Hostess Brands, Inc.

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UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
- - - - - - - - - - - - - - - - - -x
In re: 	Chapter 11
HOSTESS BRANDS, INC., 	12-22052-rdd
Debtors.
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MODIFIED BENCH RULING ON MOTION OF THE ACE COMPANIES
TO COMPEL ARBITRATION RELATED TO DEBTORS’ CASH COLLATERAL
MOTION
APPEARANCES:
JONES DAY
Attorneys for Debtors
222 East 41st Street
New York, NY 	10017
BY: 	ROBERT HAMILTON, ESQ.
HEATHER LENNOX, ESQ.
MICHAEL SILBERFARB, ESQ.
DUANE MORRIS LLP
Attorneys for ACE Companies
1540 Broadway
New York, NY 	10036
BY: 	LEWIS OLSHIN, ESQ.
WENDY M. SIMKULAK, ESQ.
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HON. ROBERT D. DRAIN, UNITED STATES BANKRUPTCY JUDGE:
The debtors in this case filed a motion, dated November 5,
2012, for authority to use cash collateral of ACE American
Insurance Company pursuant to section 363(c) of the
Bankruptcy Code, and, as applicable, sections 361 (dealing
with adequate protection) and 105.
The motion was adjourned on consent to January
2013. However, in the meantime ACE has moved to compel
arbitration of what it terms a contract dispute underlying
the debtors' cash collateral motion. 	And it is that motion
to compel arbitration that is presently before me.
The reply brief submitted by ACE succinctly
summarizes the facts. Pursuant to prior agreements, which
have been, by order of the Court, assumed (and I'm
compressing a lot into that phrase, because the orders
themselves are important and affect the interpretation of
the agreements), the debtors have agreed to provide the cash
collateral to the ACE Companies for purposes of securing
their obligations under the agreements, including the
agreement to pay deductibles, that the debtors owe to the
ACE companies under their insurance program.
Those obligations continue to accrue, although the
policies have now been replaced or expired, because,
obviously, there's a continuing expectation that injuries
covered by the policies will manifest themselves.
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ACE asserts, simply, the collateral was provided
pursuant to the collateral agreement, the collateral secures
their obligations under the collateral agreement, the
collateral agreement, in Article 4, expressly requires the
debtors to continue to provide collateral until ACE
determines that there is no longer any need for such
security, before the calculation of the insurance
obligation, as defined in the collateral agreement, and that
calculation may only be determined by interpreting the
collateral agreement. 	Therefore, ACE contends, the motion
contemplates a breach of the collateral agreement, and,
therefore, ACE contends, that breach, or that dispute, must
be arbitrated under the arbitration clause in the agreement.
That arbitration clause states, "Any controversy,
dispute, claim, or question arising out of or relating to
this agreement, including, without limitation,
interpretation, performance, or non-performance by any
party, or any breach thereof, (hereinafter collectively
“controversy”) shall be referred to and resolved exclusively
by three arbitrators through private confidential
arbitration conducted in Philadelphia, Pennsylvania."
There's a mechanism for selecting the arbitration
panel: 	"One arbitrator shall be chosen by each party, and a
third by the two so chosen. If either party refuses or
neglects to appoint an arbitrator within 30 days after
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receipt of written notice from the other party requesting it
to do so, the requesting party may choose a total of two
arbitrators who shall choose a third. 	If those arbitrators
fail to select a third arbitrator within ten days, after
both have been named, the party plaintiff shall notify the
American Arbitration Association, which shall appoint the
third arbitrator,” who shall be disinterested and neutral.
Further, “The arbitrators may abstain from
following the strict rules of law and shall make their
decision with regard to the custom and usage of insurance
business as of the effective date of this agreement."
The ACE insurers contend in their motion that
under applicable law the foregoing provision requires
arbitration of the dispute regarding the debtors proposed
breach of the applicable insurance program, and, as laid out
on the record today by counsel for ACE, at least part of the
issue relating to the cash collateral motion, which is what
is the exact amount of the debtors' obligations that are
secured under the applicable agreement.
The debtors contend, to the contrary, that the
issue before the Court is not a breach of contract issue,
but, rather, their right, whether or not the contract is
breached by exercising such right, to use cash collateral
pursuant to section 363(c)(2) of the Bankruptcy Code, which
states that “The trustee” (and, for these purposes, a debtor
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in possession is the equivalent of a trustee) "may not use,
sell, or lease cash collateral under paragraph 1 of this
subsection, unless (a) each entity that has an interest in
such cash collateral consents, or (b) the court, after
notice and a hearing, authorizes such use, sale, or lease in
accordance with the provisions of this section."
The standard for such determination is set forth
in Section 363(e) of the Bankruptcy Code, which states,
"Notwithstanding any other provision of this section, at any
time on request of an entity that has an interest in
property sold, used, or leased, or proposed to be used,
sold, or leased, by the trustee, the court, with or without
a hearing, shall prohibit or condition such use, sale, or
lease as is necessary to provide adequate protection of such
interest."
“Adequate protection” is also referred to and
defined, although, in a fairly open-ended way, in section
361 of the Bankruptcy Code, which states that "when adequate
protection is required under Section 363, it may be provided
by," and then it lists several factors in the alternative,
which have been supplemented by the case law.
At this point, following the leading decisions of
In re United States Lines, Inc., 197 F.3d 631 (2d Cir.
1999), and MBNA America Bank v. Hill, 436 F.3d 104 (2d Cir.
2006), the law regarding when and under what circumstances
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arbitration is required in a bankruptcy case, and when, if
it is not required, the Court should exercise its discretion
to stay it, is fairly well defined in the Second Circuit.
The law is well summarized by Bankruptcy Judge
Glenn in In re Bethlehem Steel Corp, 390 B.R. 784 (Bankr.
S.D.N.Y 2008). 	He states, at 789, "When determining whether
to compel arbitration and stay proceedings pending
arbitration, a court must " (that is, the bankruptcy court
in particular) "undertake a multi-step process: first, it
must determine whether the parties agreed to arbitrate;
second, it must determine the scope of that agreement;
third, if federal statutory claims are asserted, it must
consider whether Congress intended those claims to be non-
arbitrable; and, fourth, if the court concludes that some,
but not all, of the claims in the case are arbitrable, it
must then decide whether to stay the balance of the
proceedings pending arbitration." (quoting Oldroyd v. Elmira
Bank, 134 F.3d 72, 75-76 (2d Cir. 1998).
When reading the case law, it is clear that in
applying that analysis the courts are motivated or swayed in
part by not just a simple determination of whether a matter
is non-core or core pursuant to 28 U.S.C. section 157(b),
although that is an important factor, but whether, even if
it is core under that section of the Judicial Code, it is,
in fact, “substantially” core or truly a function of the
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bankruptcy process. 	They do so, I believe, in part because
they are interpreting whether, in fact, the first factor is
met, which is whether the parties agreed to arbitrate, and,
also, whether the third factor is met, which is whether
Congress intended the claims at issue to be non-arbitrable.
Bankruptcy is a multi-party process that is rooted
in the past but that in many cases drastically alters the
parties' prebankruptcy rights. 	It appears clear to me that
using Judge Glenn's phrase “substantially core” from the
Bethlehem Steel case, whether a debtor has authority to use
cash collateral is clearly substantially core. 	That is, it
is central to the bankruptcy process that Congress
contemplated as substantially altering otherwise existing
and enforceable rights under applicable non-bankruptcy law,
and that Congress did so in light of the fact that it is a
multi-party process, and not just a simple two-party
dispute.
Many courts apply that analysis in the context of
determining whether the parties actually agreed to arbitrate
the dispute, making the distinction between the prepetition
debtor and the postpetition trustee or debtor in possession.
See, for example, Bethlehem Steel, 390 B.R. at 790 and 793,
in which the court, citing many other authorities, holds
that bankruptcy law-created claims that are not derivative
of the prepetition debtor's rights are not subject to
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arbitration. 	See also -- I appreciate it's the same judge,
but the logic is the same, and equally telling -- In re S.W.
Bach & Company, 425 B.R. 78 (Bankr. S.D.N.Y 2010), at 91
through 92, as well as In re Salander-O'Reilly Galleries,
LLC, 475 B.R. 9 (S.D.N.Y 2012), in which District Judge
Seibel states, "There is no justification for binding
creditors to an arbitration clause with respect to claims
that are not derivative of one who is a party to it."
I recognize that Judge Lane in In re Cardali, 2010
Bankr. LEXIS 4113 (Bankr. S.D.N.Y 2010), took the view that
a fraudulent transfer lawsuit could be subject to
arbitration, notwithstanding that the party in the shoes of
the debtor in that case was asserting rights under the
Bankruptcy Code created by Congress. 	He did so because,
however, those rights specifically derived from state law
causes of action, and his view regarding Granfinanciera,
S.A. v. Nordberg, 492 U.S. 33 (1989). 	That view, frankly,
conflicts with numerous other cases. 	I don't need to decide
my own position on that issue, but it appears clear to me
that congressional authority to use cash collateral under
the requirements set forth in sections 363(e) and 361 of the
Bankruptcy Code is not at all rooted in a right that exists
pre-bankruptcy. 	Indeed, the whole purpose of the sections
is to alter those rights, as created by Congress.
Therefore, it appears to me that with regard to
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this particular dispute, the parties, in fact, did not agree
to arbitrate the use of cash collateral. 	I say that
notwithstanding my belief that it is a broad arbitration
agreement, as phrased, and, therefore, would satisfy in
favor of ACE (and certainly the debtors would not carry
their burden to show otherwise) that the agreement is broad.
But, to me, it does not deal with the unique bankruptcy
context of the cash collateral motion.
One can also approach the problem presented by the
motion from the perspective of whether Congress intended
this particular type of dispute to be non-arbitrable.
Obviously, Congress did not so state expressly in the
relevant provisions of the Bankruptcy Code. 	On the other
hand, Congress did expressly provide for the Court to make
the relevant determination under section 363(e), and applied
it to a trustee or debtor in possession, not the prepetition
debtor.
And, further, it is, as such, a core matter going
beyond the basic statutory definition of “core,” 28 U.S.C.
section 157(b), to be a fundamental aspect of the bankruptcy
process. 	It is hard to see how Congress would have meant to
turn over this particular type of determination, in which,
as the Second Circuit has recognized, other parties in
interest would have the right to intervene if they wanted to
(see In re The Caldor Corp., 303 F.3d 161 (2d Cir. 2002); 11
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U.S.C. section 1109(b)) to an arbitration panel in a two
party dispute, which may abstain from following the strict
rules of law and “shall make their decision with regard to
the custom and usage of the insurance business.” 	See
generally Randall G. Block, “Bound in Bankruptcy,” 29 Los
Angeles Lawyer (2007), in which the author states, "Other
provisions of the Bankruptcy Code” (other than lift-stay
motions) “that require the bankruptcy court to make findings
or approve certain actions are arguably inconsistent with
resolution through arbitration. For example, the
confirmation of a plan, sale of property outside the
ordinary course, use of cash collateral, or assumption or
rejection of executory contracts all require express
authorization by the court. 	Arguably this authorization
requirement does not comport with allowing disputes over
these matters to be handled through arbitration.”
Again, all of those issues involve both multi-
party notice and determination, recognizing the multi-party
nature of bankruptcy issues in bankruptcy cases, and,
finally, in a summary proceeding manner, the exercise, as a
final call, of the bankruptcy judge's judgment as to the
propriety of the action to be taken. 	See In re Orion
Pictures Corp., 4 F.3d 1095 (2d Cir. 1993).
It also appears to me that even if the arbitration
provision does, in fact, apply to this dispute, the Court
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should exercise its discretion and deny the arbitration
demand. 	The Court clearly has that authority, given that
this is a core proceeding. 	The cases stemming from the MBNA
v Hill decision make that clear, as does the United States
Lines decision, although MBNA also made it clear that to
exercise the court's discretion on a core matter, that is,
core under 28 U.S.C. section 157, the type of matter must be
unique to or uniquely affected by bankruptcy proceedings,
and the proceedings are a core bankruptcy function that
invokes substantial substantive rights that are created by
the Code and in severe conflict with arbitration under the
Federal Arbitration Act.
As I noted earlier, this is clearly that type of
proceeding. 	Therefore, I see no contradiction in the logic
employed by Bankruptcy Judge Walsh in Delaware in the NEC
Holdings' case, which involved a similar request for cash
collateral (the transcript of which has been attached as
Exhibit B to the objection of the motion, which is Case No.
10-1890, Docket No. 1360, Bankruptcy D. Delaware, June 30,
2011), and Judge Walsh's written decision in In re Olympus
Healthcare Group, 352 B.R. 603 (Bankr. D. Del. 2006), which
involved not use of cash collateral, but a contract dispute,
a true contract dispute, which certainly would be subject to
arbitration.
If I were to exercise any discretion here, I
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believe it would not be over whether I should hear the
section 363(e) matter, because clearly I need to hear it, I
have a duty to hear it, but, rather, whether I should parcel
out a piece of that litigation to an arbitration panel.
But, as I stated during oral argument, it would seem to me
that that piece would only be a piece to fix a specific fact
that might be at issue, as opposed to underlying rights of
the parties.
It would be analogous to compelling a piece of a
lift stay motion to go to arbitration, and then have that
fact come back to me. 	I suppose under certain
circumstances, applying the Second Circuit's factors laid
out in In re Sonnax, a court might do that, particularly if
the non-bankruptcy tribunal or arbitrable panel was about to
rule on that key issue. 	See In re Sonnax Industries, Inc.,
907 F.2d 1280, 1286 (2d Cir. 1990), laying out the twelve
factors that the Circuit believes relevant to whether to
lift the stay for another decision-making body to determine
an issue.
But it would be in that context, as opposed to
requiring arbitration, and it is the approach that has been
taken by countless courts in the analogous situation where
there was a lift-stay motion and parts of the issue were
involved in arbitration and where the courts applied the
Sonnax factors as opposed to saying that pieces of the lift
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stay issue were to be sent to the arbitrators. 	See, for
example, Salander-O’Reilly Galleries, 479 B.R. at 25; In re
St. Vincent's Catholic Medical Centers of New York, 2012
U.S. Dist. LEXIS 139584 (S.D.N.Y September 27, 2012), at 8
through 10; and In re Quigley Company, Inc., 361 B.R. 723,
743 through 44 (Bankr. S.D.N.Y 2007). 	See also In re
Spectrum Information Technologies, Inc., 183 B.R. 360
(Bankr. E.D.N.Y 1995), although I recognize that that case
predates MBNA v Hill.
I conclude, in exercising my discretion with
respect to this core matter under 28 U.S.C. section
157(a)(2) (and it is “substantially” core under the
arbitration/bankruptcy court analysis), that the issues,
which substantially affect both bankruptcy policy as well as
the conduct of this case, are such that even if the parties
did, in fact, agree to arbitrate the cash collateral issue,
and, further, that Congress did not intend to preclude the
arbitration of this issue, having considered the nature of
the claim and the facts of this case, clearly the whole
dispute (and even the portion of dispute which would not
result in anything more than providing a data point for the
Court in deciding the dispute), should not be determined by
an arbitration panel.
To do so would seriously jeopardize the objectives
of the Bankruptcy Code as expressed in section 363(c) and
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(e) and conflict with the integrity of the bankruptcy
process in this case. 	So I'll deny the motion. 	The debtors
can submit an order, and they should e-mail a copy of it to
counsel for ACE before they submit it, to make sure it's
consistent with my ruling.
Dated: White Plains, New York
January 7, 2013
/s/Robert D. Drain_______ 	__
UNITED STATES BANKRUPTCY JUDGE
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