An examination of the impact of an insolvent respondent in an arbitration.
In 2008, the catastrophic effect of the credit crunch spread to most world economies, touching governments, companies and individuals alike. As in previous recessions, insolvency is affecting increasing numbers of individuals and companies. UK government figures show that individual insolvencies went up by 8.8% in the third quarter of 2008, with corporate liquidations up by 10.5% in the same period. Commentators predict that this trend will only accelerate through 2009.
Recessionary times often bring an increase in litigation and the beginning of 2009 looks to be no different.
Against this backdrop, parties to agreements to arbitrate or to ongoing arbitral proceedings are increasingly likely, in the course of the next year or so, to find themselves dealing with insolvent companies or individuals. Faced with an insolvent counterparty, arbitration can still remain a viable option, but the ability to recover assets is likely to be the key factor in deciding whether to pursue such an option (see also section “Key points”).
This article examines:
- The impact of the insolvency of a potential respondent on a claimant’s rights before arbitration begins.
- The effects of parallel insolvency proceedings on existing arbitral proceedings.
- The practical issues that a claimant should consider when dealing with an insolvent respondent.
Where your counterparty to an agreement to arbitrate has become insolvent before arbitration, your options depend largely on whether the insolvent party is an individual or a company, as well as the nature of the insolvency proceedings themselves.
Where your counterparty is a company which has been liquidated or wound up, it is likely that any agreement to arbitrate would (in the language of Article II of the New York Convention (see Glossary)) be considered to be either “inoperative or incapable of being performed”. However, it is still possible in certain circumstances to initiate arbitral proceedings against a wound up company depending on:
- The location of the assets.
- Whether the insolvent party has a successor or assignee.
Existence of assets. Different legal systems characterise insolvency as being either territorial (in other words, that insolvency proceedings only touch on assets located in the jurisdiction where the insolvency proceedings take place) or universal (involving assets anywhere in the world). Crucially, as international arbitrators are not national court judges, this distinction is largely irrelevant for the purposes of international arbitration. On this basis alone, insolvency proceedings do not determine the fate of arbitral proceedings; particularly, if the insolvent party (or related entities that might fall within the scope of the arbitration agreement) possesses assets outside the particular jurisdiction where insolvency proceedings have taken place, commencing arbitral proceedings may constitute a commercially sound option.
However, there are likely to be complex issues as to capacity and representation (see “Practical issues” below) which have an impact on any decision to commence an arbitration.
Where an insolvent party’s assets are located in the same jurisdiction as the arbitration proceedings, for example, while technically possible to commence arbitration by virtue of Article II of the New York Convention, if all assets are in fact located in that same jurisdiction, there is a danger of running into a domestic court’s anti-arbitration injunction.
Succession or assignment. Where arbitral proceedings are against the insolvent’s successors in interest or assignees, it is again possible to commence arbitration proceedings. However, careful consideration must be given to launching such proceedings, because issues of succession and assignment create some of the thorniest problems in international arbitration, such as determining whether an arbitration agreement will bind successors or assignees particularly in situations involving complex corporate structures. In Baytur SA v Finagro Holding SA, for example, the English Court of Appeal held that the assignee of all the assets of a party to an arbitration did not automatically assume in the arbitral proceedings the role of its assignor ( 1 Lloyd’s Rep. 134).
Where a potential corporate respondent (not yet liquidated) is under some form of administration and is represented by a third party administrator, national legislation frequently provides that the administrator has the power to decide whether that respondent can be a party to arbitration proceedings. In some circumstances, however, even if an administrator refuses the involvement of an insolvent in arbitral proceedings, you may still be able to enforce the arbitration agreement. International arbitration is a dispute resolution mechanism which is independent of national courts. Arbitrators are not public servants of a particular state. They do not have lex fori. To an international arbitral tribunal all the laws are foreign. Consequently, a potential claimant could initiate arbitral proceedings against a respondent in administration even without the administrator’s consent, particularly if the seat of arbitration is not the seat where insolvency proceedings take place.
However, for the arbitral tribunal, such an arbitration would constitute default proceedings (which is where one of the parties fails to participate) and in such a case (if the arbitral award violates international public policy of the jurisdiction of enforcement), you may face enforcement problems further down the line. That said, if the respondent has assets in different jurisdictions, you may still prefer to secure an award against the insolvent respondent. Ultimately, the flexibility granted by international arbitration would provide you with a certain degree of flexibility in the available options.
Where your respondent is an individual, you would also be able to choose whether to initiate arbitral proceedings without the administrator’s authorisation (particularly if the seat of the arbitration is different from the jurisdiction where any insolvency proceedings are taking place), giving rise to a default arbitration. Your decision is most likely to depend on the existence of assets in other jurisdictions.
The situation is different where insolvency proceedings are launched once arbitration proceedings are already afoot.
In these circumstances, most legislations provide for the stay of ongoing “proceedings”; however, there is some debate as to whether the definition of “proceedings” includes international arbitration.
Some national courts have found that the definition does include arbitral proceedings and, as a consequence, insolvency may result in a stay of an ongoing international arbitration. While it is not strictly necessary, a claimant is sometimes well advised to appear before the insolvency court in question and try to avoid a stay or obtain leave to proceed with the arbitration. Given the public nature of insolvency proceedings, insolvency courts generally permit claimants to appear and make representations.
In any event, arbitrators are not bound by the order of a court, particularly when the arbitral proceedings have their seat outside the jurisdiction where insolvency takes place, so they could just move forward without need for leave or an order somewhere else. In England, court permission must be obtained to continue with existing proceedings and the court has the power to order the stay of arbitral proceedings (Articles 126(1), 130(2), 285(1) and 285(3)(b), Insolvency Act 1986).
The continuance of an existing international arbitration does not depend solely on the determination of the national courts where the insolvency proceedings take place. In some cases, a tribunal may continue with an arbitration even if the national court dealing with the respondent’s insolvency has ordered a stay of the proceedings. Staying an arbitration may hinder the independence of arbitral tribunals from national courts, encumber the flexibility sought by the parties and delay the resolution of the dispute. As a consequence, arbitrators are rightly reluctant to stay arbitral proceedings, except where a stay is imposed by international public policy (which appears to be the case in France) (generally justified only by due process considerations, such as the equality of the parties or the right to present their case).
In the majority of instances, progressing an arbitration in the context of parallel insolvency proceedings will not create issues of due process. However, potential problems in enforcement could still arise.
The choice of whether to initiate or continue arbitration when dealing with an insolvent respondent is a tactical decision. The availability of assets will be the key consideration. If the arbitration goes ahead, then the following practical issues should be considered.
Service and communication
A claimant has the burden to provide the respondent’s address for service of the request for arbitration and relevant notifications. The absence of proper service or notification of the proceedings constitutes, in most jurisdictions, a ground to set aside an award and resist its enforcement. Claimants must therefore take particular care to ensure that proper service has been carried out on an insolvent respondent, especially since there may have been changes in representation as a result of the insolvency (see “Representation” below).
In practice, the claimant should serve both the respondent and any administrator involved in the insolvency proceedings.
Additionally, insolvent parties often do not participate in an arbitral proceeding. Faced with a defaulting respondent, the claimant should explain to the tribunal in detail all the measures taken to contact the respondent. Indeed, in its award, a tribunal is likely to set out at length any actions taken by the claimant to contact a defaulting party.
Once informed of the existence of insolvency proceedings, a claimant should check if there has been any change (by virtue of the operation of law) in the representation of a respondent. A claimant is also well advised to confirm the authority of the respondent’s counsel to act on behalf of the insolvent party in the arbitral proceedings.
If necessary, a claimant should request the production of relevant court orders, directions and/or powers of attorney to clarify such issues. Some civil law jurisdictions are particularly strict in this respect and might consider that a party was never put on notice of the proceedings if mistakes were made, opening the way for challenges to enforcement.
Some arbitration rules enable arbitral tribunals to order that a respondent provide security for all or part of the amount in dispute (for example, Article 25.1(a), LCIA Rules). On the face of it, therefore, a claimant dealing with an insolvent party might hope to obtain such a security. However, in the case of insolvency, a tribunal may well refuse to order security in relation to potential damages, as this is likely to violate the principle that all creditors in insolvency proceedings have the right to be paid on an equal footing, save for the existence of preferences.
In principle, at the outset of institutional arbitration at least, parties should bear the costs of the proceedings in equal shares, including deposits on account of arbitrators’ fees. In the absence of payment by the respondent, a claimant will have to pay the share of the defaulting party. Insolvent parties often do not make any payment (in some cases because of express court prohibitions). In such cases, a claimant would have to make substitute payments, effectively bearing all the expenses of the case. Some rules of arbitration provide that these substitutive payments constitute debts immediately due from the defaulting party. It is unlikely that such debts would be recoverable before the tribunal renders an award due to the principle of equal treatment of the creditors. In complex cases, a claimant should consider the costs of the arbitration and the likelihood of enforcing an award on the respondent’s assets, before deciding whether to initiate or continue arbitration.
Conflicts of interest
If the claimant learns about the respondent’s insolvency after the tribunal has been appointed, the claimant should check with the tribunal whether there might be supervening conflicts of interest between the arbitrators and the appointed administrators or the estate. For example, it may happen that an administrator appointed in the insolvency proceedings has pre-existing commercial, professional or family connections with one of the arbitrators. Such situations may disqualify an arbitrator from further involvement in the proceedings. If there are conflicts of interest, it may be necessary to replace an arbitrator or cause a truncated tribunal (where an arbitral tribunal was composed of three arbitrators at the onset finds one of its members cannot continue the proceedings, but it nonetheless renders an award with the remaining arbitrators).
A final point relates to the drafting of arbitration clauses. Although one might look for standard clauses adaptable to insolvency situations, in reality it is difficult to give one size fits all tips on drafting. However, on a practical level, as with other arbitration scenarios the choice of arbitrators in any insolvency situation is vital. Seasoned international arbitration practitioners will understand that they are not bound by domestic insolvency proceedings and are less likely to feel constrained in progressing an international arbitration in default of an insolvent party.
Three key points are essential to bear in mind in the context of an arbitration where there is an insolvent respondent:
- The insolvency of a party does not of itself affect the enforceability of an arbitration agreement.
- Supervening insolvency of a respondent does not necessarily prevent a claimant from continuing existing arbitral proceedings.
- The existence of insolvency proceedings does not necessarily oblige an arbitral tribunal to stay the arbitration.
LCIA. The London Court of International Arbitration. One of the world’s leading arbitral institutions.
Lex fori. The law of the forum or court in which the case is tried.
New York Convention. The New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, concluded in 1958. The Convention provides a regime that facilitates the recognition and enforcement of arbitral awards. By 2009, 149 countries have acceded to or ratified the New York Convention. Consequently, in almost all countries of the world, an arbitration agreement will be enforced unless it falls short of the requirements provided for by the Convention
Seat of arbitration. The legal place in which the arbitration is conducted. The seat is often defined in the arbitration agreement as a city rather than a country. Depending on the agreement of the parties or the law governing the proceedings, the arbitration hearings may be physically conducted in a place other than the seat (though the choice of seat remains unaffected).
This article was first published by PLC on 28 January 2009