Australia: The Role And Potential For Arbitration In Cross-Border Insolvency Disputes

With the increase in global trade and business, often involving complex corporate structures in multiple jurisdictions, we expect to see a significant increase in cross-border insolvency and restructuring matters in coming years. This is especially the case with rapid advancements in technology and digital change driving “borderless” transactions and investments in every industry. The transition to net-zero emissions and an enhanced focus on sustainability by regulators and investors is causing businesses to realign and restructure operations, leveraging new sources of sustainability-linked finance and equity capital.

In this context, alternative dispute resolution (ADR) processes, particularly mediation and arbitration, have a major role to play in enhancing the efficiency of insolvency proceedings, the resolution of creditor disputes and achieving consensus among disparate stakeholders. ADR can maximize creditor returns by increasing the chance of successful restructuring outcomes for distressed but viable entities.

The benefit of ADR in an insolvency and restructuring scenario has been identified by the World Bank and UNCITRAL in their best-practice guidelines for the design and implementation of optimal insolvency systems. While mediation has had great success in recent times in helping to resolve complex creditor disputes in “mass tort” insolvency cases, and in guiding creditor negotiations during a formal reorganization process, the focus of this article is arbitration, and how it may be used as an important component of an effective insolvency system.

The existing use of arbitration in insolvency

Arbitration is already a well-developed tool of insolvency systems across the world in resolving individual creditor disputes. In the United States, the courts have generally adopted a distinction between matters that are “core” (matters involving rights specifically created by federal bankruptcy law such as avoidance provisions) and “non- core” (matters that do not invoke substantive rights created by federal bankruptcy law). The latter are capable of being resolved by arbitration taking place within the scope of an arbitration agreement entered by the parties prior to the debtor's insolvency. A similar approach is taken by courts in Singapore, France and Italy. In Australia, generally there is no automatic stay on arbitration proceedings when a company undergoes administration or a compulsory winding up of the court and leave of the court to continue with the arbitration is not required. The onus will be on an insolvency practitioner specifically to seek an extension of the usual moratorium in such cases.

Future focus: Arbitration in informal rescue scenarios

A key benefit arbitration can offer in the pre-insolvency stage is in providing a structural enforcement framework to guide creditor negotiations during an informal (or “out-of-court”) workout attempt when a debtor encounters financial distress.

Creating incentives to support informal workouts is currently a key focus of regulators globally, and features prominently in the best- practice recommendations of policy makers. In contrast to more complex, expensive formal insolvency frameworks, informal workouts have several key benefits. As noted in INSOL International's Statement of Principles for a Global Approach to Multi-Creditor Workouts:

This can have positive flow-on impacts for local and regional economies by spurring entrepreneurship; lessening the impact that deleveraging has on gross domestic product growth; improving financial stability by reducing protracted creditor disputes and coordination difficulties and thereby hastening the normalization of non-performing loans.

Informal workout negotiations are often hampered by creditor disagreements and hold-outs, in the absence of any mechanism to guide negotiations and to put forward a restructuring model that can maximize value for all stakeholders.

While mediation can be helpful in coordinating creditor claims outside the “adversarial cauldron” of the court, one key limitation of the process is that it depends on consensus-based process and leaves open the chance for an impasse when creditors are deadlocked and cannot agree on a single workout proposal. Further, while the Singapore Convention on Mediation provides an international framework for the recognition and enforcement of settlement agreements reached during a mediation process, to date it only has 56 signatories and 11 parties. Therefore, there continues to be disparity in the global “infrastructure” that supports the use of mediation in cross-border insolvency.

This is where arbitration can play a key role in filling the gap. Arbitration can provide a means for creditors to select a governing, restructuring-friendly law to be applied to their claims, providing certainty and fairness that may incentivize hold-out creditors to participate constructively in a restructuring. An arbitration award can also be recognized and enforced on a much broader basis than a mediation agreement. In that regard, the New York Convention provides for the recognition and enforcement of arbitral awards in 172 member states.

For states with an under-developed rescue culture and limited experience of workouts among creditors, whether formally or informally, arbitration can offer a particularly important means to build greater creditor collectivism and to implement a genuine pre-insolvency, rescue-oriented negotiation process.

At the same time, however, there are challenges with arbitration in this context. Notably, it would be necessary to have a set of standard insolvency-tailored arbitral rules that could be adopted as a matter of course in an insolvency-based arbitration, rather than having the rules as another contentious point of negotiation among diverse classes of creditors. These rules would need to provide for fundamental issues such as the seat or place of the arbitration, applicable rules, arbitrator powers, challenge or review of any award and confidentiality terms – but also the substantive applicable law to govern insolvency claims and priorities, and the processes for commencing formal insolvency proceedings if an arbitral award is not complied with.

One option is for insolvency-specific arbitral rules reflecting best- practice to be adopted. Examples are UNCITRAL's Legislative Guide on Insolvency and the World Bank's Principles for Effective Insolvency and Creditor/Debtor Regimes.

Insolvency-specific arbitral rules could also be developed by arbitral centers based in jurisdictions with respected insolvency and broader financial ecosystems that would encourage creditors to resort to those jurisdictions as a means for resolving their claims in a binding manner. Within the Asia-Pacific, Singapore has emerged as a preferred seat for arbitration, supported by Singapore's reputation as one of the world's centers for international trade and finance, and its place as an optimal market for raising capital and attracting investment. It also has a highly respected judiciary and supporting institutions. In the insolvency context, Singapore is also regarded as having one of the most flexible restructuring regimes in the world, with debt obligations able to be restructured effectively and efficiently. Notably, a series of reforms in 2017 incorporated several features of Chapter 11 of the US Bankruptcy Code within the Singapore insolvency system – including pre-packed restructuring plans, rescue finance (with the possibility for super-priority for new lending), a worldwide moratorium on debt collection pending a restructuring process and a non-consensual cross-class cramdown on dissenting creditors in approving a plan under a scheme of arrangement.

Insolvency arbitration is currently a focus for the Singapore International Arbitration Centre (SIAC) and the Singapore International Commercial Court (SICC), the latter being empowered to hear proceedings under the Singapore International Arbitration Act, including applications to set aside awards, jurisdictional challenges and enforcement applications. The SICC's jurisdiction was expanded in October 2022 so that it now has express jurisdiction over international restructuring and insolvency matters. It also has active case management powers, and the ability to refer parties to ADR during an insolvency proceeding. The SICC, together with the infrastructure of the SIAC, could held to drive arbitration as a key insolvency process to enhance efficiency and maximize creditor claims in the Asia-Pacific region in future.

Takeaway

With the current focus on insolvency law reform by regulators globally making financial and economic stability, arbitration can serve as a valuable option for resolving complex creditor disputes and providing a framework for creditor cooperation and negotiations during an informal workout attempt. With a widely adopted existing arbitral award enforcement model under the New York Convention, and the institutional support of international arbitration centers, there is a strong platform that could enable arbitration to become a key feature of best practice insolvency and restructuring systems across the world in future years.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.