Pandemic insolvencies reveal international arbitration issues

The global pandemic has devastated businesses large and small, especially in sectors such as travel, hospitality and entertainment, but also in the prominent areas of manufacturing, retail and the industry. energy. For many businesses, a sharp drop in income has resulted in a cash shortage severe enough to threaten debt service and raise fears of bankruptcy.

Some of the first emergency measures adopted by many governments in 2020 were designed to avert a tsunami of insolvencies. While interim loans, tax breaks and the like will be enough to close the gap for some companies, corporate insolvencies are expected to increase significantly around the world this year. In the United States, for example, bankruptcies are projected increase by 57% from 2019 to 2021.

This type of disruption has not been seen in years, probably at least since the 2008 financial crisis. As then, massive corporate bankruptcy raises the question of how troubled companies and their creditors are doing. manage the largely untested interaction between insolvency and arbitration.

Arbitration is preferred in cross-border disputes

International arbitration is the preferred method of dispute resolution for cross-border transactions, be it sales of goods and services, debt instruments, equity acquisitions, intellectual property licenses or oil and gas production sharing agreements.

Arbitration provides contracting parties with a neutral, private and confidential forum for the resolution of disputes outside the domain of national courts, with unprecedented enforcement of resulting awards around the world through the 1958 New York Convention. , a treaty that almost every country in the world celebrates.

But arbitration is a creature of the contract, and although most countries have adopted laws favoring the autonomy of the parties to design their own means of resolving disputes between them, this ‘hands off’ approach may change where the public policy is seen to be in the foreground. . The need to protect the existing creditors of a bankrupt business can upset otherwise foreseeable contractual relationships and the outcome of disputes.

In some jurisdictions, local bankruptcy regulations take precedence over arbitration laws, potentially blocking the enforcement of arbitral awards against an insolvent judgment debtor.

Insolvency is a national event

When a company declares itself insolvent, it is a deeply national event (as opposed to international). A court, normally located at the bankrupt’s place of incorporation, declares the business insolvent under local law, imposing a series of restrictive measures to retain assets and protect creditors.

The court order will limit its legal relationships, including the conduct of litigation and arbitration, both current and future. International insolvency laws are diverse and insolvency impacts arbitration from start to finish.

Arbitration agreements concluded before the insolvency generally remain binding on the bankrupt. But in some countries (such as the US, UK, and Hong Kong), an ongoing arbitration can be forcibly suspended (or “suspended”) when the insolvency is triggered. Court authorization is required to restart the arbitration process.

In the United States, courts normally lift the stay unless the arbitrators are asked to decide issues at the heart of the insolvency, such as how the insolvent party’s trustee should allocate assets. In contrast, in the United Kingdom, the onus is on the creditor to convince the court that resuming the arbitration would not complicate the fair and efficient administration of the bankruptcy estate.

The bankruptcy administrator often has the power to step into the insolvent party’s shoes to conduct the arbitration and will continue the dispute resolution process.

In most countries, arbitral awards (especially of the international variety) are not subject to appeal and can only be challenged for very limited reasons. The insolvency of a party can undermine certainty in this regard, since an award can be set aside in most countries where there is a breach of public order.

In Germany, an award may be vulnerable if the insolvency administrator has not replaced the debtor to conduct the arbitration. In France and the United States, courts can find a breach of public order when the court has moved forward to render an award instead of staying the case when one of the parties has become insolvent.

Even when an arbitration award can be obtained against a bankrupt and survives litigation, most insolvency laws around the world require enforcement to take place only in court-administered bankruptcy proceedings.

National insolvency laws can have global effects

International arbitration is frequently chosen to bring disputes to “neutral ground” beyond the reach of judges in each party’s home country. It works because arbitration laws around the world limit interference by national courts when the arbitration is “seated” elsewhere.

But national insolvency laws often have global effects, as lawmakers centralize the administration of local business bankruptcies under the jurisdiction of their own courts. Indeed, it is not uncommon for the shareholders of a defendant company to force the company into bankruptcy – by executing loans from previously dormant shareholders, for example – to disrupt and delay an arbitration which they know is. the company will lose.

In short, with a wave of corporate bankruptcies on the horizon, the international litigation strategy will need to understand the potential for insolvency and its possible impact on the case and on the enforcement of an eventual award.

This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.

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Noah Rubins heads the international arbitration group at the Paris office of Freshfields Bruckhaus Deringer and heads the firm’s CIS / Russia dispute resolution group. He specializes in investment arbitration and has practiced law in New York, Washington, Houston and Istanbul, and has served as an arbitrator in over 40 cases.

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