Insolvency litigation

What is to be done when insolvency litigation throws up a dispute that is also the subject of an arbitration clause? The arbitration clause is a binding contractual term under which the dispute is to be resolved under the bilateral private regime.

Must the requirement to arbitrate yield when the dispute also engages the public interest and arises in the context of the class action? The Court of Appeal of England and Wales (Salford Estates (No 2) Ltd v Altomart Ltd [2014] EWCA Civ 1408) held in late 2014 that the answer to this question is a qualified ‘no’ – unless there are exceptional circumstances the dispute must be resolved by arbitration.

In December 2015 the Eastern Caribbean Court of Appeal (sitting in the British Virgin Islands (BVI)) refused to follow the Salford Estates approach (Jinpeng Group Ltd v Peak Hotels and Resorts Ltd (BVIHCMAP 2014_0025 and 2015_0003)). Now the Court of Appeal of the Cayman Islands has pronounced on the subject (In the matter of the SPhinX Group of Companies CICA 6/2015). In SPhinX the Salford Estates reasoning was endorsed and applied.

Insolvency provisions

Insolvency provisions in England, Cayman and the BVI empower the courts to wind a company up where it is unable to pay its debts as they fall due. Where the debt is disputed on substantial grounds the petition will be dismissed, because a company that is not paying a claimed debt because it disputes the debt on substantial grounds is clearly not by virtue of that simple fact evidencing that it is insolvent. Where, however, the debt is admitted or is disputed, but without there being any substance in the objection to pay, the company is normally treated in all three jurisdictions as evidencing insolvency justifying an order to wind up. It is thus common to see petitions to wind up a company turning into contests over whether there are substantial grounds for disputing the debt on which the petition is founded.

Where the debt is alleged to arise under a transaction governed by an arbitration clause there is a difficulty. The difficulty arises because if a dispute falls within an arbitration clause and one of the parties brings a claim in court, the other party is entitled to a mandatory stay of the court proceedings in favour of the dispute being resolved by arbitration, unless the arbitration clause is ‘null and void, inoperative or incapable of being performed’. It has been established that for the purposes of this rule a dispute means any dispute, even one that has little substance. What that means is that a party with the benefit of an arbitration clause by merely stating that it disputes the liability is able to cause a stay of court proceedings in favour of arbitration.

Arbitration clauses – the cases

In Salford Estates the Court of Appeal in England and Wales had to consider whether a petition to wind up a company for non-payment of a debt was subject to the mandatory stay. The Court of Appeal analysed winding up proceedings as actions brought in the public interest for the benefit of a class (the creditors of the company as a whole) whose purpose was to trigger a statutory scheme for the realisation and distribution of the company’s assets. On this basis the Court of Appeal held that winding up petitions do not fall within the statutory provisions mandating a stay in favour of arbitration. At first sight this looks like a blow to the primacy of the arbitration clause; but this was not the end of the story.

The court’s power to make a winding up order is itself discretionary. The existence of an unpaid debt is a necessary but not sufficient condition for making an order. The Court of Appeal in Salford Estates went on to decide that where a debt is disputed and subject to an arbitration clause the court dealing with the petition should normally exercise its discretion to stay or dismiss the petition in order to compel the parties to resolve the dispute by arbitration (rather than having the court determine whether or not the debt was bona fide disputed on substantial grounds). The Court of Appeal held that any other disposal would require ‘exceptional circumstances’ – so exceptional that the Court was unable to envisage what those circumstances might be.

In Jinpeng the Eastern Caribbean Court of Appeal agreed with the court in Salford Estates that a petition to wind up did not itself fall within the statutory provisions requiring a stay where there is an arbitration clause. However, it refused to accept that the policy behind those provisions required the court nevertheless to order a stay unless there were exceptional circumstances. SPhinX involved an agreement (entered into by SPhinX’s liquidators) that contained an arbitration clause and concerned the release of a reserve being held by the liquidators against potential liabilities under that agreement. The argument for releasing the reserve was that nothing was owed under the agreement because the claims were ‘fanciful’ and so that the liquidators were not justified in holding on to the reserve. It was also argued that it was not for an arbitral tribunal to determine what reserves a liquidator should make.

The judge at first instance and the Court of Appeal both considered that the question whether the reserve should be released was wholly dependent upon the question whether SPhinX was liable for the fees. Adopting the reasoning in Salford Estates they both concluded a stay was required in order to avoid the arbitration clause being bypassed.

The Cayman Islands Court of Appeal commented that it was obvious that the claims were disputed by the liquidators and that the dispute fell within the fee arbitration clause in the agreement. The fact that neither party had activated the arbitration process was no bar to a stay. The question whether the claims are fanciful so that the reserve could be released depended entirely on whether those claims were bad in law; an issue squarely within the agreement. The dispute was about fees first and then only about reserves – the latter question being wholly dependent on the answer to the first. The Court of Appeal made an order deferring the applications to release the reserve until after arbitration had taken place to determine whether there was a liability in the first place.

Offshore litigation implications

The impact of arbitration clauses on insolvency litigation will depend on where you are litigating. In England & Wales and the Cayman Islands, insolvency lawyers and practitioners should be aware that the presence of an arbitration clause can limit a creditor’s remedies against a recalcitrant debtor. To avoid depriving the creditor of the prospect of debt recovery through the issue of a statutory demand or winding up petition, this needs to be taken into account when drafting agreements under which debt may arise. If there are no countervailing advantages to the inclusion of an arbitration clause (which may particularly be the case for liquidators entering agreements in the name of insolvent companies), it may be best left for the courts to deal with.

The presence of an arbitration clause also needs to be taken into account when considering and advising on debt recovery. Where a debtor is playing for time because they are potentially insolvent and there is an arbitration clause, it will be important to recognise at an early stage the possibility that no insolvency process can be instigated until the debt is either acknowledged or established in arbitral proceedings. As this step is interposed between the start of the debt collection process and formal insolvency proceedings, it will be important to pursue the arbitral remedy as expeditiously as possible.

Arbitration trend

The cases considered above all involve disputed debts, but decisions such as Fulham Football Club v Richards [2012] Ch. 333 demonstrate the same tendency in claims for minority shareholder relief. Fulham Football Club has been followed in the BVI in Ernesto Zanotti v Interlog Finance Corp and Others BVIHCV 2009/0394 and in Australia, British Columbia and Singapore. Re Quicksilver Glorious Sun JV Ltd [2014] 4 HKLRD 759 is a decision from Hong Kong also favourable to the arbitrability of a claim to wind up on the just and equitable ground. The clear trend is towards a greater acceptance of the role for arbitration in corporate litigation around the common law world.

First published in Corporate Rescue and Insolvency, June 2016

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