Northern District of Texas Refuses to Compel Arbitration in Bankruptcy Proceeding

The Northern District of Texas has refused to compel arbitration in a bankruptcy proceeding where the equities did not weigh in favor of ordering a non-signatory to arbitration, the party who sought to compel arbitration substantially engaged in adversarial proceedings and issues of bankruptcy law predominated.

In Hallwood Group, Inc. v. Balestri (No. 3:10-CV-1198-K) (N.D. Tex. Oct. 21, 2010), the Hallwood Group appealed a bankruptcy court’s order which denied its motion to compel arbitration. The Hallwood Group owns half of the general partner shares and twenty-two percent of the limited partnership interest in Hallwood Energy, L.P., a Texas natural gas exploration and drilling limited partnership. In June 2008, Hallwood Energy entered into an agreement with FEI Shale (Shale Agreement) which provided that FEI Shale “would provide funding for drilling operations in exchange for a share of the proceeds from successful wells.” This agreement contained an arbitration clause as well as a provision which required Hallwood Energy and Hallwood Group to enter into a separate agreement (Hallwood Agreement) in which Hallwood Group agreed to provide $12.5 million in cash to Hallwood Energy. According to the record, FEI Shale was concerned about Hallwood Energy’s ability to meet its obligations and conditioned enforcement of the Shale Agreement on the creation of the Hallwood Agreement.

In February 2009, a disagreement arose between Hallwood Energy and Hallwood Group regarding whether Hallwood group was obligated to make a payment under the Hallwood Agreement. Hallwood Group did not make the payment and Hallwood Energy filed for bankruptcy on March 1, 2009. On March 30^th, Hallwood Energy initiated an adversarial proceeding against Hallwood Group for breach of the Hallwood Agreement. In June 2009, both FEI Shale and Phoenix/Inwood, Hallwood Energy’s largest secured and unsecured creditor, were allowed to intervene and prosecute claims on behalf of Hallwood Energy against Hallwood Group. Hallwood Group sought to compel arbitration against Phoenix/Inwood but the bankruptcy court denied Hallwood Group’s motion.

The Northern District of Texas agreed with the bankruptcy court’s refusal to grant Hallwood Group’s motion to compel arbitration because an arbitration agreement was not included in the Hallwood Agreement and the arbitration clause in the Shale Agreement did not extend to the Hallwood Group. Additionally, the court stated the bankruptcy court did not abuse it’s discretion in holding that Hallwood Group could not invoke the arbitration clause in the Shale Agreement against a non-signatory under a theory of equitable estoppel.

The Northern District approved of the bankruptcy court’s holding that, even assuming Hallwood Group possessed an enforceable right to arbitrate, it waived that right by substantially engaging in adversarial proceedings with Hallwood Energy. The court noted that Hallwood Group’s involvement was extensive, including the initiation of three depositions, participation in fourteen more, and the filing of several counterclaims. According to the bankruptcy court, Hallwood Group prejudiced Phoenix/Inwood by its participation in the adversarial proceedings. Moreover, because Hallwood Group first moved for arbitration nearly one year after the adversarial proceedings commenced and only two months before trial was scheduled, to allow arbitration would create an unfair delay to all creditors of the bankruptcy estate.

Finally, the Northern District of Texas held that the bankruptcy court “correctly determined that it had discretion to refuse to enforce the arbitration provision under National Gypsum and In re Gandy because issues of bankruptcy law predominated.” Under National Gypsum, 118 F.3d 1056 (5th Cir. 1997), even if Hallwood Group had a right to arbitrate and did not waive it, a bankruptcy court would still have discretion to refuse to enforce an arbitration agreement when: “(1) the underlying proceedings derive exclusively form the Bankruptcy Code; and (2) arbitration would conflict with the goals of the Code.”

The court stated In re Gandy, 299 F.3d 489 (5th Cir. 2002), was a factually similar case and noted that “though state law claims were present, the crux of the lawsuit deals with bankruptcy matters.” The court held that because Phoenix/Inwood accused Hallwood Group of forcing Hallwood Energy into a declaration of bankruptcy in order to avoid its obligations under the Hallwood agreement, the bankruptcy court properly determined that arbitration would conflict with the purposes of the Bankruptcy Code.

The Northern District of Texas affirmed the bankruptcy court’s denial of Hallwood Group’s motion to compel arbitration.

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