Insolvency And Arbitration Proceedings – Are They So Happy Together?

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Insolvency proceedings can create potential roadblocks for arbitration proceedings that require careful navigation. Arbitration proceedings are private contractual proceedings intended to resolve individual claims. In contrast, insolvency proceedings are public proceedings intended to resolve claims collectively. Yet, an arbitration within an insolvency proceeding can be useful for resolving individual claims that may help resolve the collective issues. Counsel must be aware that the jurisdiction in which the insolvency proceeding is pending, as well as the applied law of the arbitration (lex arbitri) will determine the rules for resolving the conflicts between the two types of proceedings

One of the primary goals of any arbitration is to arrive at an enforceable award that is not subject to vacatur. Thus, parties should not proceed with an arbitration without knowing whether the insolvency proceeding will affect the enforceability of the award.

Basic Checklist

Will the arbitration be stayed during the insolvency proceedings?

Generally, insolvency proceedings stay all claims against the debtor, including arbitration proceedings. Sometimes the insolvency proceedings will stay not only arbitrations against the debtor, but also arbitrations brought by the debtor against others. A review of the law in the jurisdiction where insolvency proceeding is taking place, as well as any orders in the insolvency case, will determine whether the arbitration can be filed, whether it can proceed and against whom.

Can permission be obtained to file an arbitration or to proceed with an arbitration within the insolvency proceeding?

If the filing or continuation of an arbitration is stayed by the insolvency proceedings, there may be grounds to obtain relief from the insolvency court to proceed. The insolvency court wants to resolve claims and preserve assets. For example, the insolvency court may allow proceedings against the debtor’s insurance carrier only, without recourse to the debtor’s assets. Sometimes the insolvency court will allow an arbitration to commence or continue, but only to decide the quantum of the claim, so that the claim can be submitted in the insolvency proceeding.

The insolvency proceeding may have its own legal regime that applies to certain issues central to the proceeding itself — such as whether the proceeding is properly filed, whether assets have been improperly transferred or recoverable, and how the insolvency proceeding should be resolved as a whole.

The regime of bankruptcy law on these issues in the United States is well-developed. The U.S. Federal Arbitration Act is also well-developed and establishes a strong preference for arbitration where the parties have agreed to arbitrate resolution of disputes. This policy preferring arbitration conflicts with the bankruptcy laws where the substantive rights sought to be arbitrated are rights created by the bankruptcy proceeding, and would not exist but for the bankruptcy proceeding.

In bankruptcy proceedings where the issues are “core proceedings,” the bankruptcy court has the discretion to stay arbitration in favor of the specialized bankruptcy court. For example, in Pillsbury Winthrop Pittman LLP v. Cuker Industries, now on appeal to the Court of Appeals for the 9th Circuit, the district court in January 2021 denied a request to arbitrate contested counsel fees pursuant to an arbitration clause in an engagement letter. The court held that the core issue of the extent and validity of the counsel fees as a secured claim was one of the issues that could be arbitrated.

A bankruptcy court in the United States has the discretion to decide that permitting the arbitration to proceed would conflict with the underlying purposes of the Bankruptcy Code to have bankruptcy law issues decided by bankruptcy courts, centralizing resolution of bankruptcy disputes and avoiding piecemeal litigation. In the case of GE Capital Retail Bank v. Belton, the U.S. Supreme Court denied certiorari from the 2nd Circuit on March 8, 2021, which held that an otherwise valid arbitration clause would not be enforced to resolve a putative class action case against the bank for violation of the post-discharge injunction by enforcing discharged claims against credit card holders. The lower courts had found that allowing arbitration would impede the bankruptcy court from enforcing its own orders.

Cases decided in jurisdictions outside of the United States apply similar reasoning in deciding the equities of allowing the parties to work out their dispute resolution issues outside of the insolvency regime.

Does the law of the arbitration provide that arbitration can proceed over the objection or notwithstanding the insolvency proceeding?

In some cases, arbitrators have concluded that the arbitration could or should proceed notwithstanding the objection of the insolvency proceeding. This decision may be correct based on the law of the arbitration, and yet diametrically opposed to the insolvency legal regime or under the choice of law provision.

This is illustrated best in several cases involving the Polish company Elektrim SA. Vivendi Universal SA had filed an arbitration before the LCIA against Elektrim SA, which then filed a Polish insolvency proceeding. Polish insolvency law abrogates commercial arbitrations against a debtor. But UK law, where Vivendi Universal SA is incorporated, contains no such provision. The ultimate arbitration award was confirmed by the High Court of London.

The results in an arbitration filed against Elektrim SA in Switzerland were entirely different. Under Swiss law, the conflicts of law analysis determined that Polish law should apply, and Elektrim SA was dismissed from the Swiss multiparty arbitration.

Moving forward with an arbitration without the permission or approval of the insolvency court creates two risks. First, proceeding without permission or approval may violate a stay order imposed upon the non-debtor party, which could have consequences. Second, the uncertainty of the disposition of the arbitration in light of the insolvency proceedings may result in an award that is unenforceable or subject to vacatur.

What are best practices when arbitrating and the insolvency proceedings may be in conflict with the arbitration proceeding?

Generally, the non-debtor party files a notice or a proof of its claim in the insolvency proceeding. But this decision must be reviewed carefully because, in most jurisdictions, this is akin to agreeing to the jurisdiction of the insolvency proceeding. In addition, the non-debtor party should seek relief from any injunction or order that is an impediment to arbitrating the matter. In the alternative, permission can be sought to arbitrate the matter, but collection will be limited to third party assets, such as insurance proceeds and guarantors, or the arbitration award can be used to establish the quantum of the claim in the insolvency proceeding, with collection pursued through the insolvency proceeding.

Conclusion

Insolvency proceedings pose numerous hurdles for parties in or about to commence arbitration. One must tread carefully and understand the rules of both games to ensure that an arbitration award, if obtained, will be enforceable.

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