Arbitration and bankruptcy/insolvency: what are the implications for claimants in arbitration when their respondents enter an insolvency process?

The financial loss and the uncertainty caused by the pandemic continues to affect business globally, and an increase in corporate insolvency is widely anticipated. Arbitration is an effective dispute resolution mechanism, but a counterparty entering insolvency proceedings can be disruptive. We recently wrote about insolvency being one of the key trends in international arbitration in 2021. So how might counterparty insolvency affect your ability to use arbitration?

Counterparty insolvency represents an inflexion point in your dispute, with both financial and legal consequences. Financially, notwithstanding good prospects of success, if you only stand to recover a low percentage of the monetary relief and/or costs you are awarded, i.e. your debt in the insolvency proceedings as an unsecured creditor, it may no longer be a good strategy to continue an expensive and time consuming dispute resolution process. Legally, there are two key ways in which commencement of insolvency proceedings represents a shift in dynamic in an arbitration context:

1. The hallmarks of arbitration are party autonomy and privity (with potential for flexibility, speed and confidentiality). In contrast, insolvency proceedings are collective, aiming to either restructure the counterparty’s liabilities or to distribute its assets between creditors in a prescribed order.
2. Unlike arbitration, insolvency proceedings are generally supervised by national courts. Also, to be recognised internationally, insolvency proceedings frequently need to be recognised by local courts via a formal cross-border insolvency mechanism. The ease of recognition depends on the jurisdiction(s).

These changes in dynamic are illustrated by two themes. Both are consistent in insolvency proceedings across many jurisdictions.

First, insolvency proceedings typically transfer control from directors to an insolvency officeholder, such as a trustee, liquidator or administrator (with a notable exception being Chapter 11 bankruptcy in the USA). This individual generally has specialist qualifications and may be an officer of the court. They will have considerable powers, but are likely to also be accountable to the court and the counterparty’s other creditors. For ongoing disputes, this will disrupt the relationship between the parties – but a fresh perspective may give an opportunity to move past deadlocked points.

Second, insolvency proceedings typically impose a moratorium: i.e. you cannot start or continue litigation or arbitration against the insolvent party without the consent of the court or the insolvency officeholder. This reflects the collective nature of insolvency proceedings: creditors make their claims in a single process overseen by the insolvency officeholder, rather than in individual actions against the insolvent company. However, the moratorium is not always enforced. If funding can be agreed, it may be preferable to continue an arbitration that is at an advanced stage, particularly if it is before an expert tribunal. The outcome will resolve a disputed debt, which the officeholder will not then need to consider from a cold start. Also, if the arbitration is seated in a different jurisdiction from the insolvency, it may be possible to continue it regardless of the insolvency proceedings. However, doing that without the consent of the national court or insolvency officeholder may have important consequences. Critically, an arbitration award in an arbitration which is continued without consent may not be enforceable in the jurisdiction where the insolvency proceedings are based, and where key assets may be located.

Upon counterparty insolvency, you will need to reflect on your strategy. You should get the best advice on the relevant insolvency laws and the cross-border insolvency dynamic, integrated with your arbitration advice. Freshfields’ market-leading global disputes and restructuring and insolvency practices are exceptionally well placed to do this.

In our next post, we will focus on the implications of a claimant's insolvency on an arbitration.