Arbitration and Insolvency Proceedings: Chinese Law Perspective

Author: William Lu

(This article was first published in the January 2021 issue of Asian Dispute Review)

This article discusses, primarily by reference to Chinese case law and comparisons with England & Wales, Hong Kong and Singapore, how China’s insolvency and arbitration laws interact or impact upon each other and the status of arbitration agreements in underlying contracts where one party to an arbitration is an insolvent company.

Introduction

The Covid-19 pandemic will likely bring about a wave of insolvency and commercial disputes. As a result, business may have to deal with arbitrations brought against insolvent parties or by insolvency practitioners appointed by the courts. Insolvency proceedings and arbitration proceedings have diametrically opposed policy considerations. The essence of insolvency proceedings is the existence of a centralised and transparent mechanism to secure the payment of all non-secured debts; all such non-secured creditors must therefore be treated equally. The court has supervisory power to direct how the proceedings shall be conducted and private parties usually cannot contract out of statutory provisions under insolvency laws. On the other hand, arbitration is a private, confidential and party autonomy-oriented process to resolve disputes between parties. Usually, parties are free to agree on the procedures to be followed by the arbitral tribunal, which may conduct the arbitration in such manner as it considers appropriate. Where these two types of proceeding intersect, they may clash.

Insofar as it relates to arbitration, Chinese insolvency law (which is governed by the Enterprise Insolvency Law (2006) (the 2006 Law) is not very different from those of other jurisdictions. It should be noted, however, that the concept of ‘administrator’ in Chinese insolvency law broadly includes persons acting in the capacity of administrator and liquidator as such terms are used in this article.  

First of all, insolvency does not automatically invalidate an arbitration agreement entered into by the insolvent party prior to the insolvency proceedings. An equally important question to ask is whether the administrator can disclaim an arbitration agreement. If so, the administrator of an insolvent Chinese party may terminate an arbitration agreement and therefore completely shake up the foundation for a valid arbitration, be it seated in or outside China. Like many other jurisdictions, the administrator has a discretion to determine whether the insolvent party shall terminate or continue to perform an unperformed contract.[1] Given the strict doctrine of severability of the arbitration clause, even if the administrator terminates the underlying main contract, such termination will not extend to the arbitration clause in that contract. It may be argued that the arbitration agreement itself (including an arbitration clause in a wider contract) shall be regarded as an ‘unperformed contract’ subject to discretionary termination by the administrator.[2] However, such an argument has not been supported by judicial practice. In an appeal case decided by Chongqin Municipal High Court in 2019,[3] the court upheld a first instance judgment rejecting the plaintiff’s claim that the administrator could terminate the arbitration agreement contained in the underlying main contract as a separate unperformed contract.

With these general principles in mind, several specific issues in the insolvency and arbitration context are discussed below.

Should the court stay or dismiss a winding up petition brought by a creditor if the contract contains an arbitration clause?

A creditor may apply to the court to wind up a company if the company is unable to pay a debt when it falls due and is deemed insolvent. The company may dispute the debt claimed by the creditor. If an arbitration agreement exists with regard to the disputed debt, how should the courts deal with it? In many common law jurisdictions, the approaches have broadly fallen into one of two camps.[4] 

The first approach is that, despite the existence of an arbitration agreement governing the dispute, the courts will dismiss or stay a winding up petition if the debt is bona fide disputed on substantial grounds. The British Virgin Islands, for example, takes this approach.[5] 

The second approach is that the courts will generally dismiss or stay a winding up petition if an arbitration agreement governs the dispute, without examining whether there is a bona fide dispute on substantial grounds. Such an approach has generally been taken in England & Wales,[6] Hong Kong[7] and Singapore,[8] although there are qualifications in applying it. In Hong Kong, for example, there have been a number of cases critiquing this approach and so the issue has not been fully settled, while in Singapore, it applies only if a stay application does not amount to an abuse of process.[9]

There is no statutory provision in China that explicitly addresses the situation where an arbitration agreement governs the disputed debt. In a comparable case involving the absence of an arbitration agreement where a company disputes the debt and the court considers such challenge “tenable”, the court shall, pursuant to a Judicial Interpretation of 2002 (the 2002 Interpretation), dismiss the winding up petition and order the creditor to bring separate civil proceedings to prove the disputed debt first.[10] This appears to imply that the courts will examine whether, on the merits, the debt is disputed on substantial grounds. However, there are many cases in which the courts have held that a winding up proceeding was not the right forum in which to adjudicate a disputed debt on the merits and that creditors should bring separate proceedings to prove debts, in accordance with the 2002 Interpretation.[11] 

Such a principle likewise applies in cases where an arbitration agreement governs the disputed debt. As confirmed in the Guangdong Hengju case, where an arbitration agreement governed the dispute and the company disputed the debt, the court dismissed the winding up petition and informed the creditor to bring arbitration proceedings to prove the claimed debt before it could petition for winding up of the company.[12]

After insolvency proceedings have been commenced against an insolvent company, can a claimant still initiate arbitration proceedings against it?

It is generally accepted that ‘core’ or ‘pure’ insolvency issues (eg matters relating to the adjudication of insolvency itself) are inherently non-arbitrable, while other issues arising out of the insolvency of one of the parties to a commercial arbitration agreement are arbitrable. Where the dividing line precisely falls varies between jurisdictions.[13] In many jurisdictions, once a company enters into compulsory liquidation or administration, no party is permitted to bring either litigation or arbitration proceedings against it without the court’s approval.

Under Chinese law, once insolvency proceedings against an insolvent corporate entity, all extant court proceedings against it can only be brought in the court adjudicating the insolvency proceedings. No other courts have jurisdiction.[14] However, the provisions of the 2006 Law are unclear whether arbitration proceedings can still be brought against an insolvent party after insolvency proceedings against it have been commenced in court.  In a number of cases decided on this issue, counsels have argued unsuccessfully that litigation must be substituted for arbitration where an insolvent party is involved. These cases have all supported the view that parties can still submit their disputes to arbitration even after insolvency proceedings have been commenced against counter-parties.[15] This issue has now been settled by a Judicial Interpretation issued by the Supreme Court in 2019 (the 2019 Interpretation).[16] Pursuant to this interpretation, a creditor must first submit a proof of debt to the administrator, who will prepare a register of debts. Only if the administrator, the creditor and the insolvent debtor cannot agree on the amount of debt in the register can a creditor commence arbitration proceedings against an insolvent debtor. The rationale for this is that resorting to the administrator first to resolve the issue will probably save time and cost. Additionally, there may not have been a ‘dispute’ to submit to arbitration before the creditor submits proof of debt for confirmation by the debtor and the administrator. A ‘dispute’ arises only after the parties cannot agree on the amount of the claimed debt. 

What would be the consequence of a creditor not following this sequence but instead bringing arbitration proceedings directly and without first filing proof of the debt with the administrator and the arbitral tribunal then rendering an award?  Is such an award enforceable? Unless applicable arbitration rules contain such a procedural requirement, an argument to set aside or refuse enforcement of such award would be unlikely to succeed as this situation would not fall within the restrictive grounds for setting aside or refusing of enforcement. 

Although insolvency does not invalidate an arbitration agreement, so that a party may still bring arbitration proceedings against an insolvent counter-party, the subject-matter that can be arbitrated is not without limitation. As in many other jurisdictions, the administrator may apply to the court under the 2006 Law to avoid transactions entered into by the insolvent party either (1) within one year before insolvency, on the ground that the transaction was unreasonably priced, or (2) within six months before insolvency, on the ground that the payment under the transaction unfairly benefits that specific counterparty only.[17] Even if a contract contemplating such transaction contains an arbitration clause, the administrator may still seek to avoid the transaction in court. If the creditor seeks a remedy in arbitration in relation to such a matter under the contract, it will fail. This is because the 2006 Law vests the power to avoid transactions in the court, rendering them non-arbitrable. 

The situation just described could lead to a real clash in particular where, although the arbitration is seated outside China, the administrator of an insolvent Chinese company seeks avoidance of a transaction in a Chinese court. There been no reported cases in China in this regard, but the situation is well illustrated in the recent English case Riverrock Securities Ltd v International Bank of St Petersburg (Joint Stock Company).[18]  In that case, the claimant (RSL) sought and obtained an interim anti-suit injunction (ASI) to restrain the pursuit of proceedings before the Arbitrazh Court of St Petersburg and Leningrad Region brought by and in the name of the defendant (IBSP) through its official received in bankruptcy. The claim, commenced after IBSP was declared bankrupt by the St Petersburg Court in October 2019, sought the invalidation and unwinding of nine contracts for the sale and purchase of certain credit-linked notes. The contracts each contained an express choice of English law clause and an LCIA arbitration clause with England & Wales as the seat in identical terms. The basis of invalidation was alleged unequal consideration and/or intent to harm creditors under Russian bankruptcy law. IBSP’s claims that the matters were (1) outside the scope of the arbitration agreements and/or (2) not arbitrable as a matter of law or public policy failed in the English Commercial Court.

Can ongoing arbitration proceedings be continued after insolvency proceedings have been brought against a party to the arbitration?

In some jurisdictions, when an entity enters into either compulsory liquidation or administration, proceedings (including arbitration proceedings) against that entity are automatically stayed. A party must apply for the court’s permission to bring proceedings against a company in liquidation or administration. In determining whether to grant permission, the court will consider a variety of factors, including the merits of the case and whether it would be more efficient to deal with the case in the liquidation proceedings.[19]

The position in China is different. Under the 2006 Law, once a party to ongoing arbitration proceedings enters into insolvency proceedings, the arbitration proceedings shall be suspended until an administrator is appointed by the court. Upon appointment of the administrator, the arbitration proceedings shall be resumed.[20] The rationale for such provision is understandable: once an insolvent party enters into insolvency proceedings, the management of that party shall be deprived of its power to manage the business, including the management of an arbitration case, and such power shall be vested in the insolvency administrator. This will enable the administrator to get to up to speed about the proceedings, including taking an appropriate position and even changing counsels.

If the sequence described above is not followed in relation to arbitration proceedings, can an award be set aside or refused enforcement? In a case decided by the Supreme People’s Court in August 2019 (the Lishengtong case),[21] the arbitration proceedings were not suspended following commencement of insolvency proceedings against the respondent. A conciliation statement (which applies where the dispute has been mediated by the tribunal and has the same legal effect as an arbitral award under Chinese law) was rendered by the tribunal. The administrator did not raise an objection at the time the statement was served on it. The administrator later applied to the court to set aside the conciliation statement on the ground that the conciliation proceeding was defective as the arbitration proceedings had not been suspended. The court rejected the claim on the basis that although the arbitration procedure was flawed, it did not constitute a ground for setting aside the award.  This case was, however, unique in that the administrator did not raise an objection to the conciliation statement. In other situations, there is a potential risk, particularly in domestic arbitrations, that the award can be successfully attacked on the ground that the tribunal has not followed the procedures laid down by law requiring arbitral proceedings to be suspended pending appointment of the administrator. It will likely be more difficult to attack a foreign arbitral award or one recognised under the New York Convention.

What are the rights and powers of the insolvency administrator acting for the insolvent party in relation to arbitration proceedings?

Under the 2006 Law, the insolvency administrator shall act for the insolvent party in the relevant arbitration proceedings. If the administrator is not notified of the arbitration and so does not participate in the proceedings, can an award be set aside or refused enforcement on the ground that the insolvent party was not given proper notice of the arbitration proceedings or was unable to present its case? Unless the arbitration rules chosen by the parties contain relevant requirements, a challenge to the award or its enforcement is unlikely to succeed so long as the notice of arbitration was properly served in accordance with the applicable arbitration law and rules.  

In the Guode case,[22] the respondent commenced insolvency proceedings in the court on 22 November 2016. The claimant, without knowledge of the insolvency proceedings agsinst the respondent, filed an arbitration case at CIETAC on 6 December 2016. The tribunal served the notice of arbitration notice at the registered address of the respondent, but it was returned as the respondent had moved. The tribunal then served the notice on the last-known business address of the respondent, as required by the CIETAC Arbitration Rules, and service process was notarised. The insolvency administrator received neither the notice of arbitration nor the pleadings, nor did it participate in the arbitration proceedings. A default award was rendered. 

The claimant applied to the court for enforcement of the award. The respondent argued that enforcement should be refused on the ground that the notice of arbitration had not been properly served on the administrator, who had been denied the opportunity of presenting the case for the respondent. This argument was rejected by the court.  By contrast, in a case decided in 2017 by the Xi’an Intermediate Court,[23] the arbitration proceedings were not suspended following the insolvency of the respondent. The administrator was not notified of the arbitration proceedings, nor did it participate in them. Instead, the insolvent respondent’s original legal representative participated in the arbitration proceedings without the administrator’s approval. The award was set aside as the applicable Xi’an Arbitration Commission Arbitration Rules required arbitration proceedings to be suspended where a party was being suspended, pending determination of a successor to that party.

Insolvency law may impact upon parties’ substantive rights in arbitration proceedings

Insolvency laws not only affect arbitration proceedings procedurally, but they may also impact upon the parties’ substantive rights and obligations. Certain mandatory provisions of insolvency laws may trump party agreement in the contract or under the proper law of the contract.

For example, the 2006 Law provides that once insolvency proceedings engage, interest on a debt owed by the insolvent party shall cease to accrue.[24]  Once the court has accepted the commencement of insolvency proceedings against a party, the administrator has discretion to terminate or continue to perform an unperformed contract entered into before the commencement of the insolvency proceedings, and shall notify the counter-party accordingly. If the administrator does not make such notification within two months after acceptance of the insolvency application by the court or does not respond to a request for confirmation by the counter-party, the contract will be deemed to have been terminated.[25] Where a party in arbitration proceedings is an insolvent Chinese company, the arbitral tribunal may need to take these provisions into consideration regardless of any provisions to the contrary in the underlying contract or under the proper law of the contract. 

The interplay between insolvency and arbitration having a cross-border element 

When the matter has a cross-border element, two questions naturally arise, namely, (1) should a PRC-seated arbitral tribunal recognise foreign insolvency proceedings taken against one of the parties to the arbitration, and (2) should a foreign arbitral tribunal respect PRC insolvency proceedings?

Should a PRC-seated tribunal respect foreign insolvency proceedings?

This question relates to whether a tribunal shall respect foreign insolvency proceedings affecting a party to a China-seated arbitration. If insolvency proceedings are brought in a foreign jurisdiction and a court in that jurisdiction orders a stay of all other court and arbitration proceedings, should a China-seated arbitral tribunal respect such order? The answer to this question is unclear. The 2006 Law lays down only very basic principles governing the right of a PRC court to recognise and enforce foreign court decisions on insolvency based either on a treaty obligation or the principle of reciprocity.[26] There is no mandatory provision under Chinese law that a tribunal shall be bound by foreign laws or court decisions on insolvency.  Clearly, however, the tribunal must give due consideration to this issue to avoid its refusal and recognition of its award at the place of the foreign insolvency proceedings.

Should a foreign-seated tribunal respect PRC insolvency proceedings?

It appears that none of the grounds for setting aside or refusing r4ecognition and enforcement of an award under the PRC Arbitration Law or the New York Convention (to which China is a party) would embrace an alleged breach of any provisions of the 2006 Law, unless the applicable arbitration rules contain similar provisions. It is, however, always prudent for a foreign-seated arbitral tribunal to consider the pertinent provisions of the 2006 Law in any case in which the respondent is a PRC company in administration or liquidation. As the previous discussion shows, the 2006 Law largely respects arbitration and the rules laid down are all procedural and relatively easy to follow.  A tribunal should give due consideration to the 2006 Law if the award is to be enforced in China. This will particularly be the case in relation to matters that are regarded as non-arbitrable (eg, the administrator’s power to apply to the court to unwind unfair transactions entered into by the insolvent company before commencement of the insolvency, as discussed earlier. 

Conclusion

Insolvency will not automatically invalidate an arbitration agreement entered into by the insolvent party prior to the commencement of arbitration proceedings, nor can the administrator disclaim an arbitration agreement. Overall the Chinese insolvency law is arbitration-friendly. Despite the insolvency of a company, arbitration proceedings may still be brought or continued against it, but regard shall be had to certain procedural issues that may impact upon the arbitration proceedings. The arbitral tribunal cannot deal with certain non-arbitrable matters vested in the administrator. In a cross-border situation, due consideration must be given to mandatory insolvency law to avoid the award being set aside or refused recognition and enforcement.

注释

[1]2006 Law, art 18.

[2]Jin Chun, Arbitration from an Insolvency Law Perspective - Substance and Procedures” (www.iolaw.org.cn) (金春 破产法视角下的仲裁：实体与程序,中国法学网（www.iolaw.org.cn）).

[3](2019) Yu Min Zhong No 644 ((2019) 渝民终644号).

[4]Amanda Lees & Eric Chan, Does an Arbitration Agreement Clause Get You Out of a Winding-up Petition? [2020] Asian DR 155-160.

[5]Ibid, p 158.

[6]Ibid, p 157.

[7]Ibid.

[8]Ibid, pp 157-158.

[9]Ibid.

[10]Supreme People’s Court, Provisions on Certain Issues concerning the Trial of Enterprise Insolvency Cases of the Supreme People's Court (最高人民法院关于审理企业破产案件若干问题的规定) (30 July 2002) art 9.

[11](2020) Yue 01 Po Shen No 295 Award ((2020) 粤01 破申295号裁定书); (2016) Yue Min Po No 13 Award ((2016) 粤民破13号裁定书); (2017) Yue Po Zhong No 2 Award ((2017) 粤破终2号裁定书).

[12](2019) Yue Po Zhong No 17 Award ((2019)粤破终17号裁定书).

[13]Nigel Blackaby & Constantine Partasides, Redfern and Hunter on International Arbitration (6th Edn, 2015, Oxford University Press), para 2.141.

[14]PRC Enterprise Insolvency Law, art 21.

[15](2018) Gui 01 Min Xia Zhong No 29 Award ((2018) 桂01民辖终29号裁定书); (2014) Su Zhong Shang Xia Zhong Zi No 00204 Award ((2014) 苏中商辖终字第00204裁定书); (2017) Su 04 Min Zhong No 3761 Award ((2017) 苏04民终3761号裁定书); (2018) Jing 04 Min Te No 479 Award ((2018) 京04民特479号裁定书).

[16]Supreme People’s Court, Provisions on Certain Issues Concerning the Application of the PRC Enterprise Insolvency Law (No 3) (最高人民法院关于适用《中华人民共和国企业破产法》若干问题的规定(三) (27 March 2019).

[17]2006 Law, art 31.

[18][2020] EWHC 2483 (Comm).

[19]James Hargrove & Vanessa Liborio, Arbitration and Insolvency: English and Swiss Perspectives (2009) 75 Arbitration 47-55.

[20]2006 Law, art 20.

[21](2019) Zui Gao Fa Min Shen No 2565 ((2019) 最高法民申2565号).

[22](2018) Jing 04 Min Te No 479 Award ((2018)京04民特479号裁定书).

[23]2017 Shan 01 Min Te No 135 ((2017) 陕01民特135号).

[24]2006 Law, art 46.

[25]Ibid, art 18.

[26]Ibid, art 5.

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