Sternklar v. Heritage Auction Galleries, Inc. (In re Paul), 50 Bankr. Ct. Dec. 234 (Bankr. D. Mass. 2008)

In Sternklar, the debtor, a rare coins dealer, engaged in thousands of transactions with Heritage Auction Galleries, an auction house that sold rare coins. The terms of the Sternklar’s and Heritage’s engagement were governed by a participation agreement that compelled arbitration of any dispute “arising” or “pertaining” to the participation agreement or its termination. When Sternklar filed for bankruptcy protection under chapter 7 of the Bankruptcy Code, the trustee sought to avoid certain transfers made to Heritage prior to the bankruptcy filing pursuant to Bankruptcy Code sections 547 and 548. Bankruptcy Code section 547 allows the trustee to “avoid” transfers made by the debtor within 90 days prior to the bankruptcy filing, and Bankruptcy Code section 548 allows the trustee to avoid fraudulent transfers. Heritage filed a motion to compel arbitration pursuant to the arbitration clause in the participation agreement. The Bankruptcy Court for the District of Massachusetts found the arbitration agreement valid and applicable, but determined that the Federal Arbitration Act (the “FAA”) did not compel arbitration of avoidance actions.

The Bankruptcy Court relied on the Supreme Court’s decision in Shearson/A.M. Exp., Inc. v. McMahon, 482 U.S. 220 (1987). In McMahon, the Supreme Court ruled that the FAA would not compel courts to enforce an arbitration agreement if a party could demonstrate that arbitration is contrary to Congress’s intent. The Sternklar court concluded that arbitration of a preference action conflicts with the purposes of the Bankruptcy Code, which are (i) having a centralized forum for the resolution of bankruptcy issues, (ii) the need to protect creditors and reorganizing debtors from piecemeal litigation, and (iii) to empower bankruptcy courts to enforce their own orders.

The Bankruptcy Court also rejected Heritage’s argument that the trustee’s complaint seeking the avoidance of “any transfer of interests of property of the Debtor . . . for which the Debtor received less than a reasonably equivalent value . . . at a time when the Debtor was insolvent” was too broad and not compliant with Rule 9(b) of the Federal Rules of Civil Procedure. Rule 9(b) of the Federal Rules of Civil Procedure states that a party must state with “particularity” the circumstances constituting fraud or mistake. The court ruled that in preference and fraudulent conveyance actions, a more relaxed standard is appropriate because there is no way to specifically identify which transfers are avoidable without formal discovery, especially where the Debtors made thousands of transfers before filing for bankruptcy.