Can one initiate arbitration against an insolvent entity?

In addition to providing an automatic stay of certain proceedings that have already commenced, the provisions of the Corporations Act 2001 and Bankruptcy Act 1966 may also preclude arbitration proceedings from being initiated against an insolvent company or bankrupt individual, whether the arbitration is in relation to claims arising before or after the insolvency or bankruptcy. Therefore, consistent with the above:

• arbitration can be commenced against a corporation which is in voluntary administration, under small debt restructuring, in receivership, or which is being wound up in insolvency or by a court;
• arbitration generally cannot be commenced in Australia against companies subject to a deed of company arrangement (where the claimant is bound by the deed pursuant to Corporations Act 2001 (Cth), section 444D) or companies subject to a voluntary winding up, except with the leave of a court; and
• arbitration generally cannot be commenced against a bankrupt individual in Australia in respect of a provable debt, except with the leave of a court (Bankruptcy Act 1966 (Cth), section 58(3)).

Any arbitration proceedings that are permitted must be within the scope of the arbitration agreement and must be arbitrable under domestic law. Generally, disputes that affect the rights of third parties or which have public policy implications may be determined by domestic courts not to be arbitrable.

In an insolvency context, a claim against an insolvent party that is unrelated or only incidental to the party's insolvency administration may be arbitrable. However, a claim that affects the rights of third parties (such as other creditors of the insolvent party) or which concern the exercise of powers reposed in a court or in the insolvency administrator is unlikely to be arbitrable (ACD Tridon Inc v Tridon Australia Pty Ltd [2002] NSWSC 896; WDR Delaware Corporation v Hydrox Holdings Pty Ltd; In the Matter of Hydrox Holdings Pty Ltd [2016] FCA 1164).

For example, a dispute regarding the existence and quantum of a debt that was the subject of a liquidator's rejection of a proof of debt has been held to be arbitrable, as the issue did not specifically involve the exercise of the liquidator's statutory powers (WDR Delaware Corporation v Hydrox Holdings Pty Ltd; In the Matter of Hydrox Holdings Pty Ltd [2016] FCA 1164 at [136], citing Tanning Research Laboratories Inc v O'Brien (1990) 169 CLR 332).

However, given public policy considerations and the potential effect on the rights of third parties, the determination of whether to wind up a company is not arbitrable (WDR Delaware Corporation v Hydrox Holdings Pty Ltd; In the Matter of Hydrox Holdings Pty Ltd [2016] FCA 1164 at [192]).

Difficult questions can also arise where the dispute in question concerns ownership or other proprietary or security rights in respect of property of an insolvent party, or where injunctive or declaratory relief is sought against an insolvent party. Those questions will usually require consideration by a court deciding whether to grant leave to proceed with an arbitration or with enforcement of an arbitral award.

Can an insolvent entity commence arbitration?

An insolvent party can initiate an arbitration, whether in relation to claims arising before or after insolvency or bankruptcy but, generally, the decision whether to do so will rest with the insolvency administrator. A voluntary administrator, receiver or liquidator has power under the Corporations Act 2001 to bring proceedings on behalf of a company to which he/she is appointed, which would include arbitration proceedings (Corporations Act 2001 (Cth), Sections 420(2)(k) and (2)(w), 437A(1)(d) and 477(2)(a); Corporations Regulations 2001 (Cth), sch. 8A, cl. 2(j)).

Similarly, a trustee in bankruptcy has the power to commence proceedings, including arbitration, on behalf of the bankrupt, as the right to commence proceedings constitutes property of the bankrupt that vests in the trustee (Bankruptcy Act 1966 (Cth), Section 58(1)). As with an arbitration commenced against an insolvent entity, an arbitration commenced by an insolvent entity must be within the scope of the arbitration agreement and arbitrable under domestic law.

As with the decision of an insolvency administrator to continue an arbitration which has already been initiated by an insolvent claimant, the insolvency administrator will consider the merits of the claim and the utility of commencing the arbitration in the context of the claimant's insolvency. These include the likely costs of the arbitration, the likely recovery from the proceedings, and the likely return to creditors.

A respondent to an arbitration initiated by or on behalf of an insolvent party should consider the risk that the claimant may be unable to meet its obligation to pay the costs of the proceedings, should its claim be unsuccessful. To protect against this risk, the respondent party may wish to apply for security for costs.

Generally, a valid arbitration agreement is enforceable in Australia unless the parties waive their right to arbitrate, including where a dispute involves an insolvent party. This means that an Australian court cannot hear a claim concerning the application of an arbitration agreement and must dismiss or stay any proceedings brought in respect of the underlying dispute (e.g. International Arbitration Act 1974 (Cth) section 7).

However, the arbitration agreement can only be raised as an objection to court proceedings if the matter in dispute is arbitrable. Disputes that affect the rights of third parties or which have public policy implications are likely to be held by an Australian court not to be arbitrable (ACD Tridon Inc v Tridon Australia Pty Ltd [2002] NSWSC 896 at [189]-[194], citing A Best Floor Sanding Pty Ltd v Skyer Australia Pty Ltd [1999] VSC 170, where an application for a winding up order was determined not to be arbitrable).

It should be noted that, in Australia, it is often insolvency administrators (rather than courts) who will be making decisions about how the assets of an insolvent party are to be realised and distributed, including decisions as to the existence or quantum of a claim. The onus may lie on a claimant wishing to rely on an arbitration clause to bring court proceedings to compel the matter to be referred to arbitration, where the claimant is not content with the claim being addressed in the context of the proof of debt process.

In March 2020, the Australian government introduced temporary measures providing relief for companies and individuals facing distress as a result of Covid-19. In particular:

• the insolvent trading provisions of the Corporations Act 2001 (which in Australia exposes directors to personal liability for debts incurred by a company at a time when the company was, or was likely to become, insolvent) were amended to exclude from their operation any debts incurred since 24 March 2020 in the ordinary course of its business; and
• the rules relating to creditors' statutory demands and bankruptcy notices (which are precursors to action by creditors to wind up companies or bankrupt individuals) were modified to increase (from A$2,000 for creditors' statutory demands and A$5,000 for bankruptcy notices, to A$20,000) the monetary threshold for issuing a creditors' statutory demand or bankruptcy notice and to increase (from 21 days to six months) the time period for responding to a creditors' statutory demand or bankruptcy notice.

Those temporary relief measures that were in effect during 2020 expired on 31 December 2020, although from 1 January 2021, the monetary threshold for issuing a bankruptcy notice was increased permanently to A$10,000. The new debt restructuring process for small businesses (with debts of less than A$1 million) also commenced on 1 January 2021.