How to…deal with insolvency and arbitration

01 May 2011

Sarah Walker, Chris Stone

In 2008, the catastrophic effect of the credit crunch spread to most world economies. As in previous recessions, insolvency has affected increasing numbers of individuals and companies, and parties to agreements to arbitrate are increasingly likely to find themselves dealing with insolvent companies. What are the issues to bear in mind?

1/ Prior insolvency
Different legal systems characterise insolvency as being either territorial (relating only to assets located in the jurisdiction where the insolvency proceedings take place) or universal (involving assets anywhere in the world). With a territorial insolvency, it may still be possible to commence arbitration proceedings where there are assets outside of the jurisdiction of the insolvency. However, where an insolvent party’s assets are located in the same jurisdiction as the arbitration proceedings, there is a danger of an anti-arbitration injunction being imposed by the domestic court.

2/ Administrators’ powers
Where a potential respondent is in administration (but prior to liquidation) national legislation frequently provides that the administrator has the power to decide whether that respondent can be a party to arbitration. However, since international arbitration is independent of national courts, it may still be possible to enforce an arbitration agreement even without the administrator’s consent. This is particularly the case if the seat of arbitration is different to the insolvency jurisdiction.

3/ Subsequent insolvency
Where insolvency proceedings are commenced during the course of arbitration proceedings, most jurisdictions provide for the stay of ongoing proceedings; however, national courts differ as to whether international arbitration falls within the definition of ‘proceedings’. It may be in a claimant’s interests to appear before the insolvency court and try to obtain permission to proceed with the arbitration. In any event, arbitrators are not necessarily bound by court orders, particularly when the seat of the arbitration is outside the jurisdiction of the insolvency. 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.

4/ Service and communication
Claimants must take particular care to ensure that an insolvent respondent is properly served with proceedings, and should also serve the proceedings on any administrator. Where an insolvent respondent does not participate in the proceedings, the claimant should be ready to explain to the tribunal all the measures taken to contact the respondent.

5/ Security
While some arbitration rules enable tribunals to order that a respondent provide security for all or part of the amount in dispute, a tribunal may well refuse to order security in the case of an insolvent respondent, since this would put the claimant on an unequal footing with the respondent’s other creditors.

6/ Costs
An insolvent party will often make no payment towards the costs of the arbitration, leaving the claimant to make substitute payments and bear all the expenses of the case. Any such payment is unlikely to be recoverable prior to the tribunal rendering an award.

7/ Conflicts of interest
The claimant should check whether there is any potential conflict of interest between the arbitrators and the administrators. Such situations may disqualify an arbitrator from further involvement in the proceedings, and it may be necessary to replace an arbitrator or continue with a truncated tribunal.

Sarah Walker is a Partner and Chris Stone an Associate in Bird & Bird’s International Arbitration Group, in London.