Arbitration: recession–proof or another casualty of the global credit crunch?

01 October 2010

Sarah Walker, Boey Swee Siang, Luke Ryan

Sarah Walker, Boey Swee Siang, and Luke Ryan, consider the impact of insolvency on arbitration
 
Recessionary times attract an increase in disputes and the last couple of years have been no different.  Even in the good times, a claimant may face the uncertainty of not knowing whether - if ultimately successful at trial - a defendant will prove capable of paying any sum awarded.   In recessionary times, claimants require an even greater weather eye on a defendant’s financial status. 

Against this backdrop, parties to agreements to arbitrate are increasingly likely 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.  Courts are being asked to deal with issues arising from this and there has been a recent decision in Singapore where the Singapore Court rejected a company's attempt to compel arbitration of an insolvency dispute. 

In the context of arbitration, therefore, this article looks (1) generally at the impact on a claimant’s rights of the insolvency of a potential corporate respondent before arbitration begins and also, (2)  more particularly at the present situation in the key Asian arbitration jurisdictions of Hong Kong and Singapore. 

Impact of insolvency on a party to an arbitration agreement

Where the counterparty to an agreement to arbitrate has become insolvent before arbitration, a claimant’s options depend largely on whether the insolvent party is an individual or a company, as well as the nature of the insolvency proceedings themselves. We deal in this article with corporate insolvency.

Where the 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 be considered to be either “inoperative or incapable of being performed”. However, it may still be possible in certain circumstances to initiate arbitral proceedings against a company in liquidation.  This will depend on location of the assets and whether the insolvent party has a successor or assignee. Different legal systems characterise insolvency as being either territorial (i.e. that insolvency proceedings only touch upon assets located in the jurisdiction where the insolvency proceedings take place) or universal (involving assets anywhere in the world). 

As international arbitrators do not fulfil the same function as national court judges, it follows that such a distinction is largely irrelevant in this context. It must follow that insolvency proceedings are not determinative of the fate of arbitral proceedings.  In fact, if the insolvent party (or indeed any related entities that might fall within the scope of the arbitration agreement) possesses assets outside the jurisdiction where insolvency proceedings have taken place, commencing arbitral proceedings may constitute a commercially sound option. This must, of course, be balanced with any complex issues as to capacity and representation, which will affect any decision to commence arbitration proceedings.

Where arbitral proceedings are against the insolvent company’s successors in interest or assignees, there is again a possibility of commencing arbitration proceedings - although careful consideration must be given to launching such proceedings, because issues of succession and assignment create perhaps some of the thorniest problems in international arbitration (for example, 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 ([1992] 1 Lloyd’s Rep. 134)).

Administrators’ powers
 
Where a potential corporate respondent 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 seeks to prevent the participation of an insolvent in arbitral proceedings, a claimant 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.  In short, to an international arbitral tribunal all laws are “foreign”. A claimant could therefore take steps to 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.  Such steps must, however, be balanced with the consideration that, for the arbitral tribunal, such an arbitration would constitute default proceedings (ie. where one of the parties fails to participate) and, if any eventual arbitral award is shown to violate “international public policy” of the jurisdiction of enforcement further down the line, there are likely to be enforcement problems.  Commercially, if a respondent has assets in different jurisdictions, it may however still be preferable to secure an award against the insolvent respondent.

With this in mind, it is interesting to consider whether key arbitration jurisdictions outside Europe would uphold arbitration clauses in the face of insolvency.  There have been recent decisions in the courts of Singapore and Hong Kong which might cause concern to a potential claimant in arbitration proceedings. 

Singapore

The Singapore High Court rendered a decision recently on the issue of the arbitrability of insolvency and insolvency-related disputes. In the case of Petroprod Ltd v. Larsen Oil and Gas Pte Ltd [2010] SGHC 186, the High Court ruled that public policy behind the avoidance provisions under sections 98 and 99 of the Bankruptcy Act (Cap. 20) (read with section 329(1) of the Companies Act (Cap. 50)) would be compromised if the enforcement of these provisions was subject to private arrangements – including an agreement to arbitrate – between the company and a creditor who had been unfairly preferred or advantaged over other creditors.

The Plaintiff, Petroprod Ltd, was a Cayman Islands company with several subsidiaries, including Petroprod 1 Ltd (referred to in the judgment as “PP1”), Petroprod 2 Ltd (referred to in the judgment as “PP2”), Petroprod 3 Ltd (referred to in the judgment as “PP3”) and Petroprod D&P 1 Ltd (referred to in the judgment as “DPL”). It appears that PP1, PP2 and PP3 were single-ship corporations, and DPL was engaged in the construction of a rig.

The Plaintiff had entered into a Management Agreement with the Defendant, Larsen Oil and Gas Pte Ltd, in December 2006, which contained the following arbitration clause:  [ box out  ]

This Agreement shall be construed and enforced in accordance with and governed by the laws of Singapore. Disputes which cannot be resolved amicably shall be resolved by arbitration in Singapore in accordance with the provisions of the Singapore Arbitration Act. Chapter 10.”  [ box out ]

The Plaintiff was placed into liquidation on 17 July 2009 in the Cayman Islands and on 3 August 2009 in Singapore. Although its four subsidiaries were not placed into liquidation, they were technically insolvent as at 31 December 2008.

The liquidators of the Plaintiff commenced a High Court action, by way of Suit No. 866 of 2009, to avoid various payments that the Plaintiff had made to the Defendant on the basis of unfair preference or transactions at undervalue, pursuant to sections 98 and 99 of the Bankruptcy Act (read with section 329(1) of the Companies Act). The Plaintiff also sought to avoid various payments made by its subsidiaries to the Defendant, on the ground that these transactions were made to defraud the Plaintiff as a creditor of the subsidiaries.

The Defendant filed an application to have the action stayed in favour of arbitration, placing its reliance on the arbitration clause in the Management Agreement (referred to above).

In its decision, the High Court briefly discussed the concept of arbitrability, particularly the arbitrability of insolvency disputes. The court found that the concept of arbitrability applied to arbitrations governed by the Arbitration Act (Cap. 10) (as it does to arbitrations governed by the International Arbitration Act (Cap. 143A), by virtue of section 11 thereof).

The court then went on to examine whether the disputes in the case were “core” or “pure” insolvency issues, which were inherently not arbitrable, and took the view that the avoidance provisions of the statutes in question existed for the benefit of the general body of creditors in an insolvency or insolvency-related context. The policy underlying the avoidance provisions would be compromised if their enforcement was subject to private arrangements, such as arbitration agreements.

As for the Plaintiff’s claims in relation to the payments by its subsidiaries to the Defendant, the same policy considerations applied, and, given that there would be a substantial overlap of issues, it would be preferable if all claims were considered in the same forum. The proper forum was held to be the High Court. 

This decision is significant for a number of reasons.  It is the first case in Singapore to deal with the concept of arbitrability. As stated in the judgment itself, this case was the first time that a stay of proceedings was sought in relation to insolvency-related claims before a Singapore court. The concept of arbitrability is recognised in section 11(1) of the International Arbitration Act, which states that “Any dispute which the parties have agreed to submit to arbitration under an arbitration agreement may be determined by arbitration unless it is contrary to public policy to do so.” Although the (Singapore) Arbitration Act does not contain a similar provision, the court held that this concept should be taken into account when the court is being asked to exercise its discretion to grant a stay of proceedings under the relevant provisions of the (Singapore) Arbitration Act.

While it is conventionally accepted that issues relating to insolvency law are generally not arbitrable, there had, prior to this, not been any decision on point. Indeed, the Defendant tried to argue otherwise, by relying on section 148A of the Bankruptcy Act, which states that where a bankrupt had, prior to the commencement of his bankruptcy, entered into an arbitration agreement, if the Official Assignee does not accept the contract and a matter to which the arbitration agreement applies has to be determined in connection with or for the purposes of the bankruptcy proceedings, the Official Assignee or any other party to the agreement may apply to court and the court may, if it thinks fit, order the matter to be referred to arbitration.

However, the High Court held that section 148A of the Bankruptcy Act did not support the Defendant’s case, as the section relates to matters to which the arbitration agreement applies (i.e., to an arbitrable matter). Further, the court also has the discretion to decide whether to refer the matter for arbitration. The judge was of the view that section 148A of the Bankruptcy Act left room for applying the concept of arbitrability.

Hong Kong

Along with the rest of the world, Hong Kong’s economy was severely damaged in the second half of 2008 and plunged into recession. Despite this, like many of its Asian neighbours, Hong Kong has since rebounded strongly and emerged from the doom and gloom of the recession relatively quickly. Nevertheless, notwithstanding this rebound there continues to be financial casualties in Hong Kong caused by turbulence in international markets and the Hong Kong Courts have still been busy with insolvency cases, making some 14,550 bankruptcy orders and some 590 winding up orders in the 2009/2010 financial year.

It is in this context that the Hong Kong High Court has had an opportunity to again consider the conflict arising between contracting parties’ private agreements to arbitrate and their corresponding statutory rights and remedies under the Companies Ordinance in Hong Kong when the other contracting party has failed to pay debts the subject of a statutory demand.  In the recent case of Re Sinom (Hong Kong) Limited [2009] 5 HKLRD 487 (Re Sinom), a Hong Kong company, Sinom (Hong Kong) Limited (Sinom), had entered into an contract with an Australian mining company, Mount Gibson Mining Limited (MGM) for the long term supply of iron ore produced by MGM. Notwithstanding that the contract between the parties provided for any dispute to be resolved by arbitration, MGM issued a statutory demand against Sinom in Hong Kong for unpaid debts and Sinom failed to satisfy the statutory demand.

Sinom sought an injunction restraining MGM from presenting a winding up petition to the Court on the basis of alleged cross-claims and that any dispute should be resolved by arbitration. In its determination, the Court followed the decision of the Honourable Justice Barma in Hoo Cheong Building Construction Company Ltd v Jade Union Investment Ltd (HCCW 400/2003)(the Jade Union Case) and confirmed that, as laid down in that case (at paragraphs 13 to 27), whereas in an ordinary action between parties, the effect of Article 8(1) of the UNCITRAL Model Law was that the court was precluded from considering whether or not there was a “dispute” between the parties that should be referred to arbitration, it did not have any effect in relation to winding up petitions. 

Further, the Honourable Justice Barma in the Jade Union Case went on to provide that:  [ Box out ]


A petition for the winding up of a company is quite different from an action between parties, in which the parties seek the court’s determination as to their respective rights and liabilities.  By a winding up petition, a creditor invokes the court’s jurisdiction under the Companies Ordinance to wind up a company on one or more of the grounds set out in section 177(1) of that Ordinance” ( at para 18).  [ Box out ]


If the court concludes that that there is no bona fide dispute in relation to the debt, the subject of the statutory demand, then there is “…no good reason why the existence of an arbitration clause should be regarded nonetheless as somehow relevant to the court’s exercise of its discretion as to whether or not to make a winding up order” (at para 21).

Following the principles laid down in the Jade Union Case,  the Court in Re Sinom went on to hold that there was no dispute as to the debt owed to MGM (the subject of the statutory demand) and dismissed the application for the injunction to restrain presentation of a winding-up petition.

Summary

Perhaps these cases in Singapore and Hong Kong can be limited on their facts, dealing as they do with matters which are arguably ones of “pure” insolvency.  However, there is some scope to view them as a more general statement of intent that parties cannot, by a private arbitration clause, cut out the National Courts when dealing with matters of insolvency.  That is not to say, however, that the fact of an insolvent party is an absolute bar to arbitration proceedings.

The choice of whether or not to initiate or continue arbitration when dealing with an insolvent respondent remains a tactical decision.  In complex cases, the key considerations for any claimant will be the impact of any insolvency on both the issues to be determined within any arbitration as well as the practicalities of any arbitration.

Sarah Walker, is a partner in the London office of Bird & Bird; Boey Swee Siang, a partner in the Singapore office and Luke Ryan, an associate in the Hong Kong office.

Authors

Boey-Swee Siang

Swee Siang Boey

Partner
Singapore

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