As a main rule, arbitration agreements bind bankruptcy estates, but this does not apply to “disputes on issues pertaining to bankruptcy law”. This is an overview of the rules.
An increasing number of bankruptcies are expected in future. This is the expectation of most economists. Bankruptcies often give rise to claims for payment and damages, and it is therefore likely that we will see an increasing number of disputes with a bankruptcy estate being a party to the case. Here, we will look into whether a bankruptcy estate is bound by an arbitration agreement.
The main rule: A bankruptcy estate must recognise agreements entered into before the bankruptcy
Generally, a bankruptcy estate must respect the agreements which the bankrupt company has entered into prior to the bankruptcy. This applies whether the bankruptcy estate affirms or continues the agreement, or the bankruptcy estate give notice that the estate does not wish to continue the agreement.
If the bankruptcy estate affirms and continues an agreement, it is a natural consequence that the bankruptcy estate is generally bound by the provisions of the agreement. This includes an arbitration clause, if any, which might be contained in the continued agreement.
However, if the bankruptcy estate decides not to affirm and continue the agreement, it may seem less obvious that the bankruptcy estate is still bound by the provisions of the agreement, including an arbitration clause which is contained in the agreement. However, the bankruptcy estate’s lack of affirmation merely constitutes a breach of the agreement.
The effect of the bankruptcy estate’s breach of the agreement is that the other party may terminate the agreement and rely on remedies for breach vis-à-vis the bankruptcy estate.
However, the bankruptcy estate’s lack of affirmation does not imply that the agreement is considered non-existing for the bankruptcy estate. The agreement still binds the bankruptcy estate, which must generally respect the provisions of the agreement in connection with the breach, including provisions on remuneration, notice of termination, statement of loss and an arbitration clause, if any.
Arbitration agreements are thus no different than other agreements entered into by the bankrupt company from before the bankruptcy. As a starting point, they bind the bankruptcy estate.
There is an exception to every rule: disputes on issues pertaining to bankruptcy law
There is a modification of the starting point that arbitration agreements bind bankruptcy estates that this does not apply to “disputes on issues pertaining to bankruptcy law”. If it is a dispute on an issue pertaining to bankruptcy law, an agreement on arbitration entered into before the bankruptcy does not bind the bankruptcy estate.
Issues pertaining to bankruptcy law are, firstly, questions concerning:
- The occurrence of the bankruptcy (the issuing of a bankruptcy order)
- The administration of the estate (the trustee’s transactions)
- Claims made against the bankruptcy estate (claims proved in the bankruptcy estate).
As regards disputes in these areas, the bankruptcy court has exclusive jurisdiction, and an arbitration agreement does not bind the bankruptcy estate or the bankruptcy court.
Besides, questions pertaining to bankruptcy law include:
- Avoidance claims made by the bankruptcy estate
- Claims against the bankruptcy estate regarding rights pertaining to property law (the validity of a mortgage and retention of title, etc.).
- The conditions for making set-offs in bankruptcy
Common to the questions is that they arise out of the bankruptcy and cannot be made independent of the bankruptcy. In other words, disputes that can only arise with a bankruptcy estate as opponent. As regards such disputes, an arbitration clause agreed before the bankruptcy will not apply.
In practice, the arbitration agreement will rarely be to the effect that disputes regarding e.g. avoidance claims are to be settled by arbitration, but rather that any disputes between the parties in connection with an agreement are to be settled by arbitration. However, if such general arbitration agreement is relied upon in connection with a dispute about e.g. avoidance, the situation will be the same.
In this connection, it is also worth mentioning that the fact that the bankruptcy estate and a third party disagree on how to settle the mutual relationship and claims are made from both sides does not necessarily render arbitration impossible. Claims for defects/damages pertaining to the law on the sale of goods are considered part of the statement of the outstanding amount and not as a detached claim for damages for set-off. An arbitration agreement entered into before the bankruptcy therefore binds the bankruptcy estate in case of disputes pertaining to the law on the sale of goods in connection with the estate’s collection of outstanding invoice claims.
In summary, arbitration agreements entered into before the bankruptcy are not binding in disputes regarding adjudication of claims, avoidance, rights pertaining to property law and set-off pursuant to the rules of the Bankruptcy Act.
However, if the dispute is independent of the bankruptcy and has a content that would be the same whether one of the parties is administered in bankruptcy or not, arbitration agreed upon before the bankruptcy will be binding on the bankruptcy estate.