Due to the economic fallout of the COVID-19 pandemic, many economies around the world are facing the risk of a severe recession in 2020, which could involve a wave of corporate bankruptcies. To make matters worse, in a globalised economy, the effects of insolvency proceedings are likely to be felt across multiple jurisdictions. Were such a negative scenario to materialise, many companies might be confronted by the complex imbrication between insolvency law and arbitration.
Insolvency law typically involves mandatory provisions, the supervision of a state court or public authority, and centralised proceedings. By contrast, international arbitration gives great deference to party autonomy, strictly limits the intervention of state courts, and advocates a decentralised approach towards dispute resolution. Squaring the circle between these two paradigms can be a difficult exercise.
This contribution is the first part in a series exploring the uneasy relationship between Swiss arbitration law and Swiss insolvency law. In this first blog, we examine the case where a party to an arbitration agreement enters into insolvency proceedings. More specifically, we discuss the impact of such proceedings on the substantive validity of the arbitration agreement.
In some legal systems, an arbitration agreement loses its legal effect at the date of bankruptcy, and pending arbitrations must be discontinued. What does this mean for arbitrations seated in Switzerland?
The substantive validity of an arbitration agreement is governed by article 178(2) of the Swiss Private International Law Act (PILA). According to this provision, an arbitration agreement is substantially valid under Swiss arbitration law if it is valid under either:
- The law chosen by the parties to govern the arbitration agreement.
- Lex causae (the law governing the subject matter of the dispute).
- Swiss law.
This provision sets out the principle of in favorem validitatis (to preserve its validity) of arbitration agreements: it is sufficient that the arbitration agreement be valid under one of these three laws. This means that the effects of the most restrictive law are to be disregarded (even though this might cause difficulties at the enforcement stage).
According to the Swiss Supreme Court, the fact that a party enters into insolvency proceedings does not affect the substantive validity of an arbitration agreement that has been concluded beforehand. In line with article 178(2) of PILA, this means that insolvency proceedings have no effect on the substantive validity of the arbitration agreement and that the arbitral tribunal can disregard the effects of the law governing the arbitration agreement and the lex causae.
Another more complex question pertains to the substantive validity of an arbitration agreement concluded after the initiation of insolvency proceedings.
Insolvency proceedings typically entail the dispossession of the insolvent party of its rights and assets, which are transferred to a trustee (that is, a liquidator or an administrator). The trustee acquires the right to dispose and manage the estate, as well as to conduct legal proceedings. The question is then whether the trustee can validly enter into an arbitration agreement on behalf of the estate. This issue relates to the capacity (or powers) of the trustee to conclude such an agreement.
Article 187 of PILA provides that, absent any agreement between the parties, the capacity of a party to enter into an arbitration agreement is governed by the law with which the case has the closest connection. In the context of insolvency, this refers to the jurisdiction where insolvency proceedings have been initiated (lex concursus).
If said insolvency proceedings are initiated in Switzerland, they will be governed by the Debt Enforcement and Bankruptcy Act (DEBA). This notably means that, during a first creditors’ meeting, the creditors of the bankruptcy estate will have the possibility to appoint a so-called creditors’ committee, tasked with supervising the unfolding of the bankruptcy administration and approving various decisions (articles 235 to 239 of DEBA). In this regard, as per articles 237(3)(3) and 253 of DEBA, the trustee will have the authority to enter into arbitration agreements, subject to the prior approval of either the creditors’ committee or the second meeting of creditors.
In view of the above, insolvency proceedings will have no effect on the substantive validity of arbitration agreements. In case of Swiss-based insolvency proceedings, the trustee will be able to enter into new arbitration agreements on behalf of the estate, subject to the specific procedures set out in the DEBA. For foreign-based insolvency proceedings, such powers will depend on the lex concursus.
The availability of arbitral proceedings can have a significant impact on the resolution of claims that fall into the bankruptcy estate: as arbitration provides for a flexible and efficient dispute resolution mechanism, this might provide an interesting option for the estate creditors to recover as many assets as possible, instead of going through protracted court proceedings. Furthermore, the facilitated enforcement of arbitral awards also makes arbitration interesting in the specific context of a company undergoing insolvency proceedings, when some of that company’s debtors have offshore assets.