This blog is written by Anshika Agarwal, a Third-Year law student of Vivekananda Institute of Professional Studies

Abstract

Arbitration is being increasingly used as a method of dispute resolution due to its party-centric approach and cost and time effectiveness. However, there are certain areas such as cross-border insolvency which do not wholly permit the use of arbitration as a method of dispute resolution. There are certain grounds on which the distinction between arbitrable and nonarbitrable matters is made. Though, it is not completely correct and does not act as a straitjacket way of deciding if the matter in hand is arbitrable or not, it does act as a stepping stone for more clarity in this area. To govern insolvency and arbitration laws, among other trade-related matters, the United Nations Commission on International Trade Law was established.

Keywords: Arbitration, Insolvency, Dispute Resolution, Non-Arbitrable, Trade

Introduction

The world is becoming more interdependent in terms of its economies, cultures, and businesses. All of which had led to an expeditious growth in globalization. Arbitration has been gaining traction among various other methods of Alternate Dispute Resolution which include mediation, negotiation, conciliation, and others. Arbitration has been increasingly used nowadays to deal with the diverse matters related to insolvency. At a point of time when cities such as Birmingham, the second biggest city in Britain are declaring themselves bankrupt and banks such as Silicon Valley Bank are collapsing, it is evident that there is a widespread lack of economic confidence and stability. Therefore, the cases of insolvencies have mounted up. Several commercial contracts have an arbitration clause on which the company can fall back in case of any breach. In the past few decades, there have been many instances in which companies had to resort to arbitration as and when they became insolvent. As seen in the case of the collapse of Lehman Brothers in September 2008, and the bankruptcy of MF Global in 2011, ADR mechanisms were used to resolve matters related to cross-border insolvency.

Conflict Between Arbitration and Insolvency

In principle, the objectives of arbitration and insolvency proceedings are at variance with each other. Arbitration aims at higher party involvement with minimal or zero interference of the judicial institutions so that the resolution reached is for the higher good of both parties. As in the case of judicial involvement, only one party would win and the decision would only favor one party. Arbitration is thus defined by Romilly MR in the well-known case of Collins v Collins[1], An arbitration is a reference to the decision of one or more persons, either with or without an umpire, of a particular matter in difference between the parties[2]. Arbitration law is based on the idea of party autonomy and serves as a cost-effective way of addressing disputes. Not only does arbitration prevent a huge hole in the pocket but also saves time and comes across as a cost and time-effective mode of dispute resolution. The above-mentioned nature of arbitration attracts global corporations also as it helps them to get their disputes resolved according to their way and that too without opting for lengthy court proceedings. On the other hand, insolvency proceedings are centralized in nature and require consolidation of all altercations before an insolvency court which aims to achieve maximum economic efficiency and optimum returns for the creditors or the lenders. Arbitration, as an alternate dispute resolution mechanism may help in insolvency-related matters as much as it does in other civil disputes. Resorting to arbitration may not only help to reduce the pressure on insolvency courts by helping them to concentrate on crucial matters but also allow the parties to go through their preferred mode for dispute resolution while also ensuring party autonomy and interests of both the concerned parties. Cross Border Insolvency refers to a situation when the insolvent debtor has his assets in more than one place or more than one jurisdiction or his creditors belong from a place other than where the insolvency proceeding has been filed. To assist states to equip their insolvency laws with a modern legal framework and to more effectively address cross-border insolvency proceedings concerning debtors, the United Nations formed the United Nations Commission on International Trade Law (UNICTRAL). The United Nations Commission on International Trade Law was established by the General Assembly in the year 1966 by Resolution 2205(XXI) OF 17 December 1966. Its key provisions range from access, recognition, and relief to cooperation and coordination. In India, the Insolvency and Bankruptcy Code, of 2016 regulates and consolidates several laws on insolvency resolution of individuals, companies, and partnerships. The code came into force on December 15, 2016. Even though the code has been made recently, it has been evolving vastly because of amendments, new judicial interpretations, and regulations. The arbitration rules given under the UNICTRAL are comprehensive and can be agreed upon by the parties for the conduct of arbitral proceedings arising out of their commercial agreements. At this point in time, there are four different versions of the Arbitration Rules under the UNICTRAL: (i)The 1976 version (ii) The revised version of the 2010 rules (iii)The version of 2013 which comprises UNICTRAL rules on Transparency for Treaty Based Investor-State Arbitration and (iv) The version of 2021 which comprises of UNICTRAL Expedited Arbitration Rules. There exists some level of convergence between arbitration and insolvency proceedings. In a case when an insolvency proceeding has been initiated against a party to the arbitration agreement, the issue is whether the dispute would be resolved through arbitration or if it stands frustrated in accordance with the terms of the bar under the insolvency law. In the landmark judgment of Zimmerman v Continental Airlines, Inc the appeal helped in the reconciliation of two contradicting federal policies. In the United States Arbitration Act, the federal court mentions putting a stay to the arbitration proceedings if the issues pertinent to the dispute are also subject to an arbitration agreement between the parties. The contradicting policy is that of the Bankruptcy Reform Act of 1978 in which the jurisdiction for bankruptcy courts has been expanded as it is based on the notion that to protect the interests of both the bankrupt and its creditors there should be no unnecessary delay in the insolvency proceedings and they should be done with expeditiously. Sometimes the conflict at hand is resolved by giving priority to the insolvency law by taking into consideration the impact continuous arbitration would have on the rights of the creditors. Thus, in an intersection of the arbitration law and insolvency law, insolvency law would prevail over arbitration law and would overrule the rights of the defendant. In Petropod Ltd v Larsen Oil and Gas Pte Ltd[3], the Singapore High Court verified that most insolvency-related disputes cannot be settled under the realm of arbitration as they are not only the two parties but also the public at large. Similarly, in the case of Hay’s and Co v Merrill Lynch, Pierce, Fenner, and Smith, Inc.[4] it was mentioned that since both arbitration and insolvency laws are made through due process in law and have a strong standing in each of their realm, letting one law blindly subjugate the other is not a right way to adjudicate disputes. Thus, efforts should be made to bring in a standard way for deciding arbitrable insolvency-related issues and those matters which cannot be solved under arbitration.

Coordination Between the Two by Defining Grounds for Distinction

By taking into consideration the number of problems coming across due to the interplay of arbitration and insolvency laws, the Court of United States of America came up with certain ways based on which a matter can be decided whether it can be arbitrated or must go under insolvency proceedings. Broadly, we can consider three main grounds for deciding if the matter in hand would be ruled by insolvency laws or if the arbitration clause can also govern it if there is the presence of pending insolvency proceedings against the debtor. These three grounds are (i) the Distinction between core and noncore matters (ii) the Distinction between matters in Rem and in Personam (iii) the Distinction between matters that are prejudicial and beneficial matters. The distinction between core and noncore matters is prominent in the courts of the United States of America to deal with matters relating to insolvency or bankruptcy. Core matters are those matters that pertain to substantive rights which are dealt under the insolvency rules which are related to adjudication of the insolvency itself and infringes the rights of the creditors. If such matters are sent for arbitration, it may frustrate and put at risk the bankruptcy process. Core matters consist of bankruptcy disputes that are at the heart of bankruptcy processes and allowing such matters to be resolved under the arbitration agreement would not only threaten the bankruptcy process and rules but also expose the matter to risk in terms of reaching a right decision that would affect both the parties. On the other hand, the court can permit the parties to ‘non-core’ issues to take the help of any resolution method as they would want to as even if the non-core matters are sent to arbitration they will not jeopardize or put the bankruptcy proceedings to any risk. The US Court of Appeals also has the same say in this matter which was clarified in the case of Hays and Company[5], it was observed that bankruptcy courts are to enforce the clause of arbitration if doing so would not seriously threaten and jeopardize the code of bankruptcy laws. Nonetheless, The Supreme Court of USA in Shearson/American Express Inc v McMahon[6], tried to balance arbitration against the competing interest of other statues. The McMahon test was introduced to create a test for when the court has its volition to refuse to enforce the arbitration clause. It is a way for bankruptcy courts to assess a function and a purpose for the method of resolution of the dispute. The application of the test is usually done in a two-part analysis; the first one is to see if there is any contrary congressional command which can be seen through the McMahon inherent conflict analysis. The second analysis consists of looking into congressional commands. The court observed that such a command or intent can be indicated by a) relevant statute’s text b) relevant statute’s legislative authority c) existence of any underlying conflict between arbitration clause and the relevant statute’s underscored purpose. But in the US history there has been no exception to arbitration whether express or implied so the McMahon test simplified it all down to the examination of existence of any conflict between arbitration and bankruptcy. The conflict does exist between arbitration and insolvency laws because if there would be good reason for a dispute to be arbitrated would it jeopardize the bankruptcy process, if yes then there exists and exception clause and the dispute cannot be settled under arbitration. On the contrary, if the matter is a non-core matter and it does not jeopardize the bankruptcy process then it should be compelled to arbitrate. This perception led to distinction between core and non-core matters totally based on the fact if they would jeopardize the bankruptcy proceedings or not. However, what comprises of core and no core still is contentious since to draw an exhaustive list is difficult. Core matters are those that involve substantive rights, whereas non-core matters arise out of codes of bankruptcy and do not concern to the bankruptcy matters and thus remain arbitrable. Nothing comes without its flaws, so is the case with the theory of distinction of core and non-core matters. It is argued that it ignores very crucial factors that have a vital importance in determining the arbitrability of the dispute. The authorities should take into consideration the nature of matter such as pecuniary or non-pecuniary apart from considering the functions of the designated authorities. What should also be taken into consideration is the fact if the arbitration proceedings were commenced before the debtor turned insolvent and if the third-party rights are affected. Arbitration is an alternate dispute resolution method and thus arises from the voluntary submission between the parties to the contract. The arbitration clause thus does not affect any one other than the parties indulged in it and therefore is a private and only those parties are required to submit to the decision who submitted to its jurisdiction. Due to the above-mentioned nature of arbitration, the resort of arbitration is not allowed in cases where the rights and obligations owed are affecting the world at large i.e. ‘in rem.’ If arbitration would be allowed in all matters it would result in inadvertent implications for the parties not even involved in the dispute. For that reason, certain matters are excluded from the scope of arbitration, insolvency and bankruptcy are also excluded from the scope of arbitration and lie within the jurisdiction of those courts whose jurisdictions at their core are to public at large, in rem. The above was mentioned in the case of Central Virginia Community College v Katz[7]. The Supreme Court of India in the case of Booz Allen and Hamilton Inc v SBI Home Finance Ltd and Others[8], mentioned that arbitration is primarily to adjudicate in those matters where the right is enforceable against a specific person or persons which means the disputes which are ‘in personam’ in nature can be arbitrated. Although, these in personam disputes can also comprise of certain subordinate in personam disputes that arise out of broader in rem disputes. To put it into a simple manner, the disputes that come forth during the insolvency proceedings but have an in personam nature continue to be arbitrable, even though the larger proceeding of insolvency is itself non arbitrable since it comes under the scope of public and is thus, ‘in rem.’ The actions that create any effect towards the world are thus not arbitrable. A legal term, erga omnes, describes the obligation of the state to the international community in general and to the other states present. It is a judgement or a decision that affects all parties and not only the ones that are directly involved. As a result, all those in personam disputes which do not affect the rights of the other stakeholders in insolvency, can continue to be solved with the due process of arbitration. The last ground for distinction is bases on beneficial and prejudicial disputes. This way of doing the distinction is common in countries such as United Kingdom, Singapore, and India. Distinction is based on the position of the debtor and how the result would affect him. If the proceeding is in the interest of the debtor or if it has a possibility to conclude in his interest then the proceedings can take the route of arbitration for dispute resolution. While, those proceedings that may be harmful for the position of the corporate debtor or have bad ramifications on his estate are non-arbitrable and cannot take the route of arbitration as a method of dispute resolution. This distinction is based on the core principle of the insolvency law, which states that the main motive behind insolvency law is to protect and preserve the value of the stakeholder by preserving the value of the debtor. The stakeholders have themselves have themselves chosen to participate in the collective process and thus their rights and interests should be maximized. Continued adjudication of disputes would help in deriving benefits to the debtor by increasing his value which would ultimately lead to higher returns for the stakeholders. Thus, the law tries to benefit the stakeholders by maximizing the value of their returns by helping the corporate debtor to increase his value through the arbitration proceeding. On the other hand, disputes that can be prejudicial or harmful for the estate and assets of the corporate debtor are not meant to be arbitrated and are meant to be resolved through insolvency laws. Disputes initiated against the principal debtor by aggressive creditors may cause disappearance or dismemberment of the state of the corporate debtor and ultimately prove harmful for him. An incessant and uninterrupted adjudication of these disputes may force the debtor to pay some extra amount to the creditor, or require for disposal of some assets from the debtor’s side to the creditor’s side all of which would result in lowering down the value of the debtor. Therefore, in a case when it must be decided if arbitration should take place or not, the position of debtor should be considered and if the dispute at and prima facie does not benefit the debtor and is prejudicial to his position then the challenge to arbitration would sustain. On the flip side, cases which are beneficial to the debtor would be compelled to take arbitration as the method of dispute redressal. Certain judgements also talk about what would be the effect on insolvency proceedings if the parties to dispute have any pending arbitration proceeding in their country. The case of Syska v Vivendi[9] dealt with the place which would determine the arbitration proceeding taking place. The question before the court was to determine if the insolvency proceeding affecting arbitration in a state of the European Union will be governed by the law of the state where the proceedings have instituted or by the law of the place in which the reference is taking place. The court came up with the conclusion that the insolvency and arbitration proceedings should be determined by the law of the Member State where the reference is taking place. As a result, it is determined that foreign insolvency proceedings should not have any effect on the pending arbitration proceedings. The pending arbitration proceedings are governed by the law of the place where such proceedings are pending. Hence, insolvency proceedings will have no effect on arbitration agreement. It comes as a respite to the creditors who would otherwise find themselves at crossroads if arbitration proceedings would be subverted by domestic insolvency laws.

Cooperation and Future Path

The prevailing method of categorizing and differentiating the insolvency related issues into core, non-core matters or the beneficial and prejudicial matters, and so on are all debatable and their efficiency remains questionable. Even if such a categorization is needed what is the surety that this is an ideal way to categorize the disputes? For the formation of such categories two possible ways or mechanisms can be looked at (i) formation of an exhaustive list and (ii) formation of a guideline. An exhaustive list could be formulated that consists of all the no arbitrable issues so that the confusion regarding a matter being arbitrable or not is alleviated. Such a list can be made by the collective efforts of all the delegates who are experts in this field under the guidance of a universal organization such as the UNICTRAL. But still, even this way would have its negatives. Getting approval or global acceptance for a list like this is a laborious task and it may not even get approved by every country as each country may have its own opinions or way of looking at matters. Also, the list may conflict with their internal laws. All in all, there cannot be one straightjacket solution to the problem of developing one comprehensive list for deciding the arbitrability of any matter. The second problem with forming an exhaustive list is the fact that some issues that now are arbitrable may later held to be no arbitrable or new issues may arise that will question the ability of any matter to be arbitrable and thus may create interpretations that are are at odds with the actual law. Another option what can be done is to create a pro-arbitration attitude that adheres to a universalist approach. This is a more feasible and flexible way of dealing with what issues can be categorized under arbitrable and non-arbitrable. A guideline can be formed that lays down parameters for distinguishing between issues and disputes that can be solved by arbitration and those that cannot be subjected to arbitration. Such a guideline can be formed after taking opinions and deliberate discussions with subject matter experts. It would be wrong to say that this guideline will not be subject to different territorial interpretations, of course, there will be different ways of understanding the guidelines which would be influenced by national policies. However, such a guideline would also give autonomy and discretionary power to the state which can be misused also.

Conclusion

The convergence of cross-border insolvency and arbitration presents significant challenges in balancing the principles of both legal frameworks. While cross border insolvency seeks to consolidate claims and ensure equitable distribution of assets among creditors, arbitration upholds party autonomy and the enforcement of contractual agreements. As businesses operate globally, conflicts between these systems arise, particularly when insolvency proceedings disrupt ongoing arbitration or when international disputes need resolution amid financial distress. The increasing adoption of international frameworks like the UNICTRAL Model Law on Cross Border Insolvency helps promote cooperation and consistency across jurisdictions, but the interaction between insolvency and arbitration remains complex. A nuanced approach is necessary, where courts and arbitral tribunals balance the collective interests of creditors with the rights of parties under arbitration, ensuring that both mechanisms function harmoniously in addressing financial and contractual disputes across borders.

REFERENCES

[1] Collins v Collins [1997] SC

[2] Avtar Singh, Law of Arbitration and Conciliation and Alternative Dispute Resolution (11th edn, EBC Publishing 2018)

[3] Petropod v Larsen Oil ltd [2011] SGCA 21[2011]

[4] Hays and co v Merrill Lynch[1989]USCA 88[1989]

[5] Hays and co v Merrill Lynch[1989]USCA 88[1989]

[6] Shearson/American Express v McMahon [1987]US 220[1987]

[7] Central Virginia College Community v Katz [2006]USSC 885[2006]

[8] Booz Allen and Hamilton Inc v SBI Home Finance Ltd [2011]SCCA 5445 [2011]

[9] Syska v Vivendi [2009] EU 2[2009]