Arbitrability of Insolvency Disputes: the Principle of Modified Universalism

On 23 September 2020, English High Court granted an application for an interim injunction to restrain liquidators for the International Bank of St. Petersburg from pursuing insolvency proceedings in Russia in breach of an LCIA arbitration agreement.

Most jurisdictions provide several mechanisms to reverse transactions entered into by a debtor prior to the commencement of the bankruptcy procedure. The decision re-affirmed the arbitrability of such “claw-back”, “avoidance” claims under foreign insolvency legislation and examined the scope of the court’s jurisdiction in dealing with such claims.  It also further delved into the question of the existent interplay between litigation and arbitration in insolvency matters.
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The court refused to accept the argument of non-arbitrability of insolvency claims under the Russian law as a strong reason not to grant an anti-suit injunction, reiterating the English courts’ generous pro-arbitration approach in holding parties to their agreement to arbitrate.

Background of the underlying dispute

The International Bank of St. Petersburg (IBSP), a large retail bank incorporated in Russia, went out of business when the Central Bank of Russia revoked its banking license in 2018 based on various alleged failures to comply with the Russian banking law. Subsequently, the IBSP declared bankruptcy in 2019, and the Russian State Corporation Deposit Insurance Agency (DIA) was appointed as the IBSP’s official receiver in bankruptcy proceedings.

The underlying dispute concerned nine substantially similar contracts for the sale of securities under which Riverrock Securities Ltd (RSL) sold corresponding credit-linked notes to the IBSP. The contracts contained a choice of English law provisions and an LCIA arbitration clause with London as a seat of arbitration to resolve any possible disputes.

Following investigations into the financial affairs of the IBSP, the insolvency administrator, who administered bankruptcy proceedings, found various irregularities and improprieties, including highly suspicious diversions of assets. Accordingly, the official bankruptcy receiver commenced proceedings against RSL before the Commercial Court of St. Petersburg and Leningrad Region to invalidate and unwind the above-mentioned contracts for the sale and purchase of credit-linked notes in the aggregate sum of US$ 140 million. The claim alleged on the basis of the Russian Bankruptcy Law that the underlying transactions were a scheme intended to siphon off the bank’s assets.

Against this background, RSL applied to the English Court for an anti-suit injunction to restrain the IBSP from pursuing the proceedings in Russia on the basis that all the relevant contracts contained arbitration agreements and, therefore, any disputes must be resolved by means of arbitration. The IBSP, for its part, resisted the application for interim injunctive relief on the basis that claims under the Bankruptcy Law were both outside the scope of the arbitration agreements and not arbitrable as a matter of law or public policy.

Jurisdiction to determine the application for anti-suit injunctions

The High Court dismissed the IBSP’s forum non-convenience argument that Russia constituted the natural and more appropriate forum to determine RSL’s application for an anti-suit injunction.

In ruling that the English court clearly was better placed to determine the scope of the LCIA arbitration agreements and the arbitrability of the dispute, the court applied the approach articulated in the previously reported Enka v. Chubb case. The court confirmed that the court of the seat of arbitration enjoyed the power to grant anti-suit injunctions as a vital authority of the court to give effect to the parties’ legitimate expectations of certainty arising under their agreement to arbitrate.

Interestingly, the UK Supreme Court had recently radically disagreed with the Court of Appeal on the role of the seat of the arbitration in determining the law of the arbitration agreement. It, however, affirmed the holding that the courts of the seat always remain an appropriate forum to grant anti-suit injunctions, regardless of the applicable law.

In this way, the decision confirms that the English courts, as the courts of the seat, always have a proper mandate to grant interim anti-suit injunctions, irrespective of applicable law.

The arbitrability argument

The High Court found that, as a matter of both Russian and English law, the claims brought under the bankruptcy law constituted insolvency claims, that did not render them non-arbitrable under English law.

To start with, the court concluded that, as a matter of substance, invalidation claims had contractual nature. Further, claims fell within the scope of the arbitration agreement, notwithstanding that in the case at bar the insolvency administrator brought the claim in the bankruptcy context, rather than the party to the arbitration agreement.

To support the privity argument, the IBSP relied on English legal norms confirming that the right to bring avoidance claims vests in the administrator or liquidator, rather than in the company itself. By contrast, the High Court ruled that, although under the Russian law such claims can only be commenced by a temporary administrator in bankruptcy proceedings, the invalidation claims should be construed as claims of the relevant company rather than the office-holder.

Mr Justice Foxton based his conclusion on the Singapore Court of Appeal’s decision in Larsen Oil, where the court created an assumption that claims by a liquidator to set aside a transaction as at an undervalue should be treated as having been made by a party to an arbitration agreement. As such, the court ruled that the administrator brought the claim on behalf of the IBSP and not in its own right.

The High Court once again reaffirmed its strong pro-arbitration policy

The judge noted the importance of holding parties to their bargain once they opted for arbitration. In relation to foreign insolvencies, the court referred to the principle of the so-called modified universalism, that requires English courts to co-operate with the courts in the country of the principal liquidation in order to ensure that all the company’s assets are distributed to its creditors under a single system of distribution. The court acknowledged that bankruptcy should be unitary and universal. However, enforcing the LCIA arbitration agreements in the case at bar, as the court concluded, would not in any way conflict with the principle or frustrate the policy of modified universalism.

Granting an injunction would not involve recognizing a second bankruptcy on the part of the IBSP, nor prevent there being a single system of distribution. Any recoveries made by the administrator on the IBSP’s behalf in an LCIA arbitration would be subject to the single scheme for distribution constituted by the bankruptcy proceedings in Russia.

As such, the court did not determine any good policy reasons not to uphold the terms of the arbitration agreement, which required all disputes between the parties to be determined in arbitration.

Concluding remarks

The English court has re-affirmed its strong pro-arbitration policy and its willingness to vigorously enforce parties’ arbitration agreements, especially when England is a seat. The court held that avoidance claims in foreign bankruptcy proceedings (even when claims are non-arbitrable in a foreign jurisdiction) do not necessarily override the clear English law policy of upholding arbitration agreements.

In the absence of express language, avoidance claims under foreign insolvency legislation will not automatically fall outside the scope of an arbitration agreement. The case clearly demonstrates the importance of exact words used in arbitration agreements and chosen governing law and seat of arbitration.
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The ruling prevented the liquidators for the IBSP from pursuing insolvency claims in Russia, at least for the moment. An open question remains, however, as to what extent the court in Russia will give effect to the judgment in the case at hand.
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Considering the inevitable consequences of the ongoing COVID-19 pandemic and ensuing substantial increase in insolvencies, the approach taken by the court in the case at bar enhances certainty with regard to the interplay between arbitration and national insolvency laws.