UK: Court Upholds English Contract Termination Clause That Is Invalid Under Foreign Insolvency Law

Fibria Celulose S/A v. Pan Ocean [2014] EWHC 2124 (Ch)

In a significant case regarding the application of the Cross Border Insolvency Regulations 2006 ("Regulations"), the English High Court decided it would not intervene to prevent termination of an English law contract for insolvency even though such termination was inoperative or invalid under the foreign law governing the insolvency.

A termination notice was served by a Brazilian party on a Korean company in administration in Korea. The insolvency proceedings were recognised in Great Britain under the Regulations and the Korean administrator asked the English Court to grant relief under two heads. Firstly under Article 21.1(a) of the Regulations to grant a stay on the "commencement or continuation of individual actions or individual proceedings concerning the debtors' assets, rights,obligations or liabilities". Alternatively and secondly, under Article 21 to grant "any appropriate relief". After considering the UNCITRAL Model Law on Cross-Border Insolvency ("Model Law") which formed the basis for the Regulations implemented in the UK, as well as the approaches of the US and Canadian Courts, the English Court held that it had no power to order a stay or to restrain the service of a contractual termination notice on the insolvent company. In doing so, it differed from the approaches of the US and Canadian Courts.

The background

The Regulations (as based on the Model Law) provide a framework for the recognition by, and cooperation of, the English courts in relation to the insolvency proceedings commenced in foreign jurisdictions. Where "main" foreign insolvency proceedings are recognised by the English Courts, the Regulations provide for a stay of proceedings and for appropriate relief at the request of the foreign insolvency office holder, for example staying proceedings by a party against the debtor's assets.

It is common for contracts to include clauses permitting termination in certain circumstances, including the insolvency of one party. Such clauses are commonly referred to as "ipso facto" clauses.

The background facts

Pan Ocean Co. Ltd ("Pan Ocean"), a shipping company incorporated in Korea, entered into a carriage of goods contract with a Brazilian company, Fibria Celulose S/A ("Fibria") in 2011. The contract was subject to English law and contained a clause providing for any dispute to be dealt with by arbitration in London. The contract also contained an ipso facto clause.

In June 2013, Pan Ocean entered insolvency proceedings in Korea. The Korean insolvency office holder applied successfully to the English Court for recognition of the Korean insolvency proceedings. Shortly afterwards, Fibria notified Pan Ocean that it was entitled to terminate the contract. Pan Ocean disputed that Fibria had the right to terminate as a matter of Korean law. Pan Ocean's administrator stated that they had the right to elect to continue or terminate the contract under Korean insolvency law, and that the administrator elected to continue the contract. Both parties made separate applications to the English Court.

Fibria applied for permission, pursuant to the Regulations, to commence arbitration against Pan Ocean seeking declaratory relief as to Fibria's entitlement to terminate the contract.

Pan Ocean's administrator applied for relief under the Regulations for a declaration that Fibria was not entitled to exercise any right of termination under the contract and/or any such further relief as the Court saw fit. Pan Ocean later applied for further relief in the form of a request from the English Court to the Korean Court asking the Korean Court to give its opinion as to whether the ipso facto clause was void and unenforceable pursuant to Korean insolvency law.

The Court decision

The Court found in Fibria's favour and held that it was unable to order relief to Pan Ocean in the form of "staying proceedings" since the giving of the termination notice was not considered to be the commencement or continuation of "proceedings" pursuant to Article 21.1(a) of the Regulations. Furthermore, other forms of relief permitted by the Regulations were restricted to relief that would be available to the Court when dealing with a domestic insolvency and the Court refused to apply foreign law (in this case Korean insolvency law). The Court found it had no power to intervene to prevent the termination notice, as "any appropriate relief".

The Court also held that even if it had the power to intervene to prevent the termination notice, it would not have been appropriate to do so. The parties had freely chosen English law as the governing law of their contract (which permitted termination under the ipso facto clause). The English Court was not permitted to apply Korean insolvency law to the substantive rights of the parties under a contract subject to English law.

Comment

This is an important judgment of wider legal and practical interest to the shipping industry. It is important as it clarifies how the English courts will treat termination (or so called ipso facto) clauses, when challenged to render them invalid pursuant to the laws of other jurisdictions. It is also interesting when compared with differing approaches in the US and Canada that have applied foreign insolvency law. Broadly speaking therefore, this judgment aids those seeking to rely on an ipso facto clause in an English law contract, irrespective of differing laws in the jurisdiction of the insolvent party.

The decision will be welcomed by shipowners given the extra degree of certainty provided where one of the parties to a contract becomes insolvent. The judgment will have particular application in the context of shipowners purchasing newbuilds in the Far East (in particular China and Korea where ipso facto clauses are apparently invalid). On the basis of this judgment, buyers are entitled to terminate the shipbuilding contract pursuant to the ipso facto clause in the event the yard enters insolvency proceedings. Furthermore, the judgment may aid buyers demanding payment from Korean Banks under refund guarantees as it can be argued that the demand's validity under English law should be determinative without the need to consider Korean insolvency law. 

This judgment is under appeal.

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.