TP, Inc. v. Bank of America, N.A. et al

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NORTH CAROLINA
WILMINGTON DIVISION
IN RE:
TP, INC.,
DEBTOR
CASE NO.
10-01594-8-SWH
TP, INC.,
Plaintiff
v.
BANK OF AMERICA, N.A. and JONATHAN P.
JOYNER,
Defendants.
ADVERSARY PROCEEDING NO.
11-00112-8-SWH
ORDER DENYING MOTION TO DISMISS AND
GRANTING IN PART MOTION TO STAY
The matter before the court is the Motion to Dismiss, or in the Alternative, to Stay Based on
Arbitration Agreement filed by defendants Bank of America, N.A. ("BOA") and Jonathan P. Joyner
("Joyner"). A hearing was held in Raleigh, North Carolina, on June 5, 2012.
SO ORDERED.
SIGNED this 26 day of September, 2012.
________________________________________
Stephani W. Humrickhouse
United States Bankruptcy Judge
____________________________________________________________
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BACKGROUND
On or about January 10, 2003, TP entered into a Master Loan Agreement and a Promissory
Note with BOA, secured by a deed of trust and security agreement. The Master Loan Agreement
and Promissory Note contain arbitration clauses. The loan was extended and increased through TP's
execution of loan extension agreements, loan modification agreements, and amendments to the deed
of trust and security agreement. No modifications have been made to the arbitration clauses. Joyner
was a senior vice president of BOA who, beginning in 2002, worked with TP regarding its loans
with the bank.
On July 7, 2009, BOA filed a complaint against TP, the Bryants (owners of TP and
guarantors of its debt to BOA) and HP, Inc. (a company owned by Ronald Bryant) in Pender County
Superior Court for breach of the Promissory Note. It obtained ex parte orders of attachment against
TP and the Bryants and issued various notices of garnishment to TP's creditors and business
associates ancillary to the action on the note. On August 10, 2009, the defendants filed a pro se
answer and counterclaims against BOA for breach of the implied covenant of good faith and fair
dealing. On September 28, 2009, BOA filed a motion to dismiss the counterclaims, which was heard
before the Superior Court on October 5, 2009. The parties presented the court with a consent order
that was entered by the court on October 8, 2009, dismissing TP, HP, and the Bryants’ counterclaims
without prejudice. The consent order recognized that the counterclaims were submitted pro se, that
the defendants had since retained counsel, and that the defendants intended to later seek leave of
court to amend their pleadings. The counterclaims were never resubmitted or amended.
On March 1, 2010, TP filed a chapter 11 bankruptcy petition, which stayed the Pender
County action as against it, leaving only a proceeding against the Bryants and HP. 	On
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September 23, 2010, BOA filed a motion for summary judgment against the non-debtor defendants.
On October 7, 2010, the court entered summary judgment against the Bryants as guarantors of the
TP debt and against HP in the amount of $24,739,548.88.
On March 31, 2011, TP initiated the present adversary proceeding against BOA and Joyner.
On May 4, 2011, BOA filed a motion to dismiss, or in the alternative, to stay the adversary
proceeding based upon the arbitration provisions in the loan documents. BOA asserts its right to
arbitration, arguing that TP's claims are covered by the arbitration agreement, are mostly non-core
claims, and therefore the bankruptcy court should stay the action in favor of arbitration pursuant to
Section 3 of the Federal Arbitration Act. 	On May 25, 2011, TP responded to BOA’s motion
contending that BOA has waived its right to arbitrate and that compelling arbitration would
substantially prejudice it.
Upon the joint request of the parties, on June 21, 2011, the court entered a Consent Order
Regarding Mediation and Continuance of Hearing in which mediation was ordered and the hearing
on BOA’s motion to dismiss was continued. Ultimately, the mediation failed. In the meantime, the
Supreme Court decided Stern v. Marshall, 131 S. Ct. 2594 (2011). A status conference was held on
March 19, 2012, during which the effect of the Supreme Court’s decision was discussed and a
briefing schedule was set. Supplemental memoranda of law were filed by BOA on April 13, 2012
and May 31, 2012, and by TP on April 13, 2012, April 20, 2012 and May 30, 2012.
DISCUSSION
Two threshold issues are presented to the court: 1) does the arbitration provision cover the
types of causes of action asserted by TP; and 2) has BOA waived the arbitration clause? Only after
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those issues have been resolved, can the court consider BOA’s request to compel arbitration in lieu
of bankruptcy court determination of the adversary proceeding.
The Scope of the Arbitration Provisions
The arbitration provision at issue is found in the Master Loan Agreement and provides as
follows:
Any controversy or claim between or among the parties hereto
including but not limited to those arising out of or relating to this
Loan Agreement or any related agreements or instruments, including
any claim based on or arising from an alleged tort, shall be
determined by binding arbitration in accordance with the Federal
Arbitration Act . . .
Master Loan Agreement, ¶ 10.12. Federal courts view a motion to compel arbitration in light of the
strong federal and state policy favoring arbitration. See e.g., Patten Grading & Paving, Inc. v.
Skanska USA Bldg., Inc., 380 F.3d 200, 204 (4th Cir. 2004). The Federal Arbitration Act ("FAA")
establishes that "as a matter of federal law, any doubts concerning the scope of arbitrable issues
should be resolved in favor of arbitration, whether the problem at hand is the construction of the
contract language itself or an allegation of waiver, delay, or a like defense to arbitrability." Moses
H. Cone Mem'l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983) (emphasis added).
The adversary proceeding sets forth twelve causes of action:1 1) constructive fraud; 2) fraud;
3) fraud in the inducement; 4) rescission; 5) breach of fiduciary duty; 6) negligence; 7) negligent
misrepresentation; 8) tortious interference with contractual relationships and business opportunities;
9) breach of contract/implied covenant of good faith and fair dealing; 10) unfair and deceptive trade
practices; 11) alter ego/insider liability; and 12) equitable subordination/recharacterization.
1 The complaint contains claims for relief numbered “First” through “Eleventh,” but there
are two claims for relief labeled as the “Fifth.”
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The arbitration clause purports to cover any dispute between the parties, even those unrelated
to the loan relationship. The language is broad and all encompassing, and in accordance with the
majority of courts who have evaluated the scope of such provisions, the court finds that all of the
causes of action asserted by the debtor are covered by the arbitration provisions. See, e.g., Cara’s
Notions v. Hallmark Cards, Inc., 140 F.3d 566, 569 (4th Cir. 1998) (finding that an “extremely broad
arbitration clause,” which called for arbitration of “[a]ny controversy or claim arising out of or
relating to . . . any aspects of the relationship,” covered all conflicts between the parties); Levin v.
Alms and Assocs., Inc., 634 F.3d 260, 267 (4th Cir. 2011) (holding, in light of the presumption in
favor of arbitrability, that broad language referring to “[a]ny dispute” encompassed any disputes
between the parties, past or present); Wachovia Bank v. Schmidt, 445 F.3d 762 (4th Cir. 2006)
(holding that an arbitration clause encompassing all disputes under a contract covers any dispute
between the parties that has a significant relationship to the contract).
Waiver
The court turns to the question of whether BOA has waived its rights under the arbitration
clause. TP contends that BOA waited two years to assert the right to arbitration, and that it was
prejudiced due to BOA’s delay. TP also argues that it was prejudiced by the activities undertaken
by BOA in the state court action. Particularly, TP points to (1) the dismissal of the counterclaim in
the state court action; (2) the attachment and garnishment orders obtained in the state court action,
and (3) the entry of summary judgment against the non-TP defendants in the state court action.
Waiver of the right to arbitrate is "not to be lightly inferred" and the party opposing
arbitration bears a heavy burden of proving waiver. MicroStrategy, Inc. v. Lauricia, 268 F.3d 244,
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249 (4th Cir. 2001); Patten Grading, 380 F.3d 200 (4th Cir. 2004); Am. Recovery Corp. v.
Computerized Thermal Imaging, Inc., 96 F.3d 88, 95 (4th Cir. 1996).
Under Section 3 of the FAA, a party loses its right to arbitrate if it is in "default" in
proceeding with such arbitration. 9 U.S.C. § 3. Default in this context resembles waiver, but due
to the strong federal policy favoring arbitration, courts have limited the circumstances that can result
in statutory default. 	Maxum Founds., Inc. v. Salus Corp., 779 F.2d 974, 981 (4th Cir. 1985).
Default only occurs when the moving party "so substantially utiliz[es] the litigation machinery that
to subsequently permit arbitration would prejudice the party opposing the stay." Microstrategy, 268
F.3d at 249 (internal citations omitted). Sufficient prejudice may arise when the party asserting the
right to arbitration actively participates in litigation in a manner inconsistent with that right.
Maxum, 779 F.2d at 981. Actual prejudice is required. Microstrategy, 268 F.3d at 250; Patten
Grading, 380 F.3d at 206.
The extent of the moving party's trial-oriented activity is a material factor in assessing
whether the other party would be prejudiced. Fraser v. Merrill Lynch Pierce, Fenner & Smith, Inc.,
817 F.2d 250, 252 (4th Cir. 1987). However, even if the party seeking arbitration has aggressively
invoked the litigation machinery, waiver has not occurred unless the opposing party suffers actual
prejudice. Microstrategy, 268 F.3d at 249. "Neither delay nor the filing of pleadings by the party
seeking a stay will suffice, without more, to establish waiver of arbitration." Fraser, 817 F.2d at 252.
The factors relevant to the prejudice inquiry may include the
timeliness of the motion to compel arbitration, the degree to which
the merits of the nonmovant's claims have been contested by the party
moving for arbitration, whether the non-movant is otherwise aware
of the movant's intention to seek arbitration, the extent of non-merits
motion practice that has transpired, the movant's assent to the trial
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court's pretrial orders, and the degree to which the parties have
engaged in discovery.
Zimmer v. CooperNeff Advisors, Inc., 523 F.3d 224, 231 (3d Cir. 2008).
TP argues that because BOA waited two years from the time that it initiated its state court
action against the debtor and related entities to assert a right to arbitration, BOA’s motion was
untimely and that it has been thereby prejudiced. Even if the two year delay suggested by TP did,
in fact occur, there is no evidence that such delay caused TP to suffer actual prejudice. As stated
above and as noted by TP in its response, short delays should be heavily weighed against a finding
of waiver and longer delays without evidence of prejudice do not constitute waiver. 	Plaintiff’s
Mem. of Law, Docket No. 11, p. 21. TP cites a number of cases in which a delay of 3 to 15 months
in pursuing arbitration was found to be sufficient to support a finding of waiver.2 However, in the
majority of those cases, the delay occurred in the context of a single proceeding involving two
parties. For example, in Nino v. Jewelry Exchange, Inc., 609 F.3d 191 (3d Cir. 2010), an individual
brought a discrimination suit against his former employer in district court, the matter was litigated
for 15 months, and only then did the employer move to compel arbitration. On the other hand, in
MicroStrategy, Inc. v. Lauricia, 268 F.3d 244, 249-51 (4th Cir. 2001), the Fourth Circuit determined
that no meaningful delay occurred where an employer filed three separate actions against an
employee before seeking arbitration six months after filing the first action. In that case, the court
noted that the arbitration request was made one month after the employee filed her own complaint
2 See Nino v. Jewelry Exchange, Inc., 609 F.3d 191, 208 (3d Cir. 2010); American Reliable
Ins. Co. v. Stillwell, 212 F. Supp. 2d 621 (N.D.W.Va. 2002), reconsideration denied, aff'd, 336 F.3d
311 (4th Cir. 2003); Matter of Arbitration Between S & R Co. of Kingston and Latona Trucking,
Inc., 984 F. Supp. 95 (N.D.N.Y. 1997), aff'd, 159 F.3d 80 (2nd Cir. 1998), cert. dismissed 528 U.S.
1058 (1999); Viking Packaging Technologies, Inc. v. Prima Frutta Packing, Inc., 629 F. Supp. 2d
883 (E.D. Wis. 2009).
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against the employer, and that the record did not contain evidence of prejudice caused by the delay
in and of itself. In the present case, although the time between the first action filed by BOA and the
arbitration request was nearly two 	years, intervening factors occurred in that TP voluntarily
dismissed its fraud related claims in a counterclaim to BOA’s state court action, and TP filed a
bankruptcy petition, staying that action. Further, BOA sought arbitration 34 days after TP filed its
complaint initiating this proceeding, which is centered around fraud rather than collection on a debt.
While acknowledging that the two-year overall time period is lengthy, the court finds that this delay,
standing alone, does not support a finding of prejudice. This is not a case in which BOA filed a
complaint against a single defendant on a particular set of issues, litigated the case for two years,
and then filed a motion to compel arbitration. Instead, BOA sought arbitration 34 days after the
filing of TP’s complaint, which raised issues significantly different from those raised by BOA in its
initial state court action.
TP next argues that BOA waived its arbitration rights by virtue of its conduct during the
litigation in the state court action. TP contends that BOA acknowledged its right to assert its fraud-
related claims in court when it obtained a consent order dismissing the counterclaims asserted by
TP based on TP's counsel's indication that it intended to later seek leave of court to amend its
pleadings. Accordingly, the counterclaims were dismissed without prejudice to TP. TP argues that
by doing so, BOA acknowledged TP's right to seek leave of court to file its claims instead of being
required to seek arbitration of those claims and thus waived its right to arbitration.
However, TP fails to show what actual prejudice it suffered from the dismissal. 	The
counterclaim was dismissed without prejudice. The dismissal was consented to by TP's counsel at
that time. 	TP could reassert those claims at some later time, and did in fact do so by way of
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initiating an adversary proceeding in this court. There were no contested hearings, discovery or
briefing undertaken on this issue. TP did not incur substantial expense in obtaining the dismissal.
In fact, even if the parties had engaged in some level of discovery or pretrial activity, or incurred
some expense during the pre-trial or trial process, that would not necessarily support a finding of
waiver. 	See e.g. Patten, 380 F.3d at 206-07 (finding that the amount of discovery undertaken,
namely, the exchange of interrogatories and request for production of documents, was not sufficient
to support waiver); Microstrategy, 268 F.3d at 254 (finding that the moving party did not waive the
right to arbitration even though litigation of the prior claims involved many motions, responses,
depositions and other procedural maneuvers).
TP also argues that BOA took advantage of the court forum by securing attachment and other
supplemental orders which were not otherwise available within the arbitration process and thus
deprived TP of the use and pecuniary benefits of the property obtained by those supplemental
litigation processes for the duration of this dispute. Obtaining an attachment order could be a factor
for the court to consider in determining whether a party has been prejudiced. See Expofrut v. M/V
ACONCAGUA, 280 F. Supp. 2d 374 (E.D. Pa. 2003) (filing of various ex parte pleadings to effect
the attachment was a factor in finding waiver); Zimmer, 523 F.3d at 231 (reasoning that whether the
court issued an order or not was a factor for the court to consider). However, even in these cases,
the court noted that the dispositive question is whether the party objecting to the arbitration has
suffered actual prejudice or not by the use of the litigation process. See, e.g., Zimmer, 523 F.3d
at 231 (stating that “‘prejudice is the touchstone for determining whether the right to arbitrate has
been waived’ by litigation conduct”) (citation omitted). Otherwise, a party does not waive its right
to arbitration even if the attachment is only available within the litigation process and may indicate
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a party's intention to use litigation tools. TP cannot show actual prejudice as a result of BOA
obtaining attachment and garnishment orders. Pursuant to the court's Order Directing Turnover of
Property of the Debtor's Estate, the rental income and proceeds derived from the lease of real
property (including improvements) attached during the state court litigation have been turned over
to TP. See Case No. 10-01594-8-SWH, Docket No. 102. TP’s chapter 7 trustee has continued to
collect the rental income and other revenues and those monies are being held for its benefit. In fact,
according to the Master Loan Agreement, TP agreed that no “provisional or ancillary remedies shall
constitute a waiver of the right of any party . . . to arbitrate the merits of the controversy or claim
occasioning resort to such remedies.” Master Loan Agreement, ¶ 10.12(b). It is difficult to say TP
was prejudiced by that to which it agreed.
Finally, TP argues that BOA obtained a final judgment finding that TP had defaulted on a
valid debt, and this judgment impaired TP's legal position by preventing it from disputing the
validity or enforceability of the debt before an arbitrator or the court. However, the records show
otherwise. BOA has already obtained orders and judgments which found the existence of a valid
debt in the foreclosure proceedings in Pender County and Onslow County. TP did not appeal those
orders, and they became final.3 Therefore, there is no causal link between BOA obtaining summary
judgment and the claim that prejudice resulted from the finding that the debt was valid.
Moreover, even assuming that prior orders found the existence of a valid debt, TP is not
collaterally estopped from challenging this finding if it did not have a full and fair opportunity to
3 BOA did not waive its right to arbitration by engaging in the judicial foreclosure process
because the Master Loan Agreement provides that the “maintenance of an action for foreclosure”
shall not “constitute a waiver of the right . . . to arbitrate the merits of the controversy or claim
occasioning resort to such remedies. Master Loan Agreement, ¶ 10.12(b).
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litigate that issue. Allen v. McCurry, 449 U.S. 90, 94-95, 101 S. Ct. 411, 66 L.Ed. 308 (1980).
According to the record, summary judgment was only entered against the non-TP defendants. The
state court action against TP was pending at the time of the filing of the petition by TP on March 1,
2010. It was not until September 23, 2010 that BOA filed a motion for summary judgment against
the non-TP defendants and obtained the judgment on October 7, 2010. TP was not involved in this
summary judgment proceeding. Accordingly, any issues decided in the summary judgment order
are not preclusive to TP. TP still has an opportunity to litigate the issue of the validity of the debt.
In conclusion, TP does not satisfy its heavy burden of establishing any actual prejudice from
BOA's activities in prior litigation, and BOA has not waived its right to arbitration. Inasmuch as
BOA has not waived the arbitration provisions in the loan documents, the court must now determine
whether the contractual right to arbitration supersedes the bankruptcy court’s authority to determine
the dispute.
Federal Arbitration Policy
Arbitration provisions “generally are favored in federal courts. In bankruptcy proceedings,
however, whether a proceeding is a ‘core proceeding’ as defined by 28 U.S.C. § 157(b) generally
determines whether an arbitration clause can be enforced.” D&B Swine Farms, Inc. v. Murphy-
Brown, LLC, 430 B.R. 737, 741 (Bankr. E.D.N.C. 2010), citing White Mountain Mining Co., LLC
v. Congleton, LLC, 403 F.3d 164, 169 (4th Cir. 2005) and Blanchard Transp., 2008 WL 619379
at *1 (Bankr. E.D.N.C. 2008). 	More particularly, in the Fourth Circuit, controlling precedent
establishes that “[a]rbitration is inconsistent with centralized decision-making because permitting
an arbitrator to decide a core issue would make debtor-creditor rights ‘contingent upon an
arbitrator’s ruling’ rather than the ruling of the bankruptcy judge assigned to hear the debtor’s case.”
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White Mountain, 403 F.3d at 169 (internal citation omitted), quoted in D&B Swine Farms, 430 B.R.
at 741. In the bankruptcy context, then, “the burden is on the party opposing arbitration to show that
Congress intended to ‘limit or prohibit waiver of a judicial forum for a particular claim’ under the
Federal Arbitration Act.” D&B Swine Farms, 430 B.R. at 741, construing Shearson/Am. Express,
Inc. v. McMahon, 482 U.S. 220, 226 (1987), as quoted in Blanchard Transp., 2008 WL 619379
at *1. Thus, if the matter is non-core, it is generally referred to arbitration consistent with the policy
in favor of arbitration; however if a core proceeding is at issue, the policy in favor of centralized
determination in the bankruptcy court generally prevails.
In light of this dichotomy between bankruptcy and arbitration policy, the court must evaluate
each cause of action in the present adversary proceeding to determine whether it is a core
proceeding. The bankruptcy court has authority to “hear and determine all cases under title 11 and
all core proceedings arising under title 11, or arising in a case under title 11 . . . and may enter
appropriate orders and judgments.” 28 U.S.C. § 157(b)(1); Stern, 131 S. Ct. at 2604; Yellow Sign,
466 B.R. at 765. Section 157(b)(2) contains a list of sample core proceedings, and these proceedings
include, but are not limited to, the “allowance or disallowance of claims against the estate” along
with “counterclaims by the estate against persons filing claims against the estate.” 28 U.S.C. §
157(b)(2); Stern, 131 S. Ct. at 2604; Yellow Sign, 466 B.R. at 765-66. 	Although some courts
consider claims that arise in pre-petition litigation and are used to challenge a creditor’s proof of
claim to be examples of core proceedings under § 157(b)(2), other courts have found that “[p]re-
petition common law actions for a claim requiring adjudication of factual disputes unrelated to
bankruptcy are not core claims. These claims are private rights because they are ‘state law action[s]
independent of the federal bankruptcy law and not necessarily resolvable by a ruling on the
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creditor’s proof of claim in bankruptcy.’” In re Fairfield Sentry Ltd. Litigation, 458 B.R. 665, 688
(S.D.N.Y. Sept. 19, 2011) (quoting Stern, 131 S. Ct. at 2611); see also Burns v. Dennis (In re:
Southeastern Materials, Inc.), 467 B.R. at 362-63 (Bankr. M.D.N.C. 2012) (citing Granfinanciera
v. Nordberg, 492 U.S. 33, 56 (1989)) (holding that “common-law actions to augment the size of the
estate involving disputed facts to be determined by a jury are not core”); Yellow Sign, 466 B.R. at
767 n.19 (noting authority to the effect that common law actions independent of federal bankruptcy
law are not necessarily resolvable by a ruling on the creditor’s proof of claim in bankruptcy).
Some courts have found that although an action was initiated by a complaint rather than a
traditional counterclaim, “such actions are in the nature of a counterclaim when asserted against
parties who have filed proofs of claim in the bankruptcy case.” Shaia v. Taylor (In re Connelly),
___B.R. ___, 2012 WL 1098431 at *5 (Bankr. E.D. Va. 2012) (quoting Fort v. Suntrust Bank (In
re Int’l Payment Grp., Inc.), 2011 WL 5330783 at *2 (Bankr. D.S.C. 2011)); see also Blackshire v.
Litton Loan Servicing, L.P., 2009 WL 426130 at *3 (S.D. W.Va. 2009) (explaining that plaintiff’s
claims based in state law were core proceedings because the claims were essentially counterclaims
against creditors who had filed proofs of claim in the bankruptcy proceeding; furthermore, because
the plaintiff’s claims for relief arose from the same transaction upon which the creditor’s claims
against the estate were based, the adversary proceeding constituted a counterclaim under
§ 157(b)(2)(C)). This court agrees that TP’s claims against BOA are statutory core claims under
§ 157(b)(2) because they are counterclaims by the estate against persons filing claims against the
estate. These claims were filed via complaint initiating this adversary proceeding but they now
function as counterclaims to the claims filed by BOA against the estate.
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Although inartfully presented as counterclaims to the state court action, the gist of those
claims are substantially similar to the claims asserted by TP in this adversary proceeding and are
intended by way of defense, or as a set off, to the claim filed by BOA or seek affirmative relief.
These claims will therefore be treated as counterclaims asserted by the debtor to the claim filed by
the creditor, therefore the claims asserted by TP are statutorily core. However, in light of Stern v.
Marshall, the court must determine whether the claims are constitutionally core.
Ramifications of Stern v. Marshall on Bankruptcy Courts’ Authority to Enter Final Orders
in Core Proceedings
In the recent case of Stern v. Marshall, the Supreme Court found that in certain instances,
bankruptcy courts cannot constitutionally render final orders on proceedings deemed core under
§ 157(b)(2). Stern, 131 S.Ct. at 2608; Yellow Sign, 466 B.R. at 767. More specifically, the Court
found that while bankruptcy courts have the statutory authority to enter final judgments on a
debtor’s counterclaims against persons filing claims against the estate pursuant to the plain language
of § 157(b)(2)(C), bankruptcy courts may not constitutionally enter final orders in non-bankruptcy
matters that are based in common law or state law, or that would not necessarily be resolved in the
claims allowance process in bankruptcy. However, the ruling in Stern does not prohibit the estate
from bringing core counterclaims based in state law so long as the resolution of the counterclaim
is necessary to the determination of whether a creditor’s claim should be allowed in a bankruptcy
case. Spanish Palms Mktg, LLC v. Kingston (In re Kingston), 2012 WL 632398 at *2 (Bankr. D.
Idaho 2012); see also City of Sioux City v. Civic Partners Sioux City, LLC (In re Civic Partners
Sioux City, LLC), 2012 WL 761361 at *8-10 (Bankr. N.D. Iowa 2012) (explaining that Stern did
not completely eliminate state-law counterclaims by the estate from being a core proceeding, but
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rather provided guidance on how broadly these counterclaims could reach without exceeding
constitutional limitations).
In order to determine whether a matter is constitutionally core, then, a bankruptcy court looks
to the two-prong test derived from the Court’s decision in Stern. The first prong asks whether the
action at issue stems from the bankruptcy itself, and the second asks whether the issue would
“necessarily be resolved in” the claims allowance process. Stern at 2618; Yellow Sign, 466 B.R.
at 768. If either of the prongs in the Stern test are met, then the matter is constitutionally core. Id.;
Burns, 467 B.R. at 348; Yellow Sign, 466 B.R. at 768. It logically follows that if no prongs are met,
then the matter is not core.
1. 	Constructive Fraud
TP’s first claim for relief, for constructive fraud, asserts that BOA and Joyner compelled
and/or influenced TP to purchase lots owned by Joyner, using TP’s line of credit from BOA,
resulting in substantial profits for BOA and Joyner at TP’s expense. This claim does not stem from
the bankruptcy itself because it first arose in state court and is based on state law, and thus does not
satisfy the first prong of Stern.
To assess the latter half of the Stern test, courts generally look to see if a “common nucleus
of law and fact” exists to inextricably intertwine the claims and counterclaims. McElwee v. Scarff
Bros., Inc. (In re McElwee), 469 B.R. 566, 576-77 (Bankr. M.D. Pa. 2012); see also Tolliver v. Bank
of Am. (In re Tolliver), 464 B.R. 720, 736 (Bankr. E.D. Ky. 2012) (explaining that the court in Stern
looked at not only the “factual overlap of the claim resolution and the counterclaim, but also the
legal elements which must be determined to resolve the claim and the counterclaim and the remedies
sought by the counterclaim and the impact on the claims allowance process”). Furthermore, for a
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counterclaim to be necessarily resolved in ruling on the proof of claim, the relationship must be such
that resolution of the counterclaim would alter the amount sought by the claimant. See In re Olde
Prairie Block Owner, 457 B.R. 692, 698-99 (Bankr. N.D. Ill. 2011) (finding that two counterclaims
for breach of contract had to be resolved in ruling on the proof of claim because one sought
‘rescission’ based on economic duress and the other sought damages for a breach of good faith and
fair dealing, which would reduce the amount claimed by debtor). Moreover, a counterclaim that
seeks to reduce the amount that debtors owe to a claimant should be contrasted with the situation
where a bankruptcy estate is seeking affirmative monetary relief from a claimant to augment the
bankruptcy estate. McElwee, 469 B.R. at 576. In other words, a counterclaim by the estate based
in state law must seek to directly reduce or recoup the amount claimed in order to be resolved in
ruling on the proof of claim. Applying this type of test, a counterclaim by the bankruptcy estate that
seeks affirmative monetary relief to augment the estate but does not directly modify the amount
claimed would not qualify as a claim to be resolved in ruling on the proof of claim. Finally, because
this type of counterclaim would not be resolved in the claims allowance process, the claim would
fail the second prong of Stern and be deemed a non-core proceeding.
In this first claim, TP asserts that BOA and Joyner took advantage of their position of trust
in the lending relationship in order to benefit from larger profits from TP’s increased use of the line
of credit. Although this cause of action stems from the transactions giving rise to BOA’s claim, it
will not affect the calculation of the amount of BOA’s proof of claim. Instead, it appears that the
bankruptcy estate seeks affirmative monetary relief in order to augment the size of the estate, as
opposed to asking for a modification of the amount claimed by BOA (though that would indirectly
augment the estate). As such, this claim is not inextricably intertwined with BOA’s proof of claim
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and would not necessarily be resolved in the claims allowance process, thereby failing to satisfy the
second prong of Stern. Because it is therefore not a core proceeding, this claim will be referred to
arbitration.
2. 	Fraud
In its second claim for relief, TP asserts that during the course of the lending relationship,
and particularly between 2002 and 2008, BOA and Joyner made false representations to TP and/or
concealed facts with the intent to deceive TP, and that TP reasonably relied on such representations
to its detriment. 	As with the claim for constructive fraud, this claim does not stem from the
bankruptcy itself because it first arose in state court and is based on state law, and thus does not
satisfy the first prong of Stern.
Much like the first claim for constructive fraud, this cause of action arises out of the
transactions underlying BOA’s claim, but will not affect the calculation of the amount of BOA’s
proof of claim. 	As such, this claim would not necessarily be resolved in the claims allowance
process and does not satisfy the second prong of Stern. This claim will be referred to arbitration.
3. 	Fraud in the Inducement
TP’s third claim, for fraud in the inducement, asserts that BOA fraudulently induced TP to
obtain the line of credit. Based on this alleged fraud, TP contends there was no mutuality and/or
consideration for the various loan instruments executed by TP, rendering the instruments
unenforceable. Although this claim fails the first prong of the Stern test in that it first arose in state
court and is based on state law, it passes the second prong because it attacks the enforceability of
the loan documents, the basis for the proof of claim. As such, this claim will necessarily be resolved
in the claims allowance process and constitutes a core proceeding. As a core proceeding, the court
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will issue a final ruling on whether BOA and Joyner fraudulently induced TP to enter into the loan
instruments, thereby precluding enforcement of the instruments against TP. The claim will remain
in this court for final determination.
4. 	Rescission
In its fourth claim for relief, TP asserts that based on the alleged false and fraudulent
representations and concealments by BOA and Joyner, TP may rescind any agreement that it
executed with BOA. Much like the claim for fraud in the inducement, this claim fails the first prong
of the Stern test because it first arose in state court and is based on state law, but passes the second
prong in that it attacks the validity of the loan documents, the basis for the proof of claim.
Accordingly, this claim will remain in this court for final determination.
5. 	Breach of Fiduciary Duty
TP contends in its fifth claim, for breach of fiduciary duty, that BOA breached its obligation
to act in good faith and with due regard to the interests of TP, to TP’s detriment in its decisions
throughout the course of the lending relationship. This claim does not stem from the bankruptcy
itself because it first arose in state court and is based on state law, and thus does not satisfy the first
prong of Stern. Nor is the second prong of Stern satisfied. Although this cause of action arises out
of the transactions underlying BOA’s claim, it will not affect the calculation of the amount of BOA’s
proof of claim. 	As such, this claim would not necessarily be resolved in the claims allowance
process. It will be treated as a non-core proceeding and referred to arbitration.
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6. 	Negligence and Negligent Misrepresentation
In its “fifth” claim for negligence,4 TP asserts that BOA and Joyner breached the duty of care
in numerous ways during the lending relationship, ultimately causing TP to construct more homes
and take on more debt than it would have otherwise without business justification for doing so.
Similarly, TP’s “sixth” claim for negligent misrepresentation states that BOA and Joyner breached
the duty of care to TP by making material misrepresentations during the lending relationship, which
TP relied on to its detriment.
As to these claims, the court reiterates its reasoning set out above with respect to the first
claim for constructive fraud. The negligence and negligent misrepresentation claims arose prior to
the bankruptcy filing, are based on state law, will not affect the calculation of the amount of BOA’s
proof of claim, and therefore do not satisfy either the first or second prong of Stern. These claims
will be treated as non-core proceedings, and referred to arbitration.
7. 	Tortious Interference
TP further contends that BOA and Joyner essentially managed TP and did not provide
promised financing, thereby interfering with TP’s obligations on contracts with other creditors, as
well as business opportunities. According to TP, its ability to pay certain other creditors depended
on its ability to sell the property it was improperly instructed to develop, and the breakdown in
financing caused TP to abandon certain projects midstream or sell incomplete construction at a loss.
4 This is the second “fifth” claim as delineated in the complaint, thus it is actually the sixth
claim; the claims that follow in the complaint are similarly misnumbered.
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As to this claim as well, the court reiterates its reasoning set out above with respect to the
first claim for constructive fraud. 	The tortious interference claim arose prior to the bankruptcy
filing, is based on state law, will not affect the calculation of the amount of BOA’s proof of claim,
and therefore does not satisfy either the first or the second prong of Stern. It will be treated as a non-
core proceeding, and referred to arbitration.
8. 	Breach of Contract/Breach of Covenant of Good Faith and Fair Dealing
In its “eighth” claim, TP asserts that BOA breached its contracts with TP by failing to meet
various obligations with regard to funding, administration, disbursement, and renewal of the line of
credit. TP further asserts that BOA breached its duty of good faith and fair dealing based on its
actions and conduct during the lending relationship. This claim does not stem from the bankruptcy
itself because it first arose in state court and is based on state law, and thus does not satisfy the first
prong of Stern.
Although this action stems from the transactions underlying BOA’s claim, it appears that TP
seeks damages in order to augment the estate, rather than a reduction in the amount claimed by
BOA. As such, this claim will not affect the calculation of the amount of BOA’s proof of claim, and
therefore the second prong of Stern is not satisfied. This claim will be referred to arbitration.
9. 	Unfair and Deceptive Trade Practices and Alter Ego/Insider Liability
In its “ninth” claim, TP contends that the actions and conduct of BOA and Joyner during the
lending relationship constitute unfair and deceptive trade practices under North Carolina law. TP’s
“tenth” claim alleges that during the lending relationship, BOA and Joyner exercised dominion and
control over TP’s business activities to the extent that TP functioned as BOA and Joyner’s alter ego,
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with no power over its own financial affairs. Each of these claims arose prior to the bankruptcy
filing and are based on state law, and therefore fail the first prong of Stern.
Based on the reasoning set out above regarding the first claim for constructive fraud, the
court finds that neither of these claims will affect the calculation of the amount of BOA’s proof of
claim, such that each fails to satisfy the second prong of Stern. These claims will be treated as non-
core proceedings, and referred to arbitration.
10. 	Equitable Subordination/Recharacterization
TP contends in its “eleventh” claim for equitable subordination or recharacterization that
based on the detrimental nature of BOA and Joyner’s conduct during the lending relationship, any
debt owed to BOA should be subordinated to the claims of other creditors of TP. In the alternative,
TP requests that the court recharacterize any debt claimed by BOA as equity and a capital
investment rather than a loan or line of credit.
Although this claim fails the first prong of the Stern test in that it arose prior to the
bankruptcy filing and is based on state law, it passes the second prong because it directly attacks the
amount set forth by BOA in the proof of claim. As such, this claim will necessarily be resolved in
the claims allowance process and constitutes a core proceeding. As a core proceeding, the claim will
remain in this court for final determination.
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CONCLUSION
Based on the foregoing, the court finds that the claims for fraud in the inducement, recission,
and equitable subordination are core and it will exercise its jurisdiction to render final judgments
as to those claims.
The claims for constructive fraud, fraud, breach of fiduciary duty, negligence, negligent
misrepresentation, tortious interference, breach of contract/breach of covenant of good faith and fair
dealing, unfair and deceptive trade practices, and alter ego/insider liability are non-core. The court
will stay proceedings as to those claims and refer them to arbitration.
Accordingly, the motion to dismiss is DENIED, and the motion to stay is GRANTED IN
PART.
SO ORDERED.
END OF DOCUMENT
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