The role and potential for arbitration in cross-border insolvency disputes

The existing use of arbitration in insolvency

Arbitration is already a well-developed tool of insolvency systems across the world in resolving individual creditor disputes. In the United States, the courts have generally adopted a distinction between matters that are “core” (matters involving rights specifically created by federal bankruptcy law such as avoidance provisions) and “non- core” (matters that do not invoke substantive rights created by federal bankruptcy law). The latter are capable of being resolved by arbitration taking place within the scope of an arbitration agreement entered by the parties prior to the debtor’s insolvency. A similar approach is taken by courts in Singapore, France and Italy. In Australia, generally there is no automatic stay on arbitration proceedings when a company undergoes administration or a compulsory winding up of the court and leave of the court to continue with the arbitration is not required. The onus will be on an insolvency practitioner specifically to seek an extension of the usual moratorium in such cases.

Future focus: Arbitration in informal rescue scenarios

A key benefit arbitration can offer in the pre-insolvency stage is in providing a structural enforcement framework to guide creditor negotiations during an informal (or “out-of-court”) workout attempt when a debtor encounters financial distress.

Creating incentives to support informal workouts is currently a key focus of regulators globally, and features prominently in the best- practice recommendations of policy makers. In contrast to more complex, expensive formal insolvency frameworks, informal workouts have several key benefits. As noted in INSOL International’s Statement of Principles for a Global Approach to Multi-Creditor Workouts:

Although there is a growing international trend in the development of local insolvency laws to facilitate the rescue and rehabilitation of companies and businesses in financial difficulty (as opposed merely to closing them down through liquidation), it is a truism that, no matter how debtor-friendly and ‘rescue’-orientated local insolvency regimes may be, there are often material advantages for both creditors and debtors in the expeditious implementation of informal or contract-based rescues or workouts (particularly in cases of debtors having cross-border businesses or complex capital structures), compared with the unpredictable costs and uncertainties of a formal insolvency.

This is where arbitration can play a key role in filling the gap. Arbitration can provide a means for creditors to select a governing, restructuring-friendly law to be applied to their claims, providing certainty and fairness that may incentivize hold-out creditors to participate constructively in a restructuring. An arbitration award can also be recognized and enforced on a much broader basis than a mediation agreement. In that regard, the New York Convention provides for the recognition and enforcement of arbitral awards in 172 member states.

For states with an under-developed rescue culture and limited experience of workouts among creditors, whether formally or informally, arbitration can offer a particularly important means to build greater creditor collectivism and to implement a genuine pre-insolvency, rescue-oriented negotiation process.

At the same time, however, there are challenges with arbitration in this context. Notably, it would be necessary to have a set of standard insolvency-tailored arbitral rules that could be adopted as a matter of course in an insolvency-based arbitration, rather than having the rules as another contentious point of negotiation among diverse classes of creditors. These rules would need to provide for fundamental issues such as the seat or place of the arbitration, applicable rules, arbitrator powers, challenge or review of any award and confidentiality terms – but also the substantive applicable law to govern insolvency claims and priorities, and the processes for commencing formal insolvency proceedings if an arbitral award is not complied with.

One option is for insolvency-specific arbitral rules reflecting best- practice to be adopted. Examples are UNCITRAL’s Legislative Guide on Insolvency and the World Bank’s Principles for Effective Insolvency and Creditor/Debtor Regimes.

Insolvency-specific arbitral rules could also be developed by arbitral centers based in jurisdictions with respected insolvency and broader financial ecosystems that would encourage creditors to resort to those jurisdictions as a means for resolving their claims in a binding manner. Within the Asia-Pacific, Singapore has emerged as a preferred seat for arbitration, supported by Singapore’s reputation as one of the world’s centers for international trade and finance, and its place as an optimal market for raising capital and attracting investment. It also has a highly respected judiciary and supporting institutions. In the insolvency context, Singapore is also regarded as having one of the most flexible restructuring regimes in the world, with debt obligations able to be restructured effectively and efficiently. Notably, a series of reforms in 2017 incorporated several features of Chapter 11 of the US Bankruptcy Code within the Singapore insolvency system – including pre-packed restructuring plans, rescue finance (with the possibility for super-priority for new lending), a worldwide moratorium on debt collection pending a restructuring process and a non-consensual cross-class cramdown on dissenting creditors in approving a plan under a scheme of arrangement.

Insolvency arbitration is currently a focus for the Singapore International Arbitration Centre (SIAC) and the Singapore International Commercial Court (SICC), the latter being empowered to hear proceedings under the Singapore International Arbitration Act, including applications to set aside awards, jurisdictional challenges and enforcement applications. The SICC’s jurisdiction was expanded in October 2022 so that it now has express jurisdiction over international restructuring and insolvency matters. It also has active case management powers, and the ability to refer parties to ADR during an insolvency proceeding. The SICC, together with the infrastructure of the SIAC, could held to drive arbitration as a key insolvency process to enhance efficiency and maximize creditor claims in the Asia-Pacific region in future.

Takeaway

With the current focus on insolvency law reform by regulators globally making financial and economic stability, arbitration can serve as a valuable option for resolving complex creditor disputes and providing a framework for creditor cooperation and negotiations during an informal workout attempt. With a widely adopted existing arbitral award enforcement model under the New York Convention, and the institutional support of international arbitration centers, there is a strong platform that could enable arbitration to become a key feature of best practice insolvency and restructuring systems across the world in future years.