International Arbitration and Bankruptcy: Can They Be Reconciled?

DAMON DUCHENNE—Parties to a contract may elect to resolve disputes arising out of the agreement through arbitration. International arbitration involves parties based in different countries who select a “seat” where the arbitration will occur and the rules that apply to the proceeding procedure. Because international arbitration is a private form of dispute resolution, generally without the involvement of domestic courts, international arbitration offers many benefits, such as confidentiality, savings in costs and time, and a faster mechanism for enforcing decisions. In the US, courts have interpreted the Federal Arbitration Act (the “FAA”) to be a “pro-arbitration” law, so courts will generally enforce agreements to arbitrate. In contrast, the goal of bankruptcy proceedings in the US is to maximize the value of an insolvent company’s assets and redistribute the assets to creditors openly and transparently (although a corporation need not be insolvent to file for bankruptcy under US law, the terms are used interchangeably here). Moreover, the government (through bankruptcy courts) may direct bankruptcy proceedings under certain circumstances. Due to the opposing goals of international arbitration and bankruptcy proceedings, intricate issues have arisen in arbitration, or potential arbitration, involving one or more insolvent parties. These issues came to the fore following the pandemic because several corporations filed for bankruptcy over the last three years. 

A seminal issue is whether a party may commence arbitral proceedings against an insolvent party. In the US, once bankruptcy proceedings have begun, courts will usually stay any pending proceedings, including arbitration, against the insolvent party until the bankruptcy court allows it. However, the FAA’s pro-arbitration stance requires courts to enforce arbitration agreements. Moreover, international arbitration may be seated anywhere in the world. When the insolvent party is a US-based corporation, can a US court enjoin foreign entities from pursuing international arbitration seated in foreign jurisdictions? There is a risk that a foreign arbitral award issued against the US-based insolvent party may not be recognized in the US. Still, some US courts have found less discretion to deny motions to compel international arbitration, as opposed to domestic arbitration under US law.  Other US courts, as in Fotochrome, Inc. v. Copal Co., have determined that bankruptcy courts could stay foreign arbitral proceedings against an insolvent US corporation only if the court has in personam jurisdiction over the foreign party. Some US courts have gone as far as holding that decisions of foreign courts enforcing arbitral awards violate a stay of the arbitral proceedings granted by a US bankruptcy court because the Bankruptcy Code grants the court jurisdiction over a debtor’s assets, “wherever located.”

Furthermore, some US courts first decide if the matter being arbitrated is a “core” or “non-core” issue before deciding on a stay of the arbitration. A proceeding is “core” if it involves a right created by the federal bankruptcy law or would arise only in bankruptcy. If the proceeding is “non-core,” the US court generally enforces the agreement to arbitrate. The reasoning is that parallel arbitral proceedings (let alone international arbitral proceedings) would conflict with the underlying purposes of the Bankruptcy Code. The test led to another difficult question: can the bankruptcy court hold an arbitration agreement buried within a contract itself (rather than the whole contract or its subject matter) to be a “core” issue of bankruptcy such that the validity or recognition of the arbitration agreement itself is questioned?

The lack of legislation specifically addressing the interaction between international arbitration (or even to some extent domestic arbitration) and bankruptcy proceedings in the US has led to a myriad of court decisions grappling with the two competing goals of bankruptcy and international arbitration. Until Congress steps in, practitioners in the US and abroad should think carefully about the prospect of dealing with an insolvent US-based company when drafting dispute resolution clauses in international contracts or determining their best recourse following a breach of contract.