Insolvency and International Commercial Arbitration: Two Distinct Approaches

By Khyati Tuli and Daksh Mehta, Students at Amity Law School, Delhi

Insolvency and International Commercial Arbitration (“ICA”) are two parallel regimes which tend to converge at various instances. The tribunals, across the world have taken different approaches in relation to continuance of ICA when a parallel insolvency proceeding has commenced in the native state of the entity.

There are two major approaches, one that promotes arbitration without considering the fact that there is an insolvency proceeding going on in the native state whereas, the other one vocalizes about discontinuation of ICA in case of a parallel insolvency proceeding. This article tries to discuss the two parallel approaches in light of ICA and insolvency.

Approach promoting arbitration

The dominant trend in ICA is that the arbitral tribunals allow the arbitration to continue notwithstanding the existence of parallel insolvency proceedings in the native state. One of the main reasons that the arbitral tribunal refuses to discontinue the arbitration proceedings is due to the territorial nature of the insolvency proceedings. It is pertinent to note that the insolvency proceedings, notwithstanding the cross border insolvency regime, only have a national scope of application and therefore they cannot have an extraterritorial effect in the country where the arbitration is based. In his book titled, “International Arbitration and Insolvency Proceedings” Mantilla-Serrano noted that ‘concerning the grounds for denying suspension of the arbitration proceedings, the arbitrators seem to rely heavily on the territorial effects of insolvency proceedings.

The dismissal of arbitration proceedings considering an insolvency proceeding has been initiated is the violation of principles of ICA, particularly the principle of party autonomy that allows the parties to choose arbitration as a means of dispute resolution.

The award by the Bulgarian Arbitration tribunal, concerning the French Bankruptcy, held that there would be no dismissal of the arbitration proceedings because of the parallel existence of the insolvency proceedings against one of the parties. The tribunal also observed that the declaration of insolvency in the native state does not constitute a procedural impediment for arbitral tribunalsas the order by which the party has become insolvent has no extraterritorial effect. In lieu of the above, it was further stated that the parallel insolvency proceedings cannot deprive the tribunal of its competence under the arbitration agreement.

In Behring International Inc v. the Islamic Republic, Iranian Air Force, the Iran-US Claims Tribunal refused[CS|SL1]  to stay the arbitration proceedings holding that it was not bound by the Bankruptcy Code’s automatic stay provision owing to the territorial nature of the insolvency proceedings. Also, in Copal Co. v. Fotochrome Inc, the arbitral tribunal in Tokyo held that the corporate reorganization proceedings in a foreign jurisdiction should not affect the arbitration proceedings in some other country owing to the territorial nature of the insolvency proceedings.

Approach against the continuation of the arbitration

The other approach which has emerged in the Commercial world relating to the intersection of Insolvency and Arbitration Proceedings propounds discontinuation of arbitral proceedings. The rationale behind this approach can be based on the forthcoming arguments.

1. Principle of Lex Concursus and Universality

The arbitral tribunals are bound by the principles of lex concursus and universality and this should give powers only to the forum in the country of insolvency. The lex concursus principle enunciates that the applicable law for the proceedings and its legal and procedural consequences is the law of the state in which the insolvency measures have been undertaken. The principle of universality stems from the principle of symmetry between legal regulation and economic activity. Lex concursus establishes the voidability or unenforceability of legal acts detrimental to all the creditors.

In addition, the principle of vis attractiva concursus should also be attracted to the arbitral proceedings. This principle provides for the concentration of all litigation relating to the debtor in the insolvency court. It also means that the commencement of an insolvency proceeding grants the court jurisdiction over a range of other related matters

2. A Matter of Capacity

It should also be noted that the Company going under insolvency proceedings has lost its legal capacity to be a party to an arbitration. Legal capacity is the capacity to be the subject of rights and duties. It is further concluded that if the legal capacity of an entity is to be determined based on foreign law, it must be analysed if the entity is capable of having rights and duties under this foreign law.

A rule which provides for the inability to conclude contracts or arbitration agreements after the commencement of insolvency proceedings of a party governs a question of capacity. The law applicable to a company is the law of a party’s seat of business.

The Swiss Court, in the case of  Vivendi Univeral v. Argentine Republic, held that owing to the insolvency of a party, all arbitration agreements concluded by the company ceased to exist and all arbitration proceedings stands ended for the company. The rationale behind the court’s decision was that the party has lost its legal capacity to be a party in an arbitration. The court also opined that the legal capacity should be governed by the law of incorporation of the company.

3. Equality of Creditors

The idea that similarly situated creditors should be treated similarly has been widely viewed as the most important principle in insolvency and bankruptcy law. Equal treatment of creditors is one of the fundamental objectives of the insolvency law.

It is well established that there will be a common pool of debtor’s assets which will be further distributed among the creditors. It is a well-established fact that individual proceedings against the debtor are suspended or stayed to avoid individual creditors from claiming assets that should be available to the pool of creditors. An arbitration proceeding at such a juncture shall violate the principle of equality of creditors as it may cause a change in the assets of the company.

The principle of equality among creditors is considered to be part of domestic and international public policy and hence in the case of Saret v. SBBM, Dalloz, the award was set aside by the French Court because it violated the principle of equality of creditors.

Conclusion

In conclusion, it is submitted that ambiguities and loopholes continue to perplex the given situation and send the commercial world in an ever-ending spiral. This drawback can however be cured provided that international bodies pertaining to both the International Commercial Arbitration and Insolvency law follow a well-organized trail in a systematic function. It is proposed that the legislations and adjudicating authorities set up in place should take up the responsibility of removing enigmatic provisions as well as undertake the objective of making the process more conclusive and unambiguous. Further, a analysis of the above discussion also bolsters the argument that an extensive help can be sought from the comprehensive and uniform judgements coupled with undeviating awards from the International Tribunals to develop jurisprudence in this field.