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Arbitration and bankruptcy / insolvency: what are the implications for arbitration claimants when their defendants enter insolvency proceedings?

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Financial loss and uncertainty caused by the pandemic continue to affect businesses globally, and an increase in corporate insolvency is widely anticipated. Arbitration is an effective dispute resolution mechanism, but a counterparty entering an insolvency proceeding can be disruptive. We recently wrote about insolvency being one of the key trends in international arbitration in 2021. So how might a counterparty’s insolvency affect your ability to go to arbitration?

Counterparty insolvency is an inflection point in your litigation, with both financial and legal consequences. Financially, despite good prospects for success, if you can only recover a small percentage of the monetary relief and / or costs granted to you, i.e. your debt in the insolvency proceedings in As an unsecured creditor, it may no longer be a good strategy to pursue a costly and time-consuming dispute resolution process. Legally, the opening of insolvency proceedings represents a change of dynamics in an arbitration context in two main ways:

  1. The characteristics of arbitration are the autonomy and confidentiality of the parties (with the potential for flexibility, speed and confidentiality). On the other hand, insolvency proceedings are collective, aiming either to restructure the counterparty’s liabilities or to distribute its assets among creditors in a determined order.
  2. Unlike arbitration, insolvency proceedings are generally supervised by national courts. In addition, to be internationally recognized, insolvency proceedings must frequently be recognized by local courts through a formal cross-border insolvency mechanism. The ease of recognition depends on the jurisdiction (s).

These changes in dynamics are illustrated by two themes. The two are consistent in insolvency proceedings in many jurisdictions.

First, insolvency proceedings typically transfer control of directors to an insolvency official, such as a trustee, liquidator, or administrator (with the notable exception of Chapter 11 bankruptcy in the United States). This person usually has specialized qualifications and may be a judicial officer. They will have considerable powers, but are also likely to be accountable to the court and other counterparty creditors. For pending litigation, this will disrupt the relationship between the parties – but a new perspective can provide an opportunity to overcome deadlock points.

Second, insolvency proceedings usually impose a moratorium: that is, you cannot initiate or continue any litigation or arbitration against the insolvent party without the consent of the court or the insolvency official. This reflects the collective nature of insolvency proceedings: creditors assert their claims in a single process overseen by the insolvency officer, rather than in individual actions against the insolvent company. However, the moratorium is not always applied. If funding can be agreed, it may be better to pursue an arbitration that is at an advanced stage, especially if it is before an expert tribunal. The result will resolve a contentious debt, which the office holder will then not need to cold-examine. In addition, if the arbitration takes place in a jurisdiction other than the insolvency jurisdiction, it may be possible to pursue it regardless of the insolvency proceedings. However, doing so without the consent of the national court or insolvency manager can have significant consequences. Importantly, an arbitration award in an arbitration that continues without consent may not be enforceable in the jurisdiction where the insolvency proceedings are based and where the principal assets may be located.

In the event of a counterparty’s insolvency, you will need to think about your strategy. You should get the best advice on relevant insolvency laws and the dynamics of cross-border insolvency, integrated into your arbitration advice. The global litigation and restructuring and insolvency practices of Freshfields, the market leader, are uniquely positioned to do so.