International arbitration and bankruptcy are frequently encountered in practice, but in their essence, it is very different legal processes, with its own goals, objectives and underlying principles. Relations of these processes are rather difficult mostly because of their competing goals.

This article explores the complex process of coexistence of international arbitration and bankruptcy particularly in the process of arbitration. Given the magnitude of the issue, the paper focuses on the most problematic issues, such as establishing jurisdiction in disputes involving the bankrupt company and possible consequences of the bankruptcy of one of the parties to the dispute on arbitration that has commenced. In addition, through the example of the well-known case, we will explore a number of jurisdictions approaches when addressing these problematic issues.

When one of the parties to the arbitration process goes bankrupt, there are a number of important issues appear - whether the relevant provisions of national laws on bankruptcy of country of insolvency (or decisions of state courts) are binding on arbitration tribunal? Can arbitral tribunal ignore bankruptcy or should the arbitration be paused or stopped at all? Who decides when and whether to continue the arbitration or the bankruptcy should be simply ignored - the arbitral tribunal or national court?

The answers to these questions are ultimately determined by a number of national laws that apply to the concrete arbitration proceeding, given the diversity of national laws and lack of uniformity from state courts and arbitration tribunals. Thus, in order to answer these difficult questions, some general legal principles must be considered.

Bankruptcy and arbitrability of the disputes

The term "arbitrability" in this article is used to refer to the ability of a dispute to be submitted to arbitration in order of resolving it, i.e., to determine jurisdiction. Arbitrability of dispute determines what types of questions may or may not be submitted to arbitration.

International arbitration is based on the ability of the parties to grant jurisdiction to arbitrators to resolve disputes. Such jurisdiction is meaningful only if it is recognized by states, and the arbitration decision rendered pursuant to this jurisdiction will be further smoothly executed in judicial system of a country.

Herewith, the state reserves the right to prohibit the authorization of certain categories of disputes outside of its national courts. These categories are recognized by the court as non-arbitrable disputes and arbitration agreement concluded to address this category of dispute will be declared null and void by the court.

The legislator of each country determines the extent to which the arbitrability of the dispute is limited by national legislation. Neither 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention), nor any other international instrument contains substantive provisions concerning arbitrability of such disputes. These international instruments always pass the question of arbitrability to the relevant national legislation.

That is, each country can usually determine the question of dispute jurisdiction in accordance with its own national policy.

Thus, arbitrability is a condition validity of the arbitration agreement and therefore the existence of the jurisdiction of arbitration court. A bankruptcy, in turn, is an area in which the state may, in its sole discretion limit arbitrability of certain categories of disputes.

In arbitration

If a party to the arbitration claims that the dispute is not arbitrable due to the bankruptcy of the other side, there is a general rule is that the tribunal should, in principle, resolve the issue with reference to the law applicable in the jurisdiction of arbitration (seat of arbitration or lex arbitri). For example, arbitration tribunals usually do not claim that the dispute shall be settled by arbitration, if such arbitrability is contrary to the rules of international public policy at the location of the arbitration. In some cases, arbitration tribunals determine arbitrability of dispute as to the basis of the provisions applicable in the place of arbitration (place of arbitration).

The arbitral tribunal shall consider the other following sources when determining arbitrability, namely the laws applicable to:

• the arbitration agreement;

• merits of the case (lex causae and lex contractus); and

• place (-s) of possible award execution.

In state court

If the party to arbitration proceeding believes that the dispute is not arbitrable due to insolvency of the other party, and thus represents its complaint to the court in the country of insolvency proceedings, court usually applies its national legislation on bankruptcy because its provisions are mandatory and replace the provisions of the relevant tribunal’s provisions. If insolvency procedure has started in the place of arbitration, then to the extent necessary and permitted by its national law, the court shall have the right to suspend the arbitration. If insolvency proceedings instituted in another country, any foreign court orders are not necessarily paralyze arbitration. When such issues arise before the court outside the "country of insolvency", the application of insolvency legislation depends on the relevant conflict rules applicable to the court. Generally, courts will not apply foreign law on insolvency.

Ultimately, the national court may cancel the arbitration award at the place of execution and may refuse to enforce an arbitral award if, under the laws of the court’s jurisdiction the dispute lacks arbitrability due to the bankruptcy of one of the parties.

Influence of place of arbitration

As mentioned above, the arbitral tribunal shall endeavor to ensure that its decision would be valid at the place of arbitration. Arbitration tribunals usually consider themselves "bound" by provisions of bankruptcy law, in fact, where: (a) the law of the place recognizes them as binding law and/or part of the international public policy of the country of arbitration; and (b) bankruptcy procedure was (or could be) recognized in the country of arbitration.

Some scholars believe that the main provisions of bankruptcy law (in particular those designed to ensure equal treatment of creditors and proper disposal of property of the bankrupt company) are bound by the provisions of domestic law and sometimes are part of domestic and international public policy.

Since arbitration tribunals do not have lex fori, it is assumed that they should not be "concerned" about the national laws or internal public policy of the country of arbitration. Such provisions shall be binding only on the arbitral tribunal, where they form part of international public order recognized by law of the place of arbitration. Further, the existing arbitration case law shows that the courts indeed consider where exactly the bankruptcy takes place-  at the seat of arbitration or abroad. 

Elektrim against Vivendi: The story of two jurisdictions

A good example to illustrate the "genetic" difficulties when trying to define the correct law that determines the impact of insolvency on arbitration is a dispute between Elektrim and Vivendi. In this case, England and Switzerland were able to form its position on this conundrum and their conflicting results emphasize the need to investigate the matter promptly.

Background

Elektrim is a Polish company and at one time the owner of a significant stake in the PTC, a large Polish mobile company. Vivendi - a French company, has signed a contract with Elektrim, known as the Third Investment Agreement (TIA). TIA contained an arbitration agreement providing that the dispute should be resolved by the London Court of International Arbitration (LCIA) in London. In addition, English law governed the arbitration agreement itself, even though Polish law governed the rest of the TIA.

In August 2003, the dispute arose under this Agreement, and Vivendi began arbitration in LCIA. Vivendi announced that Elektrim had violated its contractual obligations under the TIA. In 2006, Vivendi began the second arbitration against Elektrim regarding the foreseeable peace agreement between the parties. The second dispute was under the Arbitration Rules of the International Chamber of Commerce (ICC) in Geneva.

LCIA decision

In early 2007, LCIA Court scheduled a hearing on liability on 15-19 October the same year. However, August 2, 2007, Elektrim was declared bankrupt by Warsaw district court decision, and thus became "bankrupt" within the meaning of Polish law, according to which:

  "Article 142

Any arbitration agreement concluded by bankrupt becomes invalid on the date of bankruptcy and all arbitration proceedings shall be terminated. "

Elektrim claimed that, through its bankruptcy, and as evidenced by the Polish bankruptcy law, arbitration agreement contained in TIA should be terminated, thereby the jurisdiction of the Tribunal should be cancelled. However, despite the objections of Elektrim, the October hearing planned before was held in London, and LCIA tribunal heard both sides on jurisdiction and responsibility on key issues.

Subsequently, LCIA issued interim decision accepting jurisdiction over the dispute and ruled in favor of Vivendi on the merits. Elektrim appealed the decision of the Tribunal, referring to s.67 of the Arbitration Act 1996 (England) on the grounds that the Tribunal was deprived of its primary jurisdiction over the dispute because of the bankruptcy of Elektrim. The main issue concerned the interpretation of the phrase "lawsuit pending" provisions of 4.2 (F) and 15 EU Regulation on insolvency (EU Regulation), which is directly applicable in the UK.

Accordingly, Elektrim argued that the phrase "lawsuit pending" was limited by executive process of the debtor's assets, and that it cannot apply to arbitration, since arbitration is not an instrument of execution. The High Court of England ruled (later confirmed by the Court of Appeal) that the phrase "pending lawsuit" was broad enough to include a reference to arbitration for the purposes of Articles 4.2 (F) and 15. Therefore, the English courts have rejected arguments and Elektrim refused to cancel or modify the decision of LCIA tribunal.

The significance of these British courts’ decisions confirms that when the company was the subject of bankruptcy proceedings in Poland, but was involved in arbitration proceedings in London before the commencement of bankruptcy procedure, then it is the law of England (the law of the seat), which must determine the impact of the bankruptcy process on arbitration. In addition, the court held that there was nothing in the domestic English law that could stop the arbitration proceedings, despite the bankruptcy process in Poland. On the other hand, if arbitration had not started before the bankruptcy, then the Polish bankruptcy law would determine the effect of the bankruptcy process on the future possibility of initiating arbitration, and any suspension or cancellation of arbitration under Polish law would have effect in England.

ICC decision (Switzerland)

In the second arbitration in Geneva, Vivendi argued that the law of the place of arbitration should determine whether the Tribunal has retained its jurisdiction over the dispute, regardless of whether Elektrim in bankruptcy process or not. However, since Switzerland is not a member of the European Union, Vivendi failed to refer to EU Regulation as it was in English decisions. Accordingly, the central issue in ICC tribunal was to determine whether Elektrim has the right to be a party arbitration, as soon as he became bankrupt in the light of Polish law on insolvency (art.142).

After hearing the parties on this issue, ICC Tribunal issued an interim solution, which explained that the purpose of art.142 is deprivation of arbitration courts’ jurisdiction over the Polish bankrupt parties. The court ruled that the party's ability to participate in the Swiss arbitration is governed by the conflict provisions of Swiss law on private international law.

These rules provide that companies governed by the State in which they are created, and "shall manage, in particular: ... (c) capacity and capability." And if so, ICC tribunal, and then the Swiss Supreme Court should apply the Polish bankruptcy law (art.142), which abolishes the Elektrim’s ability to participate in the arbitration. Under this approach, when Elektrim became bankrupt, any arbitration clause concluded by it are no longer valid and all arbitration processes such as the Geneva arbitration have been discontinued.

In view of the above, it should be concluded that there is no single approach to decide "the destiny" of insolvent party after arbitration proceedings began. What arbitrators and practitioners have learned from Elektrim against Vivendi is that they must be prepared in advance to the effects of the bankruptcy of one of the parties to the arbitration process. As shown above, the impact of the bankruptcy of one of the parties on unresolved disputes can vary considerably, depending on the national legislation, which varies between jurisdictions and in most cases can be unpredictable.

Parties should carefully consider any potential jurisdictional issues that may arise at the conclusion of the arbitration agreement. In particular, in light of the global financial crisis and its ongoing consequences, the parties should closely analyze:

• laws of the State in which bankruptcy can potentially be launched;

• laws of the place of arbitration; and

• any other laws that are likely to be applied by the court (eg EC Regulation and the Model Law).

Taking these into account, the parties may minimize the risk of negative impact of bankruptcy in the arbitration proceedings.