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Arbitration Not Waived in Lawsuit Pending for Two Years

Defendants in a lawsuit didn’t waive their right to arbitrate even after moving to dismiss and answering a complaint, a court held last week.  Arbitration wasn’t waived because the defendants hadn’t filed affirmative defenses or counterclaims and had taken no discovery. Trevino v. Select Portfolio Servicing, Inc. (In re Jose Sr. Trevino), Adv. Pro. No. 16-7024, 2018 Bankr. LEXIS 3605 (Bankr. S.D. Tex. Nov. 14, 2018).

The issue arose in a chapter 13 case where the debtors sued both the mortgagee and loan servicers.  The complaint asserted eight claims, including abuse of process, breach of contract, violations of various lending and real property statutes, and a request for injunctive relief.  The defendants filed motions to dismiss, a motion for sanctions, a motion to abate discovery, answers to the complaint, and a statement consenting to entry by the bankruptcy court of final orders and judgment.

Then, two years after all this began and eight years after the bankruptcy case was filed, the defendants moved to arbitrate.  They cited an arbitration clause in a rider to a deed of trust that plaintiffs had signed.  The plaintiffs argued that the defendants’ actions in the litigation waived their right to arbitrate.

The legal test before the court was whether (i) the defendants had “invoked the judicial process,” and (ii) the plaintiffs would be prejudiced by arbitration.  The court said the judicial process had not been invoked and that arbitration would not prejudice the plaintiffs.

Written arbitration clauses are “valid, irrevocable, and enforceable” under the Federal Arbitration Act.  9 U.S.C. § 2.  The FAA represents “a congressional declaration of a liberal policy favoring arbitration . . . .”  Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 103 S. Ct. 927, 941 (1983).  Even so, a contractual right to arbitrate can be waived.

The bankruptcy court in Trevino observed that the judicial process is invoked when a party seeks to litigate a matter that could otherwise be arbitrated.  But “a party waives arbitration when it seeks a decision on the merits before attempting to arbitrate.”  2018 Bankr. LEXIS 3605, at *15.  The defendants here didn’t waive arbitration because they hadn’t sought to litigate.  They had merely filed motions to dismiss when sued and didn’t assert affirmative defenses or counterclaims.  They also didn’t delay seeking to arbitrate after their motion to dismiss was denied.

The court also ruled that arbitration wouldn’t prejudice the plaintiffs.  The test for prejudice has three prongs: delay, expense, and damage to a party’s legal position.

Delay alone will not cause prejudice, the court observed.  Usually prejudice results when delay is combined with another factor.  And, here, there was no delay, the court said.  The defendants moved to compel arbitration just two months after filing an answer.

The plaintiffs also noted that they had incurred legal expenses in the lawsuit before the motion to compel arbitration was filed.  But, the court said, the expenses concerned “elementary matters”: motions to dismiss and answers.  No affirmative defenses or counterclaims had been filed; the plaintiffs didn’t need to respond to discovery; and no summary judgment motions had been filed.

This conclusion led to the court’s decision on the final prong:  that the plaintiff’s legal position had not been prejudiced.  Because there had been no discovery or expert witness reports and testimony yet, the defendants hadn’t gained insight into the plaintiffs’ legal strategy.  Thus, the plaintiffs hadn’t shown any prejudice, and the parties’ agreement to arbitrate would be respected.