Arbitral tribunals often deal with complex legal and factual questions that take months or even years to resolve. One of them arises when a party to the dispute ceases to be financially sound and becomes subject to bankruptcy proceedings in a state court. Should this happen, the tribunal shall decide how to proceed with the arbitration since the parallel bankruptcy proceedings may significantly impact its capacity to hear the case.
In Russia, the primary legal act on bankruptcy is Federal Law dated 26 October 2002 No. 127-FZ “On Insolvency (Bankruptcy)” (“Bankruptcy Law”). Article 33(3) of the Bankruptcy Law stipulates that an arbitral tribunal cannot rule on the bankruptcy of a party, including the order and extent, in which creditors’ claims should be satisfied. However, the Bankruptcy Law is silent on what the tribunal shall do in an ongoing arbitration if the bankruptcy proceedings against a party are initiated in a state court. Here, the author seeks to determine whether the proper course of action in such situations can nevertheless be deduced from Russian legislation and the relevant jurisprudence and, if so, what are the permissible options for arbitral tribunals.
The impact of various bankruptcy stages on the tribunal’s jurisdiction
After filing a bankruptcy petition by a creditor, there are five possible bankruptcy procedures (stages) potentially applicable to a company-debtor in proceedings in the commercial (arbitrazh) court. In this piece, two procedures will be mainly discussed: supervision and liquidation.
Supervision is initiated to analyze the debtor’s financial position, safeguard its property, and accumulate creditors’ claims. The introduction of supervision limits the corporate debtor’s freedom to dispose of its assets. Moreover, under Article 63 of the Bankruptcy Law, only the judge in the bankruptcy case can consider new monetary claims.
If there are other disputes before state courts, the creditor has the right to request the stay of such proceedings and their transfer to the judge in a single bankruptcy case. Absent such request, the court is not entitled to transfer other cases to the bankruptcy proceedings (Resolution of the Plenum of the Supreme Commercial (Arbitrazh) Court of the Russian Federation (the “Supreme Commercial (Arbitrazh) Court”) dated 22.06.2012 N 35).
It could be inferred from Article 63(1) of the Bankruptcy Law that this Law does not explicitly exclude the competence of other courts and arbitral tribunals in cases that were initiated before the supervision is introduced. Despite this, in RAC Award dated 11 August 2021, the sole arbitrator contemplated whether he should stay the arbitration due to a bankruptcy petition against the party to the dispute. While seeing the merit in the suspension until the state court adopts the particular bankruptcy procedure, the sole arbitrator decided to proceed. One of the reasons was the insignificant amount of claims in that dispute. In the meantime, he also cautioned that the arbitration should not be used to undermine the bankruptcy proceedings because otherwise, arbitration may create an appearance that the creditor’s claim is substantiated.
Meanwhile, the courts differently approach the question as to whether the tribunal has jurisdiction in situations where the claimant or respondent is already subject to supervision. For example, the Commercial (Arbitrazh) Court of the Sverdlovsk Region ruled that the arbitral tribunal becomes short of jurisdiction to render an award on the merits once supervision is introduced. This Court reasoned its decision by stating that the arbitral award at issue in that dispute concerned the rights of other creditors who did not participate in the arbitration but had the right to raise objections against the creditors of the indebted company under the applicable law. Therefore, the bankruptcy judge did not consider that award prejudicial for its findings and re-examined the claims (Ruling dated 13 November 2020 Case No. А60-59676/2019). There are also cases in which state courts considered in similar circumstances that arbitrators had jurisdiction to render an award (for instance, Resolution of the Commercial (Arbitrazh) Court of the Moscow Circuit dated 19 February 2020 Case No. А40-167953/2016). In any event, if supervision is introduced after the tribunal adopted an award, arbitrators were not stripped of their powers to hear the case in the first place (Resolution of the Presidium of the Supreme Commercial (Arbitrazh) Court dated 15 July 2014 N 5940/14 Case No. А40-166263/13).
The situation is a bit more straightforward when a court initiates liquidation of the company-debtor with no prospects of becoming financially viable. In RAC Order dated 19 January 2021, the sole arbitrator emphasized that once a party to arbitration (respondent) is found bankrupt, only a commercial (arbitrazh) court has jurisdiction to consider monetary claims which arose before the commencement of bankruptcy proceedings. Accordingly, any other courts or arbitral tribunals shall decline jurisdiction and terminate the ongoing proceedings.
The prohibition for an arbitral tribunal to consider claims against a bankrupt company stands on the following arguments heavily discussed by the courts. Firstly, the conduct of arbitration is dogmatically premised on the existence of the consensus among its parties, i.e., the parties shall explicitly agree to the tribunal’s jurisdiction. Therefore, only a limited number of participants could take part in the arbitration. The “consensus” aspect in arbitration is fundamentally different from the liquidation stage, where all creditors shall join in safeguarding their proprietary rights and do not need to conclude among themselves a separate agreement to subject their claims for consideration by a bankruptcy judge. Either way, it is nearly impossible to reach an arbitration agreement among many creditors who often have conflicting interests. Suppose an arbitral tribunal renders an award against a bankrupt party. This award will contravene the fundamental principle of the unified legal protection of creditors under Russian law, in accordance with which some creditors’ claims cannot be satisfied to the detriment of the others.
Secondly, a tribunal’s award shall be final and cannot be appealed on the merits. Although finality is usually an advantage of arbitration, it creates obstacles for the creditors to receive a share of the insolvency estate according to their legal rights and, generally, hinders the formation of the insolvency estate.
Some courts ruled that if a claimant is in liquidation, the arbitration agreement is not automatically inoperable. A necessary prerequisite for that would be the demonstration by the liquidation officer that the bankrupt company has no financial means to cover costs of arbitration (Ruling of the Commercial (Arbitrazh) Court of Moscow dated 16 October 2020 Case No. А40-101294/20-96-675).
A similar logic can be traced from the approach of the Supreme Court of the Russian Federation to enforcement proceedings. If a party to the dispute seeks enforcement of an arbitral award against another party in liquidation, state courts do not issue a writ of execution. Instead, the enforcement application could be considered only by the bankruptcy judge within the bankruptcy proceedings according to the bankruptcy laws. Otherwise, the writ will be annulled as violating the interests of creditors of the liquidated party (Ruling dated 17 September 2019 Case No. 4-КГ 19-36).
Should the insolvency officer be involved in an arbitration?
During the supervision stage, the state court appoints a temporary officer to analyze the debtor’s financial position, safeguard its property, and adopt other measures to ensure smooth conduct of the supervision. Meanwhile, supervision does not per se prevent the director and other governing bodies of the corporate debtor from exercising their functions. However, they shall act with limitations under Article 64 of the Bankruptcy Law. For example, some corporate transactions can be done only with the consent of the temporary officer.
The Bankruptcy Law allows the temporary officer to actively participate in state court proceedings. For instance, the officer can take part in the hearings about whether the debtor’s objections against creditors’ claims are substantiated. The officer can also petition the court to adopt additional measures safeguarding the indebted company’s assets and receive any information and documents regarding the debtor’s operation (Article 66 of the said Law).
It is unclear whether the above competence of the temporary officer extends to arbitration proceedings and, if so, to what extent. It appears that if a company-debtor and its creditor agreed on an arbitration clause prior to a temporary officer’s appointment, the temporary officer would not automatically become a party to the arbitration in the absence of the overall agreement to his/her participation in the arbitration. In this vein, the Ninth Commercial (Arbitrazh) Appellate Court stated that the temporary officer could not participate in an arbitration conducted among the limited number of participants, despite its statutory right to act as a third party in state court proceedings other than the bankruptcy case (Resolution dated 08 August 2016 N 09АП-34519/2016 Case No. А40-2650/2016).
Moreover, one has to bear in mind that the arbitration proceedings are supposed to be confidential. Any unauthorized disclosure, including that to a temporary officer, may prejudice the enforceability of the arbitral award. The need to ensure confidentiality of various aspects of the proceedings finds its support in the most institutional rules (such as Article 22 of the ICC Arbitration Rules 2021, Article 30 of the LCIA Arbitration Rules 2020, Article 45 of the HKIAC Administered Arbitration Rules 2018).
However, leaving a temporary officer entirely in the dark may also be not a good idea. By notifying the temporary officer about the arbitration, the arbitrator can ensure the enforceability of the award. The notification can demonstrate that the arbitration had been conducted properly and in compliance with the state’s public order. The arbitrator can do so after consultations with the parties or on its initiative. Unless otherwise is stipulated by the applicable arbitration rules, such notification is the tribunal’s right, not a duty. By contrast, a judge would have the duty to let the temporary officer know about the respective court proceedings.
By informing the temporary officer, the tribunal does not make him/her a party to the arbitration agreement. Furthermore, the confidentiality of arbitration will not be jeopardized as the arbitrator can choose which information will be provided to the temporary officer and limit it to the facts that the arbitration takes place and that the indebted company is a party to that arbitration. For instance, in RAC Award dated 27 February 2020, the sole arbitrator decided to inform the temporary officer of the respondent (who fell into supervision after the procedural timetable was agreed upon) about the arbitration to which the respondent was a party. Subsequently, the temporary officer invoked Article 66 of the Bankruptcy Law in its request to provide him/her with the statement of claim and supporting documents. The arbitrator declined this request as beyond the temporary officer’s under the said provision. Another reason for the arbitrator to disregard the request was the need to protect the confidentiality of the proceedings. In the end, the arbitrator suggested that the temporary officer join arbitration as a third party. However, the temporary officer did not follow this suggestion.
If the court initiates liquidation, it appoints a liquidation officer to administrate the procedure. The liquidation officer’s powers are broader than those of a temporary officer. In contrast to the latter, a liquidation officer acts as a director and other governing bodies of the bankrupt company (see for details Article 129 of the Bankruptcy Law).
By virtue of this fact, the status of the liquidation officer in arbitration is less problematic. In RAC Order dated 19 January 2021, it was underlined that a liquidation officer is a representative of the respondent from the date of his/her appointment. As a result, the liquidation officer had the authority to participate in the arbitration as a “consenting party” based on the Bankruptcy Law.
The arbitrator should be able to act right when the bankruptcy proceedings are initiated against a party to the dispute since those proceedings may heavily impact the enforceability of its award.
The options available for the tribunal depend on the party’s bankruptcy stage. In the context of supervision, the tribunal is at a crossroads. If the arbitrator finds jurisdiction to render an award, later the bankruptcy judge can disregard it and re-examine the case on the merits. At the same time, the Bankruptcy Law does not per se deprive arbitrators of their jurisdiction in case of supervision. The most cautious approach for the tribunal is to stay the arbitration to see whether a party will come out of bankruptcy or be liquidated. Based on the outcome, the tribunal may safely render an award or decline its jurisdiction and terminate the arbitration proceedings. The second option for the tribunal is to directly proceed to rendering an award on the merits. However, it can put the award at risk. The bankruptcy judge may rule that the other creditors were unable to participate in the arbitration to present their claims and render the objections. As a result, the award will be disregarded, and the arbitration proceedings will be for nothing.
The question of the existence of the tribunal’s jurisdiction is more straightforward in the case of liquidation. If the court finds the respondent-company bankrupt and launches a liquidation procedure, the tribunal shall decline its jurisdiction. However, if a claimant is bankrupt, the arbitrators still have a choice whether to proceed with rendering an award.
Another puzzling question the tribunal needs to resolve is whether to inform the insolvency offer about the arbitration. While there is no general duty for a tribunal to inform the temporary officer about the arbitration proceedings, such a notification is deemed to be highly instrumental in contributing to the enforceability of the award.
The approach that the tribunal shall take depends on various factors and circumstances of each case. Given the courts’ inconsistent jurisprudence, the arbitrators shall be cautious and follow the most balanced approach to render an enforceable award.
Ekaterina Baliuk is a case manager of the Russian Arbitration Center. She has acted as a tribunal secretary in many domestic and international arbitrations and leads complex legal and educational projects.