One year into the COVID-19 pandemic, its full impact on the world economy remains unclear. While the statistics appear optimistic – in 2020 France saw a 40% reduction in insolvencies compared with 2019 (the lowest reported number in the past 30 years) – in reality, they are likely to change soon.
The ostensibly optimistic figures can be explained by the various measures adopted at the EU and national levels to ease the strain on businesses during the pandemic. The European Commission adopted a temporary framework allowing member states to provide financial support to struggling industries notwithstanding the prohibition on state aid. The temporary framework was originally supposed to expire on 31 December 2020 but has been extended until 30 June 2021.(1)
On 27 March 2020 the French government adopted an ordinance adapting insolvency rules in light of the COVID-19 pandemic.(2) This act established that from 12 March 2020 until 23 August 2020, the question of whether debtors were in a situation of 'cessation of payments' would have to be answered on the basis of their situation as of 12 March 2020. On 20 May 2020 and 25 November 2020 the government issued additional ordinances adapting other procedural aspects of the insolvency regime to the current health crisis.(3)
These ongoing measures may have temporarily curbed bankruptcies, but a global surge in insolvency is still expected in 2021 and 2022.
It is important to anticipate the effects of a party's insolvency on ongoing and future disputes subject to arbitration. As a general point, these effects will depend on the timing of the insolvency – namely, whether it occurs before, during or after the arbitration.
Pre-arbitration phase – considering subjective and objective arbitrability
During the pre-contentious phase, parties should consider whether insolvency might affect the validity of the arbitration clause or arbitrability of their potential dispute.
In France, arbitration agreements concluded by a debtor before insolvency proceedings begin are binding on the insolvency administrator.(4) The subjective capacity of a person to validly conclude a binding arbitration agreement is regularly referred to as 'subjective arbitrability'. Further, the opening of insolvency proceedings in France does not prevent the debtor from validly entering into an arbitration agreement. As with any other contract concluded by an insolvent party, such an agreement would have to be entered into by the insolvency administrator and would be subject to several procedural requirements.(5)
On the other hand, in most jurisdictions, insolvency and bankruptcy matters cannot be settled by arbitration as they involve sensitive public policy issues that fall under the exclusive jurisdiction of national courts applying domestic law (referred to as 'objective arbitrability'). In this regard, disputes concerning 'core' bankruptcy functions (eg, matters relating to the adjudication of the insolvency itself or the verification of creditors' claims) are almost universally – including in France – considered non-arbitrable.(6) Conversely, claims which are arbitrable include those:
- that do not arise from the opening of the insolvency proceedings;
- which derive from agreements concluded prior to the insolvency; and
- which would have occurred regardless of the insolvency.
When arbitration is already ongoing and one party becomes insolvent
In France, when insolvency proceedings are opened, any ongoing proceedings in which a creditor is seeking a monetary payment or contract termination due to failure to pay should be stayed so that the creditor may declare its debt in the insolvency proceedings.(7) The courts have long held that this rule is part of international and internal public policy and must be observed by arbitral tribunals seated in France.(8) Therefore, a failure to stay pending arbitral proceedings seated in France may lead to the annulment of the award due to a breach of international public policy.(9) The arbitration can be subsequently resumed once the necessary procedural steps associated with the opening of the insolvency proceedings have been carried out.
The European Union has adopted a specific conflict of laws rule for determining which law applies to the effects of an insolvency on pending arbitral proceedings. In particular, Article 18 of the EU Recast Insolvency Regulation (2015/848) provides that the:
effects of insolvency proceedings on a pending lawsuit or pending arbitral proceedings concerning an asset or a right which forms part of a debtor's insolvency estate shall be governed solely by the law of the Member State in which that lawsuit is pending or in which the arbitral tribunal has its seat.
There is no French case law on the application of Article 18(10) but its significance was highlighted in the decision of the High Court of England and Wales in Elektrim v Vivendi. The High Court approved the reasoning of the arbitral tribunal, which had applied the law of the seat to the effects of the insolvency rather than the law of the jurisdiction where the insolvency proceedings had been opened.
When a dispute subject to arbitration arises after insolvency proceedings begin
In France, creditors must submit their debts for verification to the insolvency administrator before they can be submitted to arbitration.(11) Thus, a creditor is required to submit its debt against an insolvent party to the insolvency administrator in charge of verifying the debts so that the claim may be registered in the insolvency proceedings by the insolvency judge once the verification is complete.
Where a claim in insolvency proceedings concerns an individual debt subject to arbitration, the insolvency judge will decline to hear the case and refer the parties to arbitration.(12) It will then be up to the arbitral tribunal – rather than the insolvency judge – to ascertain the debt and determine its amount.(13) After the tribunal has established the amount, the insolvency judge will register the debt in the insolvency proceedings.
Regardless of the timing of a party's insolvency, certain issues are likely to arise at the post-award stage.
As discussed above, in France, filing for insolvency will result in the automatic stay of any pending proceedings, including enforcement or annulment proceedings. After insolvency proceedings have been opened, the creditor must first declare its debt in the insolvency proceedings before seeking recognition of the award. Further, while the creditors can then obtain recognition of the award through exequatur proceedings, they cannot obtain enforcement of said award,(14) which essentially means that the creditor must wait until the end of the insolvency proceedings to be paid in the same way as the other creditors of the insolvent debtor.
Moreover, discontinuance of individual proceedings and the equality of creditors form an integral part of domestic and international public order in France. Therefore, an award will be set aside if the arbitral tribunal failed to stay the proceedings when the insolvency was opened or ordered payment as opposed to simply determining the amount of the debt.(15) The courts will also set aside an award that does not respect the impecunious party's right to access justice.(16)
In these uncertain times, and especially when there is an indication that a counterparty may face financial difficulties in the near future, there are certain factors that a party should keep in mind to mitigate risks at the outset.
Considerations to be taken into account when drafting an arbitration clause include:
- checking the availability of an expedited procedure under the applicable arbitration rules, which might become a viable option to rapidly pursue claims against an insolvent respondent;
- choosing flexible arbitration rules regarding the joinder of a party, should bringing in such a third party become necessary due to the respondent's insolvency, against which the award could later be enforced; and
- giving preference to a pro-arbitration jurisdiction when choosing the place of arbitration and governing law, which will affect the enforcement of an arbitration agreement and any ensuing award against an insolvent party.
In addition to cautiously drafting an arbitration agreement, parties should consider the inclusion of guarantee clauses – such as on-demand bonds or a parent company guarantee – for the purposes of granting additional security to a party.
As for the actual prospect of arbitration, potential claimants should conduct a thorough risk analysis of whether it makes commercial sense to commence arbitration against an insolvent party, as it may be difficult to recover arbitration costs and the amount awarded by the arbitral tribunal (in the event of a successful judgment) against an impecunious respondent.
A party's insolvency can affect pending and future arbitrations, which will generally depend on the timing of the insolvency with respect to the arbitration (ie, whether it occurs before, during or after the arbitration). At all stages, the parties should be aware of local bankruptcy regulations, since a failure to adhere to the local laws in question may affect a party's ability to enforce an existing or future arbitral award or even result in the setting aside of the award. At the same time, in order to ensure that the arbitration process goes smoothly, and that an enforceable award is rendered, the interaction between the arbitral tribunal and the domestic courts is necessary from the moment that the insolvency proceedings are commenced. Moreover, early comprehension of certain basic factors might mitigate future risks ensuing from a counterparty's insolvency.
Endnotes
(1) The state aid temporary framework was adopted on 19 March 2020 to support EU member states in their efforts to deal with the effects of the COVID-19 crisis. The European Commission has extended the scope of the temporary framework from 31 December 2020 to 30 June 2021. The section enabling recapitalisation support (which allows states to take stakes in non-financial companies affected by COVID-19 by means of recapitalisation or subordinated debt instruments, in order to prevent their market exit) has been extended for a further three months until 30 September 2021.
(2) Ordinance 2020-341 of 27 March 2020.
(3) Ordinance 2020-596 of 20 May 2020 and Ordinance 2020-1443 of 25 November 2020.
(4) Court of Cassation, 29 January 2014, 12-29.104 and Court of Cassation, 1 April 2015, 14-14552.
(5) Article L(642-24) of the Commercial Code.
(6) In France, insolvency judges have exclusive jurisdiction to hear "all the disputes arising out of the insolvency proceedings or over which the proceedings have a legal influence". Court of Cassation, 8 June 1993, 90-13.821. Also see Article R 662-3 of the Commercial Code.
(7) Article L(622-21) of the Commercial Code.
(8) Court of Cassation, 5 February 1991, 89-14.382.
(9) Court of Cassation, 8 March 1988, 86-12.015.
(10) Formerly Article 15 of the Council Regulation (1346/2000/EC) of 29 May 2000 on insolvency proceedings.
(11) Court of Cassation, 2 June 2004, 02-18.700. If arbitration proceedings have already started, they must be suspended when the insolvency is opened, by virtue of Article L(621-41) of the Commercial Code. The creditor must then submit its claims for verification to the insolvency administrator before the arbitration can be resumed to liquidate the amount of the debt.
(12) With regard to individual debts, the Court of Cassation has held that if arbitration is not already ongoing when insolvency proceedings are opened, the insolvency judge must refuse to hear the declaration of said debts if there is a valid arbitration clause (see Court of Cassation, 2 June 2004, 02-18.700 and 25 November 2008, 07-21.888).
(13) Court of Cassation, 6 May 2009, 08-10.281.
(14) Paris Court of Appeal, 14 May 2019, 17/09133. The Court of Cassation confirmed this decision on 12 November 2020 (19-18.849).
(15) Court of Cassation, 6 May 2009, 08-10.281.
(16) Paris Court of Appeal, 26 February 2013, indicated in Revue de l'arbitrage (2013), pp749-751.
