April 12 2012
The interaction between insolvency proceedings and arbitration is treated differently in different countries. The French legal position is clear: the supervening insolvency of a party does not render a dispute inarbitrable. Insolvency does not prevent arbitrators from carrying out their mission – except for matters of public policy on which only the bankruptcy court may decide (ie, acknowledging the status of insolvency or dealing with proof of debts).
In a recent decision the Paris Court of Appeal found that the International Court of Arbitration of the International Chamber of Commerce (ICC) had committed an "excessive measure" justifying the annulment of the award when it decided to withdraw counterclaims that had been introduced by the defendant which could not pay the advance on costs due to its insolvency.(1)
The arbitral tribunal had made findings in its award that rendered the counterclaims moot. Indeed, the counterclaims constituted a mirror image of the defendant's defence to the points of claim, which the tribunal denied in its award. The counterclaims were introduced in order to reinforce the defence's arguments. Therefore, while as a matter of form the ICC court's decision to withdraw the counterclaims deprived the defendant of an opportunity to obtain a ruling on these counterclaims, as a matter of substance, it appears that the arbitral tribunal had taken into account – and dismissed – the arguments that underpinned the counterclaims.
According to the court of appeal, that a party was impecunious and could not, as such, introduce subsequent arbitration proceedings amounted to a breach of the right of access to justice. The severe approach of the court – which championed a strictly objective assessment of the breach of procedural public policy – has been subject to criticism.
In December 2001 Italian company Pirelli & C SPA and Spanish company Licensing Project SL (LP) entered into an agreement pursuant to which LP was granted an exclusive licence for the production and marketing of shoes under several brands owned by Pirelli. The agreement contained an arbitration clause which stated that any disputes relating to the validity, interpretation, performance or termination of the contract would be submitted to arbitration in accordance with the ICC's 1998 Rules of Arbitration.
A dispute arose between the parties regarding the Pzero brand, since LP had suspended the payment of royalties provided for under the agreement. In April 2007 Pirelli sent LP a termination letter.
In July 2007 LP went into insolvency, pursuant to the ruling of a Barcelona court.
In November 2007 Pirelli initiated arbitration proceedings before the ICC, requesting the arbitral tribunal to:
LP introduced several counterclaims before the arbitral tribunal. It asserted that Pirelli had granted it a licence for the Pzero brand, which it did not actually own, and requested the arbitral tribunal to hold Pirelli liable to compensate it for having paid royalties in relation to the brand, as well as for sums invested in business development activities in this respect. LP also alleged that Pirelli had unlawfully terminated the agreement and requested damages for the resulting loss of profits. LP requested that Pirelli be ordered to pay damages for unfair competition and prevented from concluding any licence agreements with third parties regarding the relevant brands.
In a first award rendered in September 2008, the arbitral tribunal in Paris held that it had jurisdiction to hear the dispute. In the same award the arbitrators held that Article 52.1 of the 2003 Spanish Bankruptcy Law (22/2003), pursuant to which bankruptcy proceedings forestall the effects of arbitration clauses, did not apply to international arbitration. The parties did not challenge this award.
In January 2009 the Barcelona court opened liquidation proceedings against LP.
In March 2009, on Pirelli's request, the ICC court decided to fix separate advances on costs for the claims and the counterclaims pursuant to Article 30(2) of the 1998 ICC rules (now Article 36(3) of the 2012 ICC rules), despite LP's objection that its being involved in winding-up proceedings prevented it from paying the advance set by the ICC court.
LP was unable to pay the advance on costs. Consequently, in August 2009 the ICC court informed the arbitral tribunal and the parties that since LP had not paid the advance on costs corresponding to its counterclaims, the counterclaims were deemed to have been withdrawn in accordance with Article 30(4) of the 1998 ICC rules (now Article 36(6)). The court added that LP would not be prevented from reintroducing the same counterclaims in subsequent arbitration proceedings.
In October 2009 the arbitral tribunal rendered its final award, in which it admitted all of the claimant's claims. It acknowledged the rightful termination of the licence agreement, enjoined LP from using the brands covered by the licence agreement and ordered LP to pay the outstanding royalties to Pirelli. The arbitral tribunal therefore rejected all of LP's arguments in response to Pirelli's claims.
In November 2009 LP introduced an action to set aside the award in France.
In March 2010 the Barcelona tribunal authorised M Belil, a creditor of LP, to challenge the award in the interest of all creditors. In September 2010 Belil introduced proceedings against LP and its liquidators, and less than two weeks later against Pirelli, LP and LP's liquidators. The last set of proceedings was introduced with a view to replacing the proceedings introduced against LP and its liquidators only.
In their pleadings, Belil and LP claimed that as a result of the withdrawal of LP's counterclaims by the ICC court, LP had been deprived of the right to a fair trial before the arbitral tribunal. Consequently, Belil and LP claimed that the award should be annulled on the grounds that:
They asserted that because of LP's inability to provide the required advance on costs due to the winding-up proceedings, LP had been deprived of its right of proper access to justice and Pirelli had been placed in a more favourable position. They concluded that this constituted a violation of the principle of equality of arms enshrined in Article 6(1) of the European Convention on Human Rights.
Belil and LP also argued that the award:
All of the parties requested that the various proceedings be consolidated into one.
The Paris Court of Appeal consolidated the proceedings on the grounds of good administration of justice. It held that the ICC court's decision to withdraw LP's counterclaims on the basis that the Spanish company did not pay the requested advance on costs, despite the fact that LP was in practice unable to meet this requirement due to the insolvency proceedings introduced against it, was an "excessive measure" constituting a breach of both the right of access to justice and the principle of equality of arms.
The Paris Court of Appeal annulled the award on the grounds that due process had been violated and that the recognition or enforcement of the award would be contrary to international public policy. It did not rule on the rest of Belil's and LP's claims.
An appeal against the reported decision has been lodged before the French Supreme Court.
Arbitration proceedings must comply with due process requirements. A breach of the right of access to justice or the principle of equality of arms can constitute grounds for the annulment of an arbitral award.
This is explicitly recognised by the French law on international arbitration. Article 1518 of the Code of Civil Procedure (previously Article 1504) provides that annulment proceedings may be brought before French courts against arbitral awards rendered in France where "due process was violated" (Article 1520 4° of the Code of Civil Procedure, formerly Article 1502 4°) or "recognition or enforcement of the award is contrary to international public policy" (Article 1520 5° of the Code of Civil Procedure, formerly Article 1502 5°).
Thus, arbitrators must comply with – and enforce – the right of access to justice and the principle of equality of arms, both of which are principles of international public policy.(2) The observance of such fundamental principles by arbitrators is protected by state courts pursuant to Article 1520 of the Code of Civil Procedure.
Nevertheless, however fundamental the right of access to justice and the principle of equality of arms may be, an award should be annulled only if a serious breach of such principles is established (ie, where the arbitral tribunal has left unsanctioned a serious obstacle to any party's right to have its (counter)claims heard by a judge).
This is precisely what the Paris Court of Appeal should have considered when it annulled an award on the grounds that the right of access to justice and the principle of equality of arms had been breached.
Although the ICC court's decision prima facie deprived the defendant of the right to access to justice, the Paris Court of Appeal's decision is subject to criticism, mainly because the arbitral tribunal's findings necessarily implied, de facto, the dismissal of the counterclaims.
The arbitrability of insolvency proceedings issues was not at stake in the present case. The arbitral tribunal did not rule on the insolvency itself. Indeed, it ruled only on:
No issue of the arbitrability of insolvency proceedings was therefore involved.
The interaction between insolvency proceedings and arbitration is complex. Submitting disputes to arbitration incurs funding requirements that are significantly larger than the legal costs that may be involved before a state court in France. Impecunious insolvent parties may be unable to provide an advance on costs. However, under French law, this is irrelevant when assessing the arbitrability of a dispute. Disputes involving a professional and a consumer or a non-commercial party are arbitrable under French law.(3) Thus, the impecuniousness of a party does not prevent the arbitrators from conducting their mission. That the court of appeal, on the pretext of protecting the right of access to justice, actually controlled the party's ability to pay the costs of an arbitration is debatable, as it introduces a degree of uncertainty that is not wholly compatible with a pro-arbitration stance.
Arbitral tribunals must comply with fundamental procedural principles
Although arbitration is a private form of justice, arbitral proceedings must still comply with a number of fundamental principles, the observance of which is protected by state courts when requested to rule on the enforcement or annulment of an arbitral award. The right of access to justice and the principle of equality of arms, being corollaries of the right to a fair trial, are encompassed within these fundamental principles. They must therefore prevail over the arbitration rules chosen by the parties.
According to the Paris Court of Appeal, the right of access to justice implies that a party may not be prevented in practice from having its claims heard, unless such restriction is proportionate to the need for good administration of justice. The Paris Court of Appeal held that the right of access to justice is equally applicable to state courts and arbitration proceedings. Thus, when requested to rule on the enforcement or annulment of an award, state courts perform a proportionality test, balancing the need for an efficient procedure against the fundamental requirement that all parties be able to have their claims heard by the arbitral tribunal.
In the present case, the court considered that the decision to withdraw LP's counterclaims was disproportionate in view of the circumstances. The court held that withdrawing a counterclaim on the basis that the defendant was unable to pay for the advance on costs due to the insolvency proceedings introduced against it was an excessive measure, since it totally deprived the defendant from having its claims considered by the arbitral tribunal.
The principle of equality of arms requires that the parties be in a position of equality before the judge. The Paris Court of Appeal held that this principle is breached in a situation where a defendant would be authorised to reply only to the claimant's initial claims and prevented from introducing its own counterclaims. The Paris Court of Appeal considered that the principle of equality of arms had been breached in the case at hand.
Although LP and Belil had relied on Article 6(1) of the European Convention on Human Rights, which provides for the right to a fair trial, at no point in its analysis did the Paris Court of Appeal mention this. The reason for this is that Article 6(1) may not be directly invoked by a party against an arbitral tribunal and does not constitute, per se, a basis for considering the annulment of an award.(4) However, domestic courts are bound by the requirements set out under Article 6(1) when requested to set aside an award on the grounds of a breach of due process or of international public policy (Articles 1520 4° and 5° of the Code of Civil Procedure). Although Article 6(1) is not per se applicable to arbitration, the standards it sets are upheld via the test performed by the Paris Court of Appeal.(5)
Thus, the right of access to justice and the principle of equality of arms must be upheld by the arbitral tribunal itself, in the absence of which the award may be set aside.(6)
Right of access to justice and insolvency proceedings: ICC rules safety net was pointless
Under the ICC rules, when a defendant does not provide its share of the advance on costs, the claimant must pay the whole advance. On the other hand, if the defendant wishes to introduce a counterclaim, the ICC may request it to pay an advance on costs corresponding to its counterclaim.
Article 30(2) of the 1998 ICC rules (now Article 36(3)) provides that "the court may fix separate advances on costs for claims and counterclaims". In case the defendant fails to pay such advance, its counterclaims may be deemed to be withdrawn. Yet pursuant to Article 30(4) of the 1998 ICC rules (now Article 36(6)), a party whose claim was withdrawn due to non-payment of the advance on costs "shall not be prevented…from reintroducing the same claims or counterclaims at a later date in another proceeding".
This 'safety net' provided for under the ICC rules is meant to protect the right of access to justice. The defendant's only option is to reintroduce the same claims or counterclaims at a later stage, in a subsequent arbitration. Albeit restricting the party's right to be heard, this provision of the ICC rules must be put in perspective against the fact that, being a private form of justice, arbitration necessarily implies a certain cost, which the parties accepted to bear when they included an arbitration clause in their agreement. It can therefore be assumed that such a restriction of the party's rights should be considered fair and proportionate.
In assessing the proportionality of the withdrawal of the counterclaims, the court of appeal rejected the argument that the safety net provided under the ICC rules would give LP a second chance to bring its claim in another instance. Instead, the Paris Court of Appeal first found that the counterclaims were introduced within the scope of the arbitration clause, and that the arbitral tribunal was exclusively competent to rule on them. Then, the court observed that LP was de facto prevented from introducing its counterclaims before the tribunal, since it was subject to insolvency proceedings and had no financial means to introduce its counterclaims subsequently before a new arbitral tribunal. The court concluded that therefore, LP had no means at all to have its counterclaims heard in arbitration, and as a result, the safety net provided by the ICC rules could not temper the impossibility for LP to introduce its claims. What may be considered an acceptable departure from the right to access to justice where all parties are in a healthy financial condition was considered a denial of these fundamental rights in circumstances where a party was insolvent.
The Paris Court of Appeal sanctioned the ICC court for not having considered the facts adequately.
The ICC rules do not contain specific provisions intended to tackle issues arising from the insolvency of a party in arbitration. However, the ICC rules are a flexible instrument and the ICC court enjoys discretion in their enforcement, notably in deciding whether a defendant introducing a counterclaim should pay the corresponding advance on costs.
In the case at hand, considering the insolvency of the defendant, the ICC court should have requested the claimant to pay the whole advance on costs in respect of both the claims and the counterclaims. Indeed, the Paris Court of Appeal did not criticise the ICC rules themselves, but instead criticised the ICC court's decision, which did not take into account the specific circumstances of the case - which could have been done if the ICC court had required the claimant to pay the advance on costs for all claims and counterclaims. Therefore, the ICC court was criticised for having applied the ICC rules in an objective manner, as opposed to a fact-specific one. It is thus the application of the ICC rules that the court found to be disproportionate, rather than the ICC rules themselves.
This decision should be seen as a warning to the ICC court itself that attention should always be given to the particular facts at stake when reaching decisions on the advance of costs.
However, it is questionable whether the Paris Court of Appeal took a balanced view when it considered the application of the right of access to justice and the principle of equality of arms to the circumstances. The court of appeal's judgment appears open to criticism in two respects at least.
Arbitral tribunal has no power over advance on costs
Under French law on international arbitration, the decisions of the arbitral institution (ie, the ICC court in the present case) do not bear jurisdictional character and therefore are not subject to review by state courts.(7) However, when the administrative decisions of an arbitral institution have an impact on the parties' rights – as the present decision of the ICC court had – it is reasonable for a court to take them into account while ruling on the annulment of the subsequent award. Indeed, had the arbitration been an ad hoc arbitration, such an administrative decision would have been made by the arbitral tribunal itself – and would therefore have been subject to review by the Paris Court of Appeal in the context of annulment proceedings.
By insisting on the fact that the administrative decision of the ICC court was "taken for granted" by the arbitral tribunal, the Paris Court of Appeal blamed the arbitral tribunal for having adopted a passive attitude towards the ICC court's decision and for having enforced it. However, the arbitral tribunal has no power over the advance on costs under Article 30(2) of the ICC rules (now Article 36). Since the parties had agreed that any dispute relating to their contract would be submitted to arbitration in accordance with the ICC rules, the arbitral tribunal was bound by them and could not overrule the decision of the ICC court. It was therefore inconceivable for the arbitral tribunal to disregard the ICC court's ruling and decide, on its own motion, to hear the counterclaims introduced by the defendant.
Hence, even though decisions of an arbitral institution (ie, the ICC court in the present case) are not subject to review by state courts, the Paris Court of Appeal should not have blamed the arbitral tribunal, for the latter had no power to challenge the decision of the ICC court. Besides, the court of appeal did not take into account the factual circumstances of the case: the arbitral tribunal did hear the defendant's counterclaims and no actual breach of the right of access to justice was made.
Excessively strict objective approach
In its decision, the Paris Court of Appeal adopted a strict approach by applying an objective test when assessing whether the right of access to justice and the principle of equality of arms were observed during the arbitral proceedings. By doing so, the Paris Court of Appeal did not take into account the specific facts of the case.
Indeed, the decision of the ICC court was prima facie depriving the defendant from the right to have its counterclaims heard by a judge. As such, the court of appeal was right in criticising the ICC court's decision.
However, even though it was prevented from hearing LP's counterclaims, pursuant to the ICC court's decision, the arbitral tribunal did in fact hear LP's arguments which formed the basis of its counterclaims. Indeed, LP's counterclaims were the exact mirror of Pirelli's claim. They were not counterclaims, since no new argument was put forward by LP that would have been more than a reply to Pirelli's claim. Thus, the arbitral tribunal, when analysing the merits of the claims and especially the defendant's arguments in response to such claims, necessarily analysed the merits of the counterclaims. By accepting Pirelli's claims, the arbitral tribunal ruled in a way that necessarily implied the dismissal of the counterclaims.
This was exactly Pirelli's position when it argued that the defendant's counterclaims should be interpreted as the mere reply to the claimant's main claim. The Paris Court of Appeal rejected this argument and held that such a circumstance was "not likely to put the parties on the same level". In other words, the fact that the defendant was prevented from introducing a counterclaim on the basis that it was unable to pay for the advance on costs would amount, per se, to a breach of due process. According to the Paris Court of Appeal, this is an intangible rule which must be applied objectively. Should a defendant be prevented from introducing a counterclaim, French courts will not assess whether the counterclaim may be analysed as a reply to the initial claim. This position results from the inflexible character given to the right to a fair trial, according to which defendants must in any circumstances be able to introduce a counterclaim, regardless of their financial means.
Thus, the Paris Court of Appeal failed to consider the particular circumstances of the case - namely, that LP's alleged counterclaims were de facto a reply to Pirelli's claim and as such had necessarily been heard by the arbitral tribunal.
Instead, the Paris Court of Appeal hastily held that the decision of the ICC court had been "taken for granted" by the arbitral tribunal, and that the award should consequently be set aside. In its decision the Paris Court of Appeal adopted a strictly objective approach, rather than a subjective one, tailored to the actual facts of the case. Ironically, this is precisely what the Paris Court of Appeal criticised the ICC court for doing.
This approach not only is inadequate, but also puts the stability of arbitration at risk. Indeed, in times of economic crisis, defendants in situations of insolvency might make tactical counterclaims and refuse to pay their share of the advance on costs in an attempt to seek the benefit of this decision so as to try to escape from an award rendered against them.
This decision will create a considerable burden for claimants against impecunious defendants, as it will increase their exposure to costs that they may be unable to recover. This decision may also encourage bad faith and dilatory tactics - precisely what the decree reforming French law of arbitration in early 2011 sought to avoid.
The Paris Court of Appeal did not need to rule on the other claims introduced by Belil and LP - namely, that the award:
However, it may be assumed with certainty that the court would not have accepted the challenge on such grounds. French courts consistently rule that state courts are not entitled to review the way tribunals apply the rules of law applicable to a dispute.(8) Indeed, under French law, judges are prevented from reviewing arbitrators' legal reasoning and their interpretation of legal statutes. Thus, in the present case the Paris Court of Appeal would have refused to rule on the way that the arbitral tribunal applied Spanish law.
Almost 20 years have passed since the decision of the Court of Cassation was rendered in the Dutco case, in which the French Supreme Court annulled an award on the grounds that the right of access to justice had been breached.(9) Following this decision, the ICC rules were amended and practitioners are cautious when drafting arbitration clauses likely to involve multiple parties. This decision is a warning to the ICC court, which may consider more carefully the issue of advances on costs in future circumstances where counterclaims involve insolvent parties.
Furthermore, this decision will doubtless have a certain impact in times of economic crisis. There is scope for defendants which find themselves in a situation of insolvency to use the decision strategically. In the meantime, parties contemplating ICC arbitration (the most frequently chosen arbitral institution) with the place of arbitration being Paris (one of the most arbitration-friendly jurisdictions) are advised to consider waiving their right to bring an action to set aside, as expressly permitted by Article 1522 of the Code of Civil Procedure.
For further information on this topic please contact Elie Kleiman or Claire Pauly at Freshfields Bruckhaus Deringer by telephone (+33 1 44 56 44 56), fax (+33 1 44 56 44 00) or email (email@example.com or firstname.lastname@example.org).
(2) J L Devolvé, G H Pointon, J Rouche, French Arbitration Law and Practice (2009, 2nd edn), paras 228-229; E Gaillard and J Savage, Fouchard, Gaillard, Goldman on International Commercial Arbitration (1999), paras 1652 et seq.
(3) Cass Civ 1, May 21 1997, V 2000  Rev Arb 536-537; Cass Civ 1, 5 January 1999  Rev Arb, 206-261; Cass Civ 2, March 30 2004, Rado  Rev Arb 115-118; CA Paris, January 17 2002  Rev Arb, 203-205; CA Paris, December 9 2003, AGGR  Rev Arb 641-644; CA Paris, January 21 1999, RG no 08/18859.
(5) T Clay, "Note – Cour de cassation (1re Ch. civile) février 20 2001"  Rev Arb 511, para 35; C Jarrosson, "L'arbitrage et la Convention européenne des droits de l'Homme"  Rev Arb 573; C Seraglini, Note under Cass Civ 1, February 20 2001, Société Cubic Defense System Inc v Chambre de Commerce Internationale  RCDIP 126. See also JB Racine, "Note – avril 3 2008, Cour européenne des droits de l'Homme (5e Section)"  Rev Arb 802, p807.
(7) Paris Court of Appeal, May 17 1983, Société Techni Import Professionnel (TIP) v Société Electro Scientific Industries (ESI)  Rev Arb 310; Cass Civ 2, June 8 1983, Société Appareils Dragon v Empresa central de abastecimientas y vantas de equipos  Rev Arb 310; Cass Civ 2, October 7 1987, Société Opinter France v SARL Dacomex  Rev Arb 479; Cass Civ 1, February 20 2001, Société Cubic Defense System Inc v Chambre de Commerce Internationale  Rev Arb 511; CA Paris January 22 2009, SNF SAS v Chambre de Commerece International  Rev Arb 314.
(8) Cass Civ 1, October 22 1991, Société Compania Valenciana de Cementos Portland v Société Primary Coal Inc  RCDIP 113; Paris Court of Appeal October 27 1994, Lebanese traders distributors et consultants LTDC v Société Reynolds  Rev Arb 709; Paris Court of Appeal, January 22 2004, Société National Company for Fishing and Marketting "Nafimco" v Société Ffoster Wheeler Trading Company AG  Rev Arb 647; Paris Court of Appeal, November 18 2004, SA Thalès Air Défense v GIE Euromissile  RCDIP 104; CA Paris, September 15 2005, SA Vivendi Universal v Société Prohygiène  Rev Arb 1095; Cass Civ 1, June 4 2008, SAS SNF v Société Cytec Industries BV  JDI 1107; Cass Civ 1, March 11 2009, de Prémont v Société Trioplast AB  Rev Arb 240.
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