Arbitration and insolvency

‘A conflict of near polar extremes.’

In (post-)COVID times, this topic has become more relevant than ever.

Business interruption caused by COVID-19 has been predicted to result in a growing number of disputes. Given the effects of the pandemic, an increasing number of disputes may involve parties with cash flow issues and/or facing actual insolvency. Added to this, arbitration is a popular means of solving cross-border disputes. The combination of these factors will likely see an increase in arbitration proceedings where at least one party is either insolvent or facing severe financial difficulties.

This may pose a problem. Arbitration and insolvency don’t mix well due to their competing policy aims. Whilst insolvency is public and centralised, arbitration is private and decentralised. That is to say, most disagreements relating to the same issue are solved bilaterally in arbitration, whereas in insolvency court all creditors’ claims are combined. Insolvency is also about treating similar creditors equally, which arbitration may, de facto, circumvent. For this reason, insolvency proceedings sometimes put a stay on any other type of dispute proceedings, including arbitration.

Sounds pretty bleak for arbitration, right? The reality is a little more complicated. Put simply, if a company is domiciled in a specific country, which we’ll call Country A, then it is the laws of Country A that will (usually) govern its insolvency. It is this law that will (sometimes) hold that arbitration proceedings must be paused. However, the law of Country A, and thus the duty to pause the proceedings, will generally not be binding on arbitral tribunals unless they are seated in Country A.

Many tribunals will therefore continue proceedings in Country B, even where Country A requires that proceedings are halted. This brings us to a secondary consideration: it’s all well and good that tribunals are not bound by a particular country’s laws and may (and often do) continue proceedings despite insolvency, but there is a risk that it will be an issue when the award needs to be enforced in Country A. Some courts may hold that the insolvency should have been recognised, or may simply be unwilling to enforce the award against a party subject to insolvency proceedings for public policy reasons. The whole point behind staying (i.e., pausing) proceedings is to give a company the chance to financially recuperate (or to maximise its assets ahead of its inevitable demise).

In practice, however, most ‘arbitration-friendly’ jurisdictions do still enforce awards, unless the law of Country A was at some stage ‘recognised.’

In a nutshell, the matter is complicated and highly variable between nations. Overall, however, arbitrators can (and do) proceed despite insolvency proceedings, although potential issues at the enforcement stage should be carefully considered. It is certainly an area that all arbitration practitioners should have a grounding in, and in relation to which we hope for further clarifications in years to come.

You can read a longer piece we’ve written about arbitration’s intersection with the insolvency laws of England & Wales here.