How Can Insolvency Impact Ongoing Arbitration Proceedings?
Will insolvency action halt essential arbitration proceedings already underway? What activity in this vein have we seen during the COVID-19 pandemic? What else must be kept in mind when a party to a dispute is entering insolvency proceedings?
Keith Tully, a partner at Real Business Rescue, shares his knowledge on the ripple effect of insolvency on active dispute resolution proceedings.
An arbitration agreement may be entered into under the condition that if, alternative dispute resolution (ADR) methods such as mediation or conciliation fail, this route would be pursued to ease a definitive outcome and conclude the chapter. Arbitration can neutralise parties and command cooperation following the appointment of an impartial arbitrator.
A firm solution can be sought outside of the courts through arbitration, and therefore, every effort is injected into the process to ensure fairness to all parties involved. The process is often faster, cheaper, and held under a veil of privacy, which differs from formal litigation proceedings.
The timeline for arbitration proceedings will be determined by the availability of all parties involved, including third-party arbitrators, or an arbitrator panel. The financial status of the parties involved will also dictate their ability to participate in arbitration proceedings and make a monetary commitment towards the arbitral award.
Arbitration and insolvency – is this a viable combination?
The coronavirus pandemic triggered unprecedented trading conditions and economic uncertainty, which tipped many healthy businesses in the UK into extreme financial distress. The ultimate fight for survival rolled out as cash flow was obliterated overnight and consumer spending took a downturn.
Arbitration can neutralise parties and command cooperation following the appointment of an impartial arbitrator.
To accelerate business recovery and prevent the demise of the UK’s largest contributors to the labour market, the UK government introduced state-backed loans, COVID-19 grants, and emergency COVID-19 funding.
A moratorium on winding up petitions was also announced through the Corporate Insolvency and Governance Act 2020 to protect businesses crippled by COVID-19 economic disruption. As creditors waited on the sidelines until the moratorium was lifted on 30 September 2021 to seek legal action against debtors, a wave of corporate insolvencies is now underway as predicted by the sector.
Insolvency statistics provided by Real Business Rescue for Q2 2021 shows that there were 3,116 company insolvencies in Q2 overall. This represents a 31% increase vs Q1 figures (2,371 insolvencies) and is also the highest quarterly insolvency figure since before COVID-19.
When a business is under serious financial pressure due to poor cash flow, tax debts and reduced consumer demand, and can no longer afford to continue trading, it is the director’s prerogative to cease trading and seek professional support. All trading must halt, and a licensed insolvency practitioner must be appointed to review the business and decide to either close the company or rescue the company if there is a possibility of business turnaround.
The primary aim of the insolvency practitioner will be to act in the best interests of creditors, raise funds to repay creditors and maximise value. As a result, ongoing dispute resolution proceedings may be temporarily paused or terminated while the licensed insolvency practitioner takes control of the business.
Insolvency statistics provided by Real Business Rescue for Q2 2021 shows that there were 3,116 company insolvencies in Q2 overall.
The Insolvency Act 1986
The interplay between insolvency and arbitration proceedings will ultimately be determined by national or international insolvency law, the jurisdiction in which the insolvent company operates, contract law and the seat of the arbitration. The type of insolvency procedure pursued on a voluntary or compulsory basis will determine if it is feasible for arbitration proceedings to continue.
Company liquidation – If a company is placed into insolvent liquidation, a licensed insolvency practitioner will be appointed as company liquidator. The liquidator will take control of company affairs and raise funds to repay creditors with the view to maximise value. The closure of the company will be forensically controlled to ensure that all distributions are made per the Insolvency Act 1986, which sets out who gets paid first during liquidation.
If the ongoing dispute concerns a creditor, the circumstances will be judged to determine if an agreement can be reached through arbitration, or if a claim should be submitted through the insolvency process.
Company administration – During company administration, a licensed insolvency practitioner will be appointed as the company administrator to oversee intensive recovery and facilitate rescue, such as a business sale. When entering company administration, the business will be protected against legal action from creditors to allow for uninterrupted recovery.
A moratorium on legal proceedings is automatically applied when a business enters a compulsory insolvency procedure and appoints a licensed insolvency practitioner.
The Insolvency Act 1986 states that, during a moratorium, no legal process (including legal proceedings, execution, distress or diligence) may be instituted, carried out or continued against the company or its property except:
(i) employment tribunal proceedings or any legal process arising out of such proceedings,
(ii) proceedings, not within sub-paragraph (i), involving a claim between an employer and a worker, or
(iii) a legal process instituted, carried out or continued with the permission of the court
This typically applies to arbitration proceedings, for which express permission must be granted by the court or a licensed insolvency practitioner for proceedings to continue. This is to ensure that a solution can be reached through this route without disruption to the insolvency procedure and a potential breach of creditor rights.
If an application submitted by a creditor can demonstrate that the administration or liquidation process will not be obstructed by continuing arbitration proceedings, permission may be obtained. In this event, the insolvent party will likely be replaced by the insolvency practitioner.
Alternative to arbitration proceedings
If arbitration proceedings are likely to hamper the insolvency procedure and a solution can be better employed through the legal route, the arbitration agreement may be concluded. The claimant must then pursue their claim through the insolvency process and submit a proof of debt to the licensed insolvency practitioner. If the debt amount is in dispute, this can be challenged through the insolvency process.
If arbitration proceedings are likely to hamper the insolvency procedure and a solution can be better employed through the legal route, the arbitration agreement may be concluded.
During an insolvency procedure, all monetary claims are centralised and dealt with in an orderly and transparent manner.
Heightened risk of COVID-19 insolvency
As the moratorium on winding up petitions has now been lifted, businesses on the brink of collapse may be in the firing line of a winding up petition from creditors or voluntarily enter a formal insolvency procedure.
Steps must be taken to analyse the insolvency risk of financially distressed parties to assess if it is commercially possible for the party to commit to a favourable award, and if they can cover their share of the costs incurred to facilitate arbitration proceedings. This information is publicly available on Companies House, the Gazette and business intelligence platforms, such as Red Flag Alert.
It is paramount to understand the relationship between arbitration and insolvency, upon which a licensed insolvency practitioner can advise you further.
Keith Tully, Partner
340 Deansgate, Manchester, Greater Manchester, M3 4LY
Tel: +44 0161 210 5109
Keith Tully is a partner at Real Business Rescue (part of Begbies Traynor Group) and an insolvency professional with 30 years of experience in supporting company directors in financial distress.
Real Business Rescue is part of Begbies Traynor Group, which recently retained its position as the UK’s leading business recovery practice with regard to total corporate insolvency appointments. The company offers comprehensive director support through its nationwide office network, including representation in Scotland, Wales, Northern Ireland and throughout England.