing that his sole
income is $650 per month in disability benefits, and attaching to his memorandum a copy
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of a fee schedule from the National Arbitration Forum (one of the three acceptable dispute
resolution entities identified in the arbitration agreement). He contends that the potential
fees chargeable to him, were he compelled to seek arbitration, could exceed $1,000.
Plaintiff’s Memorandum Opposing Wells Fargo’s Motion, at 22-23. Such a large fee in
relation to his monthly income, he maintains, renders his claims against the defendants
effectively unenforceable.
Delta, in its Supplemental Brief, at 3-4 n.3, argues that the cost provisions of
the arbitration agreement (quoted earlier) afford the arbitrator discretion not to assess fees
against the plaintiff/borrower, and that arbitration entities such as JAMS and the American
Arbitration Association (the other two specified entities) can make appropriate fee waivers
where a party is indigent. Id. This defendant also contends that the arbitration cost
provision in its agreement has been upheld by other courts. See Anderson v. Delta
Funding Corp., 316 F. Supp. 2d at 567.
The New Jersey Supreme Court took a different view of this very cost
provision, a view consistent with concerns articulated by the Court of Appeals in Blair, in
analyzing Delta’s arbitration agreement. The Court observed:
It is well understood that fee-shifting provisions can deter a
litigant from pursuing a claim. . . . The prospect of having to
shoulder all the costs of arbitration could chill Harris and
similarly situated consumers from pursuing their statutory
claims through mandatory arbitration. Other courts that have
analyzed the allocation of arbitration costs under federal law,
have taken into consideration the possible “‘chilling effect’”
that certain cost provisions can have both on an individual
claimant and on similarly situated litigants. Morrison v.
Circuit City Stores, Inc., 317 F.3d 646, 657-67 (6th Cir. 2003)
(finding cost-splitting provision unenforceable) . . . .
Although the public policy of our State would permit an
arbitration agreement to shift costs and attorney’s fees to a
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consumer who brings “frivolous” or “bad faith” claims, see
N.J.S.A. 2A:15-59.1 (recognizing public policy against
frivolous and bad faith litigation and establishing penalties for
same), no such limitation is evident in the cost-shifting
provision applicable to Harris. Delta claims that arbitrators
rarely, if ever, shift costs to a consumer. However, contract
unconscionability must be decided based on the contract as
written because the language of the agreement is what
consumers must consider when assessing whether to pursue a
statutory-rights claim against Delta. Delta drafted the
arbitration agreement giving the arbitrator unfettered discretion
to shift the entire cost of arbitration to Harris. The agreement
as written, and as yet uninterpreted by an arbitrator, could
force Harris to bear the risk that she will be required to pay all
arbitration costs. That risk is unconscionable in that it is a
deterrent to the vindication of her statutory rights.
The fact that, under the agreement’s terms, Delta will consider,
in “good faith,” advancing any costs to Harris does not alter
our analysis. Even if Delta elected to advance the costs of the
arbitration to Harris, the advance is merely a loan. Harris
ultimately could still be saddled with the entire cost of
arbitration. That creates a substantial and unreasonable
deterrent to the vindication of the statutory rights of Harris and
others who are similarly situated. A contract of adhesion that
contains such a term, which effectively would deter the
vindication of a consumer’s statutory rights, would be
unconscionable and unenforceable if interpreted and applied in
the manner described above.
Delta Funding Corp. v. Harris, 189 N.J. at 42-44 (citations and footnotes omitted).
In bankruptcy cases, debtors who file adversary proceedings (such as this
one) are not assessed any filing fee. Appendix to 28 U.S.C. § 1930, Bankruptcy Court
Miscellaneous Fee Schedule (6). If the debtor here is compelled to commence an
arbitration action, he could conceivably be assessed considerable costs. Given his modest
income, such a potential liability could deter such action. And there is no dispute that the
this arbitration provision was in a form drafted by Delta for use in its loan agreements.
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I further conclude that the debtor had “a lack of meaningful choice in the
acceptance of the challenged provision and the provision unreasonably favors the party
asserting it,” Salley v. Option One Mortgage Corp., 925 A.2d at 119, in that it might
insulate Delta and its assigns by deterring consumer protection law claims. Accordingly,
Pennsylvania law of unconscionability would concur with the analysis quoted above by
New Jersey Supreme Court that the fee allocation provision in the Delta arbitration
agreement is unconscionable.
Although this aspect of the arbitration agreement is unenforceable under
state law, the appropriate remedy, consistent with the arbitration agreement itself, is to
sever the cost provision and thus direct that the defendants pay for their desired arbitration.
See Delta Funding Corp. v. Harris, 189 N.J. at 46; Spinetti v. Service Corp. International,
324 F.3d 212 (3d Cir. 2003); see also Delta’s Supplemental Brief, at 4 n.4 (acknowledging
that severance of an unconscionable cost provision may be appropriate).
IV.
Finally, the debtor maintains that Counts II and III of this adversary
proceeding constitute “excluded claims” within the meaning of the arbitration agreement,
as they both purportedly are raised defensively in response to the secured proof of claim
filed by Wells Fargo, and seek recoupment. This position overlooks that Delta has not
filed any claim in this bankruptcy case and yet is named as a defendant from whom relief
apparently is sought. Thus, as to Delta, the two consumer protection claims raised by the
debtor could not be defensive.
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A party can waive the right to arbitrate a dispute “if the party ‘[s]ubstantially5
invoke[s] the litigation machinery before asserting its arbitration right.’ . . . A party substantially
invokes the litigation machinery when, for example, it files a lawsuit on arbitrable claims,
engages in extensive discovery, or fails to move to compel arbitration and stay litigation in a
timely manner.” Lewallen v. Green Tree Servicing, L.L.C., 487 F.3d 1085, 1090 (8th Cir. 2007)
(citation and quoted reference omitted). Here, the defendants in this proceeding have asserted
their arbitration right promptly after the debtor’s commencement of litigation and have not acted
inconsistently with that contractual right.
21
Whether, as to Wells Fargo, the debtor’s two claims are within the scope of
the definition of excluded claims must be determined by the arbitrator.
To the extent the debtor’s argument imputes significance to Wells Fargo’s
filing of a proof of claim, I note that numerous courts have concluded that a creditor who
files a proof of claim does not, by that act alone, waive its contractual right to arbitrate a
dispute. See, e.g., In re Kaiser Group Int’l, Inc., 307 B.R. 449, 454-55 (D. Del. 2004); In
re Hart Ski Mfg. Co., 22 B.R. 763, 765 (D. Minn. 1982), aff’d, 711 F.2d 845 (8th Cir.
1983); In re Mor-Ben Ins. Markets Corp., 73 B.R. 644, 647 (B.A.P. 9th Cir. 1987) (“A
claim may be filed to secure a creditor’s right to partake in distribution of the debtor’s
estate without waiving his right to arbitration.”); In re Transport Associates, Inc., 263 B.R.
531, 536 (Bankr. W.D. Ky. 2001) (“Bankruptcy courts uniformly hold that filing a proof
of claim does not waive a party’s right to invoke an arbitration provision.”); see also In re
Mintze, 434 F.3d at 225-26 (adversary proceeding commenced after defendant/creditor
filed a proof of claim was arbitrable); In re Cooley (same). 	Thus, Wells Fargo has not5
waived any contractual arbitration rights simply by filing its claim in this chapter 13 case.
Nor would an objection to the proof of claim be per se non-arbitrable. See In re Transport
Associates, Inc., 263 B.R. at 535.
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22
Furthermore, the fact that the debtor’s amended complaint labels the relief
sought as “recoupment” does not necessarily imply that the two claims are merely
defensive. For example, under Pennsylvania law, Truth in Lending recoupment claims are
considered impermissible counterclaims, rather than affirmative defenses, to foreclosure
actions. See Fleet Real Estate Funding Corp. v. Smith, 366 Pa. Super. 116, 126-27 (1987).
Thus, the debtor’s classification of his desired relief in Counts II and III of this adversary
proceeding is not dispositive of the issue. Rather, the proper scope of the arbitration
agreement is determined by the intention of the parties, which intention may be expressed
by the language of the arbitration agreement itself.
Recently, in Certain Underwriters at Lloyd’s London v. Westchester Fire
Ins. Co., 2007 WL 1673876 (3d Cir. 2007), the Third Circuit Court of Appeals considered
“the sometimes vexing issue of the respective roles of the court and the arbitrators” in
determining whether a claim is within the scope of the arbitration agreement. Id., at *4.
The appellate court analyzed two decisions issued by the Supreme Court, Green Tree
Financial Corp. v. Bazzle, 539 U.S. 444 (2003); Howsam v. Dean Witter Reynolds, Inc.,
537 U.S. 79 (2002), and noted the following language of Green Tree :
“In certain limited circumstances, courts assume that the
parties intended courts, not arbitrators, to decide a particular
arbitration-related matter (in the absence of ‘clea[r] and
unmistakabl[e]’ evidence to the contrary). AT & T
Technologies, Inc. v. Communications Workers, 475 U.S. 643,
649, 106 S. Ct. 1415, 89 L. Ed. 2d 648 (1986). These limited
instances typically involve matters of a kind that ‘contracting
parties would likely have expected a court’ to decide.
Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 83, 123
S. Ct. 588, 154 L. Ed. 2d 491 (2002). They include certain
gateway matters, such as whether the parties have a valid
arbitration agreement at all or whether a concededly binding
arbitration clause applies to a certain type of controversy.”
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Id., at *6 (quoting Green Tree Financial Corp. v. Bazzle, 539 U.S. at 452).
In other words, absent language or clear evidence to the contrary, a court
will typically determine the scope of the arbitration agreement based upon the parties’
presumed intent. However, in considering this gateway issue, a court must “look to the
Agreement to see if the parties affirmatively addressed the question of who decides
arbitrability. The presumption is that disputes about arbitrability are for the court to
resolve unless there is clear and unmistakable evidence that the parties agreed to have the
arbitrator determine arbitrability.” Sadler v. Green Tree Servicing, LLC, 466 F.3d 623,
625 (8th Cir. 2006).
In support of his contention that Counts II and III are not arbitrable, the
debtor emphasizes language in the arbitration agreement that “defenses asserted by [the
borrower] constitute ‘excluded claims.’” 	He maintains that the parties intended that only
claims giving rise to affirmative relief were included within the scope of the agreement,
not recoupment claims giving rise only to an offset, and that any ambiguity in this
provision must be construed against its drafter. The defendants, though, counter that
arbitrable claims under the arbitration agreement expressly include HOEPA and UDAP
claims.
I take no position on this issue. The arbitration agreement specifically
defines an arbitrable claim as any dispute “including the validity, enforceability or scope
of this Agreement.” (Emphasis added.) This language is sufficiently clear to meet the
standard set forth in First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 944-45
(1995), requiring an arbitrator to determine if the relief sought by the debtor in Counts II
and III are arbitrable. See generally Quackenbush v. Allstate Ins. Co., 121 F.3d 1372,
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24
1380 (9th Cir. 1997). Therefore, whether Counts II and III are arbitrable must be resolved
by the arbitrator.
V.
In sum, I agree with the defendants that the debtor entered into an
enforceable arbitration agreement under Pennsylvania law, except for the provision
concerning arbitration costs. The costs of arbitration shall be borne solely by the
defendants. I further conclude that I have no discretion not to enforce the prepetition
arbitration agreement. Finally, whether Counts II and III of the debtor’s amended
complaint are outside the scope of arbitrable claims will be an issue for the arbitrator to
decide. If the arbitrator decides that those claims are arbitrable, the arbitrator shall render
a decision concerning the rights of the parties under relevant law. The arbitrator’s
decision shall be reviewable in this court solely within the limited scope of the FAA.
Until that arbitration ruling is made, this court shall stay the disposition of
Counts II and III.
An appropriate order shall be entered.
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UNITED STATES BANKRUPTCY COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
In re 	: 	Chapter 13
KENNETH HERRINGTON 	:
Debtor 	: 	Bankruptcy No. 06-14433bif
____________________________________
KENNETH HERRINGTON 	:
Plaintiff 	:
v. 	:
WELLS FARGO BANK, MINNESOTA, 	:
N.A., DELTA FUNDING CORPORATION
and COUNTRYWIDE HOME LOANS 	: 	Adversary No. 07-0009
Defendants 	:
____________________________________
.................................................
ORDER
.................................................
AND NOW, this 8th day of August 2007, for the reasons stated in the
accompanying memorandum, it is hereby ordered that defendants’ motions to compel
arbitration are granted and this adversary proceeding is stayed as to Counts II and III only,
pending resolution of those claims in arbitration or a determination by the arbitrator that
the two claims are non-arbitrable.
It is further ordered that the plaintiff is directed to initiate arbitration
proceedings within thirty (30) days from the date of this order in a manner consistent with
the arbitration agreement.
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And, it is further ordered that all costs of arbitration shall be the joint
responsibility of defendants Delta and Wells Fargo.
BRUCE FOX
United States Bankruptcy Judge
copies to:
Montgomery L. Wilson, Esq.
Community Legal Services
3638 N. Broad St.
Philadelphia, PA 19140
Martin C. Bryce, Jr., Esq.
Ballard Spahr Andrews & Ingersoll LLP
1735 Market Street, 51st Floor
Philadelphia, PA 19103
Dashika R. Wellington, Esq.
Pelino & Lentz, P.C.
One Liberty Place, 32nd Floor
1650 Market Street
Philadelphia, PA 19103
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