Turkey: A Tale Of Two Proceedings: Arbitration And Insolvency

Introduction

The COVID-19 pandemic has forced businesses to adapt to a new world order. Businesses are trying to survive the COVID 19-caused disruption in the economy by radically changing their operations, while the sword of Damocles hangs over their heads; the risk of going bankrupt, as well as dealing with an insolvent counterparty.

International arbitration often collides with public policies of states. While arbitral tribunals insist on defending parties' freedom and intent to resolve their disputes at arbitration, states have a tendency to refrain from opting out of their territorial sovereignty and public policies. This tale of two proceedings is one that we might hear even more frequently as the COVID-19 pandemic triggers force majeure clauses and events of default more than ever.

Arbitrability of Insolvency Related Issues

When we discuss parallel proceedings in arbitration, we must tackle the arbitrability of insolvency related matters as a preliminary issue. Arbitrability refers to the question of whether a particular dispute may or may not be settled through arbitration.¹ National laws often restrict the parties from submitting their dispute to arbitration when the dispute involves a public policy issue. When the arbitral tribunals do not take into account such policy concerns, it is very likely for the arbitral awards to face 'the inarbitrability challenge' while seeking enforcement.

When dealing with arbitrability, two main questions come to mind: (i) Whether the subject matter of the dispute is arbitrable; and (ii) Whether the insolvent party has the capacity to arbitrate, or whether the trustee/administrator is bound by the arbitration agreement.

In order to answer the first question, it would be useful to turn to the fundamental legal framework of international arbitration. Article II (1) of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards ("New York Convention") refers to arbitration agreements as "concerning a subject matter capable of settlement by arbitration." Which subject matters are capable to be resolved at arbitration differ from one jurisdiction to another. It would be fair to say insolvency related matters are considered as non-arbitrable in most of the jurisdictions. From a common law perspective, for example, in the United States of America ("US"), the US bankruptcy courts generally apply "the core matter test" when dealing with disputes subject to both the US Bankruptcy Code and the Federal Arbitration Act. To reconcile the competing interests of these two pieces of legislation, the courts generally discuss whether the dispute involves a "core matter" arising exclusively under the US Bankruptcy Code.² If the US bankruptcy courts find the issue at hand as "non-core," then they typically consider the subject of the dispute to be arbitrable. From a civil law stand point, for instance according to French law, public policy related matters cannot be settled through arbitration. Since the suspension of individual legal actions, once insolvency proceedings have been initiated, or the observance of equality among the creditors is part of French public policy, these policy concerns would also hinder the freedom of the parties to submit their insolvency related claims to arbitration.

Article II (3) of the New York Convention provides that national courts should refer the parties to arbitration unless it finds that the said agreement is null and void, inoperative, or incapable of being performed. That brings us to our second question of whether the insolvent party has the capacity to arbitrate or, if not, whether the trustee/administrator is bound by the arbitration agreement.

As for the matters concerning the capacity of the insolvent party, the arbitrators consistently refer such issues to the personal law of such party, which for corporations is generally the law of the place of incorporation.³ Most of these national laws prohibit the debtor from disposing of and managing the estate once the insolvency proceedings have commenced or once the bankruptcy declaration has been issued. Since national laws have a tendency to strip the debtor of its rights over the bankrupt estate, the same rationale may be adopted for the capacity to arbitrate just because the outcome of the arbitration would eventually affect the bankrupt estate. Nevertheless, one may disagree with this approach by simply referring to the continuation of the company's legal existence under national laws. In other words, if a party is entitled to be a party to the arbitration proceedings, that is sufficient for such capacity, and the fact that the party is in liquidation does not affect this ability nor the validity of the arbitration proceedings.⁴

As for the second part of the question as to whether the trustee/administrator is bound by the arbitration agreement, decisions and awards have been issued in both directions. One of these directions refers to the bankrupt estate as the proper party to all post-bankruptcy legal proceedings since it has assumed, by universal succession, all rights and obligations of the debtor and, therefore, is bound by the arbitration agreement. The opposite direction leans towards the fact that the trustee/administrator's existence, rights, and obligations arise exclusively from the bankruptcy legislations of the states and, as a consequence, the trustee/administrator is not bound by the arbitration agreement.

Impact of the Insolvency Proceedings to Ongoing Arbitration

Some of the national laws of insolvency provide for a stay of ongoing proceedings in the event a company enters into insolvency or bankruptcy, so that the trustee/administrator may consolidate the debts and assets of the insolvent company. There is an ongoing discussion as to whether arbitration is one those proceedings. Arbitral tribunals also have their own concerns about the validity of arbitration agreements, party autonomy, and territoriality of insolvency proceedings. The following are examples showing each perspective.

The Austrian Supreme Court held that all pending proceedings in which the debtor is the claimant or the respondent, are automatically stayed upon the commencement of bankruptcy proceedings, which also applies to the arbitral proceeding.⁵

The English courts offer a more moderate approach. Under English law, when a company enters into administration, no legal process, including arbitration, may be continued against the company or the property of the company, except with the consent of the court or the administrator.

National courts have reasonable arguments for insisting that insolvency related matters be a part of their public order. These proceedings aim to distribute the assets of the insolvent as all of the creditors can participate in one common collective proceeding, and an ongoing arbitration would violate the rights of those mainly unsecured creditors to intervene in the arbitral proceedings. The amount of the insolvent's estate will be decreased by the arbitral awards which would damage the entire process.

One of the milestone cases - which would be helpful to understand the arbitral tribunals' open-to-interpretation approach - took place in a dispute between Vivendi Universal SA, French conglomerate and Elektrim SA, a Polish company. The parties commenced two separate arbitration proceedings, one under the rules of International Chamber of Commerce ("ICC") and the other under the rules of London Court of International Arbitration ("LCIA"). Elektrim filed for bankruptcy in Poland while the arbitration proceedings were pending. Elektrim argued that the arbitration proceedings should end because their right to dispose of and manage the assets were revoked due to the insolvency proceedings and, hence, the arbitral tribunals lacked jurisdiction. The arbitral tribunals decided to tackle the question of whether they have jurisdiction on the disputes under the principle of comptenz-competenz. The arbitral tribunals, constituted as per LCIA rules, concluded, on the one hand, that they did not lack jurisdiction on the grounds that the application of Polish law was procedural and not substantive, that English law was the applicable law, and nothing in English law prevents the arbitration from proceeding. On the other hand, the arbitral tribunal, constituted under the ICC rules, considered the issue to be substantive, and that Polish law was the applicable law, and that Elektrim had no legal capacity to participate in the proceedings. Therefore, the arbitral tribunal determined that it lacked jurisdiction. These contrasting arbitral decisions were reviewed by the U.K. and Swiss courts and were upheld as valid.⁶

In certain cases, arbitral tribunals also refuse the legal effect of insolvency legislations on the grounds of territoriality of insolvency proceedings. In other words, one can argue that a bankruptcy proceeding initiated in one country does not constitute a procedural impediment for arbitral proceedings in another country. Even if a state court is bound to suspend all of the proceedings, the same effect cannot be extended to arbitration as grounds for dismissal because the parties' conscious choice to arbitrate and not to litigate would be enough to point out the territorial effect of insolvency proceedings, which is also in line with the arbitration's fundamental principle of party autonomy.

Conclusion

Commercial arbitration disputes mostly arise from contractual claims where one of the parties asks for payment of a certain amount of money. This subject matter, itself is, no doubt, arbitrable. That being said, when one of the parties is insolvent, insolvency laws usually mandate the insolvent party and its estate to go through a verification procedure conducted by national courts or administrators. Therefore, arbitral tribunals and national courts keep looking for the answer to the following question: Does the claim itself become non-arbitrable when one of the parties is subject to bankruptcy or insolvency on the grounds that the claim is now interlinked with the amount of the bankrupt's estate?

The New York Convention is silent on insolvency related matters. The New York Convention, however, casts a duty on all contracting states to recognize and enforce arbitration agreements and arbitral awards. The New York Convention was drafted by sovereign states with the aim to respect the fundamental principle of party autonomy. Does "this autonomy go deep; deep enough to render the judgment of a party appointed sole arbitrator to have greater international force than nine unanimous justices of the US Supreme Court?"⁷ We have to wait and see whether the sovereign states are willing to answer 'yes' to that question.

Footnotes

1 Kleiman, Elie; Pauly, Claire: Arbitrability and Public Policy Challenges, Global Arbitration Review, The Guide to Challenging and Enforcing Arbitration Awards, First Edition.

² Goins, Adrianne; Heverin, Kevin; Peet, Jessica; Louise Woods: When insolvency and arbitration interact, Global Arbitration Review, 2020.

3 Dreyzina, Anna: Insolvency Proceedings and International Commercial Arbitration, Central European University eTD Colelction, 2009, p. 11.

4 Dreyzina: p.12.

5 Riedl, Katharina: Austrian Supreme Court: Pending arbitration stayed due to insolvency proceedings, Global Arbitration Review, 2016.

6 For Elektrim SA v Vivendi Universal SA & Ors, England and Wales High Court (Commercial Court) (Mar. 20, 2007); Vivendi SA et al v. Deutsche Telekom AG, 4A_428/2008, Swiss First Civil Law Court (Mar. 31, 2009) please refer to Camp, Charles H; Gore, Kiran Nasir: The Interplay Between Insolvency Proceedings and Parallel International Arbitration Proceedings in the Post-Pandemic World, The World Financial Review, 2020.

7 For ICSID Review Foreign Investment Law Journal, Volume 25, Issue 2, Fall 2010, p. 340, please refer to Madaan, Ishaan: Insolvency and International Arbitration: An Alternate Perspective, Kluwer Arbitration Blog, 2020.

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