By Manuel Penades (King's College London)
Introduction
Since 2019, Working Group V of UNCITRAL has been working on the adoption of a choice of law instrument that regulates the law applicable to the international effects of insolvency proceedings. The project seeks to include a rule on the law governing the impact of insolvency in arbitration. The relationship between insolvency and arbitration has traditionally been a complex and controversial topic and the negotiations at UNCITRAL over the last years confirm this.
I. The positive contribution of Working Group V to the insolvency & arbitration debate
To date, the efforts of WG V have been commendable for various reasons:
WG V has rightly acknowledged that arbitration law is generally insufficient (indeed, silent) in regulating the effects that foreign insolvencies have on arbitration agreements and proceedings seated abroad (see para. 64 A/CN.9/1169). This is an insolvency-specific issue and the better approach is for insolvency law to regulate this, both substantively and at the level of conflict-of-laws.
National laws vary widely on the effects that the opening of insolvency proceedings have on the possibility to commence and continue arbitration involving the insolvent party (see IBA Toolkit on Insolvency and Arbitration, Explanatory Report, para. 10). Rather than attempting to unify this diversity at a global level, WG V has opted for the more feasible and measured approach which seeks to agree on a choice of law rule that will identify the law that courts and tribunals will apply to determine the impact of insolvency in arbitration.
WG V has also acknowledged that the law governing the impact of insolvency in arbitration does not intend to replace the overall regulatory framework applicable in each international arbitration case (see para. 64 A/CN.9/1169). Rather, the regulatory scope of that law is limited to the determination of the specific effects produced by the opening of insolvency proceedings. Unaffected facets of arbitration will continue to be regulated by the law applicable in ordinary circumstances.
Finally, WG V has recognised that the starting point should be that the law governing the effects of insolvency is the same for arbitration and for court proceedings (see para. 67 A/CN.9/1169). Such consistent approach is explained by the fact that, despite not being governed by the same instruments internationally, arbitration and litigation ultimately raise similar questions concerning the possibility to conduct proceedings outside of the collective insolvency process. For that reason, much of what is said below applies to arbitration as well as litigation, even if litigation is not mentioned expressly.
II. The model so far: The lex fori concursus and the exception for pending proceedings
Up until the 63rd session, 11-15 December 2023, and the documents that derived from it, WG V had worked with a model which, essentially, provided that the law of the State in which insolvency proceedings have opened (the lex fori concursus) will govern the possibility to conduct arbitration proceedings concerning the insolvency estate (even abroad). This rule, however, was subject to an exception in favour of the law governing the arbitral proceedings (lex arbitri, which frequently is the law of the seat - lex loci arbitri) when the arbitration proceedings are already pending at the time insolvency commences. In essence, the lex fori concursus governs the possibility of commencing arbitration whereas the lex loci arbitri determines the possibility of continuing it.
As mentioned elsewhere [here and here], there are various reasons why this model offers a satisfactory compromise between the competing insolvency and arbitration policies. It provides for the general rule that the lex fori concursus governs universally the possibility to conduct individual proceedings involving the insolvent party; but it also acknowledges the fact that when such individual proceedings are already afoot when insolvency commences, it is appropriate to respect that the law governing the already existing procedural relationship (the lex loci arbitri) determines the effects of the foreign insolvency.
This recognition facilitates the acceptance of the choice of law rules used by arbitral tribunals and national courts acting in arbitration-related litigation (as opposed to courts acting in an insolvency capacity). These rules are primarily the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards and national arbitration law (very often following the UNCITRAL Model Law on International Commercial Arbitration) Still, it inserts insolvency considerations into the arbitration sphere. This is because, while it respects the continued application of the lex loci arbitri, it requests arbitrators and courts to apply the insolvency-specific effects provided by the lex loci arbitri to respond to the irruption of a foreign insolvency process.
In addition, and importantly, the described conflict-of-laws model is outcome-neutral; i.e., it does not mean that the pending arbitration proceedings will necessarily continue. That will be for each national law to decide. In fact, if the foreign insolvency was recognised by the courts of the seat of the arbitration, Article 20 of the UNCITRAL Model Law on Cross-border insolvency (UMLCBI), as part of the lex loci arbitri, would automatically stay the pending proceedings in favour of the insolvency forum.
Incidentally, the model of rule and exception favoured by WG V up until their session in May 2024 replicates the solution that has been tested and worked satisfactorily for over two decades in the European Union, which provides for the same distinction between new and pending proceedings in Articles 7.2(e) and 18 of the EU Insolvency Regulation.
III. The new model: the absolute application of the lex fori concursus
This model, however, seems to have been abandoned by WG V.
In their 64th session, 13-17 May 2024, WG V has proposed to delete the exception in favour of the lex loci arbitri for pending arbitration proceedings. Under the new model, the lex fori concursus will govern all the effects of insolvency in arbitration agreements and proceedings, regardless of their status at the time of the commencement of insolvency. Document A/CN.9/1169, issued by WG V after the 64th session briefly justifies the decision on the following grounds:
“67. […] That approach was considered coherent with the other items on the lex fori concursus list and the goal to prevent interference of irrelevant laws in the administration of insolvency proceedings. It was also explained that the impact that ongoing proceedings would have for the insolvency estate in terms of claims, liabilities, assets and costs, and because that impact would be assessed and managed by the insolvency representative and the insolvency court, justified that the lex fori concursus would be the governing law. Taking that approach was considered also appropriate and timely in the light of current trends in the arbitration market and attempts of more States to attract international arbitration cases by providing a framework favourable to arbitration, which might be at the cost of insolvency law considerations. It was submitted that a rule deferring to the lex loci arbitri might exacerbate those concerns. Nevertheless, it was acknowledged that the lex fori concursus could not govern all matters related to arbitration.”
The cited justification does not withstand scrutiny (III.1) and would be a source of serious disfunctions (III.2).
A) The feeble justification of the new model
The first sentence of the cited paragraph refers to the coherence of the proposed solution “with the other items on the lex fori concursus list and the goal to prevent interference of irrelevant laws in the administration of insolvency proceedings”. While insolvency models based on the principle of universalism have traditionally recognised the primary application of the lex fori concursus, every advanced regime on cross-border insolvency (including WG V’s own proposal) recognises the need to foresee choice of law exceptions to allow for the application of laws other than the lex fori concursus to regulate discrete issues that do not impinge on the core of the insolvency process. In this case, that would be the possibility to continue with ongoing claims involving the insolvent party outside of the forum concursus.
Importantly, an exception in favour of the lex loci arbitri for pending arbitrations would be compatible with the application of the lex fori concursus to any substantive effects on the contract subject to the dispute resolution process. This would be a merits issue, separate from the jurisdictional and procedural matters governed by the lex loci arbitri.
Equally, the lex fori concursus would also govern how any resulting award is integrated into the insolvency process in terms of admissibility, ranking and patrimonial distribution. This is why the exception is not an “interference of irrelevant laws in the administration of insolvency proceedings”, as wrongly suggested in Document A/CN.9/1169. Much the contrary, the exception is necessary to acknowledge and respect the existence of a live procedural relationship already established between the insolvent party, third parties and arbitrators before the opening of the insolvency. While it can be understood that the lex fori concursus might want to have a say on the commencement of new individual proceedings after the opening of insolvency (even if the arbitration agreement was concluded pre-insolvency and in bonis), the imposition of the lex fori concursus over a pending proceeding is excessive and unnecessary for the “administration of insolvency proceedings”. If, under the law of the arbitration, the proceedings are allowed to continue, the credit subject to them can be registered in the insolvency as litigious or contingent until the case comes to an end (see IBA Toolkit on Insolvency and Arbitration, Explanatory Report, paras. 126-128).
Document A/CN.9/1169 also justifies the new model on “the impact that ongoing proceedings would have for the insolvency estate in terms of claims, liabilities, assets and costs, and because that impact would be assessed and managed by the insolvency representative and the insolvency court”. Again, this justification is misplaced. Should the individual proceedings remain afoot, the foreign arbitral tribunal or national court shall adapt the representation of the insolvent party in light of the prescriptions of the lex fori concursus, which (as personal law) will govern the procedural capacity and locus standi of the insolvent party and the insolvency representative. Current practice of arbitral tribunals and Article 12 UMLCBI already accept this. Equally, as explained above, the application of the law of the place of arbitration will not necessarily mean that the individual proceedings will continue. What is more, and this is important, even if arbitration was allowed to continue (for instance, because the State where the seat is located has not adopted Article 20 UMLCBI, or because the stay was lifted by the courts of the seat), this would not necessarily lead to the enforcement of any award that could be issued against the insolvent party. Three reasons support this:
In many jurisdictions, the continuation of the arbitration is subject to the requirement that the relief available in arbitration is merely declaratory and not condemnatory (see, e.g., the IBA Reports for France, para. 108, and Germany, para. 17). The same has been accepted by arbitral awards (including, by way of example, the awards issued under the auspices of the International Chamber of Commerce in cases ICC 11876 (2002) [seat London, French insolvency law], 7563 (1993) [seat Paris, French insolvency law], 7337 (1996) [(seat Germany, Swedish insolvency law)] and 7205 (1993) [seat Paris, French insolvency law]). Therefore, the award might be a valid title to join the queue of creditors in the insolvency proceedings, but it lacks teeth to bite assets of the insolvent estate outside of the collective proceedings and thus it does not threaten the par conditio creditorum.
Equally, if the lex loci arbitri does not provide for this limitation on arbitral relief, the courts of the seat that decide on the possibility to lift the stay under Article 20 UMLCBI can rule that any such lift is “subject to a condition that no enforcement action, whether in this jurisdiction or otherwise, be taken […] in respect of any award it obtain[ed] from the arbitration”, just as the High Court of Singapore decided recently in Re Sapura Fabrication Sdn Bhd [2024] SGHC 241 (18 September 2024).
Finally, even if the arbitration results in a condemnatory award, recent studies confirm that in the “overwhelming majority of jurisdictions, […] even where the arbitration itself is not stayed, the enforcement of any resulting arbitration award typically must be pursued through the single, collective bankruptcy process” (see IBA Toolkit on Insolvency and Arbitration, Explanatory Report, para. 124). By way of example, a recent French decision has refused the enforcement of an ICC award against a company subject to insolvency proceedings in Italy on the grounds that an individual enforcement action would infringe the principle of equality of creditors and contravene the prohibition of individual executions under the foreign insolvency law (see, Cour d'appel de Paris, 3 October 2024, n° 22-15049).
It cannot be denied that the conduct of individual proceedings might be a source of expenses for the insolvency estate, but this is not unavoidable. Those proceedings may be amended pursuant to expedited or fast-track procedures to accelerate the dispute resolution process, while maintaining the forum selected by the parties prior to insolvency. In addition, the discontinuation of those proceedings when they are already pending and potentially advanced, to commence a proof of debt process within the insolvency forum might duplicate costs and be a source of inefficiencies.
Finally, Document A/CN.9/1169 explains that the new model “was considered also appropriate and timely in the light of current trends in the arbitration market and attempts of more States to attract international arbitration cases by providing a framework favourable to arbitration, which might be at the cost of insolvency law considerations. It was submitted that a rule deferring to the lex loci arbitri might exacerbate those concerns”. This statement is misguided. The most relevant global development on the interplay between insolvency and arbitration in the last decade has been the IBA Toolkit on Insolvency and Arbitration. The IBA Toolkit consciously adopts a measured and neutral approach, precisely to gain acceptance by the and arbitration communities and avoid criticisms based on hostility towards either area. It is not fanatic in either direction. While it is true that some jurisdictions seek to attract arbitration business through arbitration-friendly legislations, Document A/CN.9/1169 fails to identify any instance where the so-called “current trends in the arbitration market and attempts” have led to an unjustified misplacement of legitimate insolvency considerations under the original model.
More importantly, UNCITRAL’s publication also wrongly presupposes that resorting to the law of the place of the individual proceedings (e.g., lex loci arbitri) would be hostile to insolvency. The truth is that the choice of law regime under the original model was outcome-neutral. Each State remains free to decide what the impact of insolvency should be, including the possibility of an automatic stay pursuant to Article 20 UMLCBI. As explained below, the absolute imposition of the lex fori concursus for all individual proceedings, pending or not, involving the insolvent party is testament of the same unilateral and biased approach Document A/CN.9/1169 seeks to avoid. A model based on the general application of the lex fori concursus alongside an exception for pending proceedings offers a measured and much more balanced compromise.
B) The operational pathologies of the new model
Besides motivational flaws, the proposed new model would be a source of serious disfunctions. Such disfunctions are not just conceptual. That is, a criticism of the new model could be based on the fact that it overrides party autonomy, crystallised in the arbitration (and choice of court) agreements concluded by the insolvent party and its counterparties prior to insolvency. While relevant, this argument is overly simplistic and insufficient. First, because insolvency law is precisely about (justifiably) impacting existing individual arrangements in favour of a collective good. Second, because, if UNCITRAL’s intention is to treat arbitration and litigation equally (as explained above and in para. 67 A/CN.9/1169), the exception for pending individual proceedings would also apply to litigation commenced before national courts in the absence of choice of court agreements or voluntary submission; i.e. cases where party autonomy or common consent do not constitute the legal basis of the court’s jurisdiction. Therefore, the real problems produced by the proposed new model are practical rather than conceptual. There are at least three.
B.1) The risk of abuse
Practice shows that the ability of one party to an ongoing dispute resolution process to trigger insolvency proceedings in their home jurisdiciton in order to claim that the lex fori concursus will unilaterally and mandatorily govern the possibility to continue with that process could readily become a source of potential abuse. Parties choose neutral fora to prevent the uncontrolled application of one party’s laws to resolve their common disputes. The application of the law of that neutral forum to define the impact of insolvency on the possibility to continue any pending proceedings is a source of legal certainty and favours international transactions. Attempts by parties to torpedo their ongoing cases (particularly when they might not be progressing as favourably as desired) by simply triggering insolvency protection in their home jurisdiction can back-fire and generate scepticism from arbitral tribunals and courts acting in an arbitration-capacity. This is particularly concerning given the application of the proposed choice of law regime to various types of insolvency proceedings that go beyond traditional liquidations and administrations, and which might be easily accessible, including reorganizations, expedited reorganization proceedings, simplified insolvency proceedings and interim restructurings.
B.2) The incompatibility with Article 20 UMLCBI and the clash of jurisdictions
As pointed out in previous posts [here and here], Article 20 UMLCBI includes an implied choice of law rule in favour of the law of the recognising State. That is, Article 20 MLCBI triggers an automatic stay in its own right and does not import the effects of the law governing the foreign insolvency proceedings. It imposes its own relief, which might be more or less stringent than the lex fori concursus (UMLCBI with Guide to Enactment and Interpretation, par. 178). The new choice of law regime in favour of the lex fori concursus is directly incompatible with the philosophy of Article 20 UMLCBI and it is very unclear that the rules on coordination will be sufficient to overcome this clash. For instance, if the lex fori concursus allows individual proceedings and Article 20 UMLCBI in the recognising State provides for a stay, the incompatibility will only be resolved if the law of the recognising State allows for the lifting of the stay (which not every jurisdiction does). Or, if the lex fori concursus orders the stay in absolute terms and the recognising State provides for a stay under Article 20 UMLCBI but allows for the possibility of a lift, it is unclear which one should prevail.
Equally problematic will be the cases where the lex fori concursus and the recognising State regulate the possibility to lift the stay, but each of them subject such lift to different criteria. Or even when Article 20 UMLCBI does not apply or has not been adopted by the State where the seat is located, the question will be whether the possibility to lift the stay will be a matter governed by the lex fori concursus (if the stay is characterised as a jurisdictional matter) or the lex loci arbitri (if classified as a procedural issue). It is easy to predict that a position that favoured the lex loci arbitri would produce a partition between the regulation of the stay (governed by lex fori concursus) and the lifting of the stay (governed by the lex loci arbitri). De facto this would offer each recognising jurisdiction discretion to establish their own rules regarding the lifting of stays and hence potentially reintroduce the very conflicts that the new model proposed by WG V seeks to mitigate.
Another related question would be the identification of the competent court to decide on the possibility to lift the stay (basically, the forum concursus or the courts of the seat of the arbitration). To an extent, it would appear that the forum concursus would be better placed to assess the insolvency considerations relevant to decide on the possible lift. However, this would clash frontally with the philosophy underlying Article 20 UMLCBI, which confers jurisdiction on the courts of the recognising State over these matters. Equally, it would be somehow paradoxical if the forum concursus could decide on the stay of proceedings located abroad, as it would directly impact on the jurisdiction of foreign courts and arbitral tribunals that would be already hearing the case (hence, violating the basic principle of competence-competence). It would also raise the concerns of extraterritoriality that led English courts to rule that the stay mandated by English insolvency law should not apply to foreign proceedings (see Harms Offshore AHT ‘Taurus’ GmbH and Co KG v Bloom [2009] EWCA Civ 632).
It is worth noting that Document A/CN.9/1169 fails to acknowledge in detail any of the very serious issues identified in the previous paragraphs, let alone resolve them. Importantly, none of these complexities would exist if the lex loci arbitri governed the impact of insolvency on pending proceedings, subject to the amendment to Article 20 UMLCBI suggested in previous posts [here and here].
B.3) The difficult compatibility with Article V New York Convention (NYC)
The new model proposed by WG V would be compatible with Article II NYC, but it would be a source of significant tensions with Article V NYC.
Article II
When a court other than the forum concursus has to decide on the enforcement of an arbitration agreement, Article II NYC applies. According to Article II NYC, the courts of the Contracting States shall refer parties to arbitration if the dispute concerns ‘a matter capable of settlement by arbitration’ (Article II.1) and unless the arbitration agreement is ‘null and void, inoperative or incapable of being performed’ (Article II.3). The NYC does not define these concepts or even prescribe a closed set of choice of law rules to identify the law applicable to give content to the referred terms. In cases of foreign insolvency, this silence concerning the relevant applicable law might allow courts to integrate relevant choice of law considerations pertaining to the cross-border insolvency sphere. That is, when examining the arbitrability of the dispute or the validity and effectiveness of the arbitration agreement the court might be able to use the law applicable under the cross-border insolvency regime (in the last proposal of WG V, the lex fori concursus) to define the effects of insolvency on arbitration, instead of the law ordinarily applicable to those matters under the general arbitration regime of that State.
Article V
The situation is not equally accommodating at the post-award stage. Article V NYC contains a closed list of grounds that can be invoked to refuse the recognition and enforcement of a foreign arbitral award. This includes the loss of capacity of the insolvent party or the invalidity and ineffectiveness of the arbitration agreement (Article V.1.a), exceeding of the scope of the arbitration agreement (Article V.1.c), the inarbitrability of the dispute (Article V.2.a) or the violation of public policy (Article V.2.b). Unlike Article II NYC, the grounds in Article V NYC contain prescribed choice of law rules. The capacity of the parties is defined by their personal law; the arbitration agreement is governed by the law chosen by the parties or, failing any indication thereon, by the law of the seat; and the arbitrability of the dispute and the relevant notions of public policy are prescribed by the law of the forum.
With the exception of capacity (as illustrated in Vivendi v Elektrim, Swiss Federal Tribunal, 4A_428/2008, 31 March 2009), none of these applicable laws will ordinarily point toward the lex fori concursus. Therefore, under the last proposal of WG V, a court that is presented with a request to recognise and enforce a foreign award that has not followed the lex fori concursus would face the dilemma whether to apply the lex fori concursus (as proposed by WG V) or to follow the different laws applicable under the grounds listed in Article V NYC, which in some States might be considered as hierarchically superior due to the fact that the NYC is an international treaty. If none of the laws under Article V NYC prevented the continuation of the arbitration, the only option to impede the effectiveness of the foreign award would be to invoke a breach of public policy under Article V(2)(b) NYC. Sometimes, this will permit the refusal of the recognition as well as the enforcement of the award issued in violation of the lex fori concursus. Other times, however, the refusal will only concern the enforcement of the award, but not its recognition. That is, it is only the patrimonial diminution of the insolvent estate that is protected by the principle of par conditio creditorum from a substantive point of view. However, the mere invocation of an award for recognition purposes (even if it breached the lex fori concursus) might not violate public policy.
This is not a novel issue. In Elektrim v Vivendi, the Polish courts accepted the recognition of a LCIA award issued in England against a Polish insolvent party despite the prohibition to arbitrate provided by Polish law. In an unpublished decision dated 16 November 2009, the Polish Court of Appeal found that the breach of that prohibition did not violate Polish public policy insofar the award creditor filed the award with the insolvency court to join the queue of creditors. Much more recently, the French Cour de Cassation has decided in Cass. Civ. 15 May 2024, no. 23-11.012 that the continuation of arbitration despite a stay mandated by the insolvency forum might not violate the public policy of the lex fori concursus if ultimately the award creditor submits the award before the insolvency court for recognition (as opposed to enforcement). A similar decision had been issued by the French Cour de Cassation in Cass. Civ. 12 November 2020, no. 19-18.849, accepting the recognition of a Swiss arbitration award in French insolvency proceedings despite the breach of the French rules on stay.
These cases exemplify that Document A/CN.9/1169, para. 65, is not entirely reflective of practice when it suggests that:
“(a) in some jurisdictions, the arbitral award resulting from the arbitral proceedings commenced or continued in disregard of the stay of proceedings imposed under the lex fori concursus would be considered void; (b) in some places of arbitration, such an award would be annulled by the court under the domestic public policy; (c) in other jurisdictions, such an award might be set aside or not recognized and enforced by invoking the public policy or other exception under the New York Convention or other applicable framework; and (d) the arbitral tribunal’s disregard of mandatory conflicts of law provisions imposed under insolvency law might lead to the same results.”
Contrary to these partial suggestions (which might be correct in some jurisdictions, but certainly not in others), the mentioned cases confirm that, while the enforcement of an award against an insolvent party is indeed highly improbable, the NYC will not be sufficient to guarantee the application of the lex fori concursus by arbitral tribunals or national courts acting in an arbitration context. That is, WG V would be proposing a choice of law rule that would be difficult to apply globally and whose breach would be incorrigible in many instances. The same might occur under equivalent regimes on the setting aside of awards, including Article 34 of the UNCITRAL Model Law on International Commercial Arbitration or Article IX of the 1961 European Convention on International Commercial Arbitration, which might impede the annulment of an award issued in breach of the stay mandated by a foreign lex fori concursus.
Importantly, the same incompatibility of regimes would exist between the last proposal of WG V in favour of the lex fori concursus and Article 9 of the 2005 Hague Convention on Choice of Court Agreements, which contains a closed list of grounds to refuse the enforcement of judgments derived from exclusive choice of court agreements similar to Article V NYC. This is relevant in light of the fact that, as mentioned above, WG V has recognised that the starting point should be that the law governing the effects of insolvency are the same for arbitration and for court proceedings (see para. 67 A/CN.9/1169).
IV. Conclusion
To conclude, a choice of law rule that seeks to impose the lex fori concursus to determine the effects of insolvency in every arbitration and court proceeding involving the insolvent party regardless of their status at the time of the opening of the insolvency is seriously misguided. While apparently justified by legitimate universalist ideals, the motivations provided by WG V of UNCITRAL are flawed and would give rise to serious practical problems. The application of the lex fori concursus to pending individual proceedings would permit abusive recourse to insolvency proceedings to boycott pending arbitrations and lawsuits; it would clash with the regime introduced by Article 20 UMLCBI; and it would be incompatible with some of the key provisions of the New York Convention (and equivalent rules of the 2005 Hague Convention on Choice of Court Agreements).
In contrast with this clash, a choice of law rule that subjected the effects of insolvency on pending arbitrations to the lex loci arbitri (and lex fori for pending litigation) would align the applicable laws under the insolvency and arbitration choice of law rules in the vast majority of cases. Meanwhile, it would still allow for a stay to operate under the lex loci arbitri (e.g., if mandated by Article 20 UMLCBI) and would prevent the enforcement of awards against insolvent parties under the public policy exception (Article V(2)(b) NYC) to protect the substantive facet of par conditio creditorum.
For these reasons, WG V is invited to return to the original choice of law rule which, subject to the amendments suggested in previous posts [here and here], recognised an exception in favour of the lex loci arbitri to govern the effects of insolvency in pending arbitration proceedings and the lex fori for pending litigation.
(*) Dr Manuel Penades is Reader in International Commercial Law at The Dickson Poon School of Law, King's College London. He was the academic chair of the IBA Toolkit on Insolvency and Arbitration.