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Landmark decision of the Swiss Supreme Court on the effect of a foreign insolvency on arbitration proceedings in Switzerland
Practical Law UK Legal Update 3-522-9661 (Approx. 6 pages)
Landmark decision of the Swiss Supreme Court on the effect of a foreign insolvency on arbitration proceedings in Switzerland
by PD Dr. Nathalie Voser (Partner) and Anya George (Associate), Schellenberg Wittmer (Zurich)
| Published on 06 Dec 2012 • Switzerland |
In a landmark German-language decision of 16 October 2012, the Swiss Supreme Court ruled that the insolvency of the Portuguese respondent did not affect its capacity to be a party in an arbitration seated in Switzerland. In its detailed conclusions, the Supreme Court revisited its decision in Vivendi v Elektrim and addressed the criticism to which that decision gave rise.
Background
Article 87 of the Portuguese Insolvency Code (PIC) provides that:
"Without prejudice to provisions contained in applicable international treaties, the efficacy of arbitral agreements relating to disputes that may potentially affect the value of the insolvency estate and to which the insolvent is party shall be suspended.
Procedures that are pending at the moment of the declaration of the insolvency shall continue, without prejudice to the provisions set forth in Article 85(3) and of the Article 128(3) if applicable."
Under the Swiss lex arbitri, the validity of arbitration agreements is governed by Article 178(2) of the Swiss Private International Law Act (PILA), according to which:
"[…] an arbitration agreement is valid if it conforms either to the law chosen by the parties, or to the law governing the subject-matter of the dispute, in particular the main contract, or to Swiss law".
Article 155(c) PILA provides that the legal capacity of an entity is determined according to the laws of the state where that entity is incorporated.
Article 187(1) PILA provides that the arbitral tribunal shall decide the case according to the rules of law chosen by the parties or, in the absence thereof, according to the rules of law with which the case has the closest connection.
Facts
The dispute arose out of the performance of a sale and purchase agreement (SPA) for multicrystalline silicon wafers between a Chinese company (Y) and a Portuguese company (X). In November 2009, X was declared insolvent by the Portuguese authorities.
The insolvency administrator informed Y that, due to its alleged breaches of the SPA, she "formally refused compliance with the outstanding contractual obligations under the Agreement" and requested that down-payments made to Y, amounting to approximately US$ 42 million, be returned to the insolvent estate of X.
In July 2010, the insolvency administrator called in a bank guarantee provided on behalf of Y by the Bank of China. Y immediately sought and obtained provisional measures from the Chinese courts to prevent payment of the guarantee by the Bank of China.
On 6 August 2010, Y initiated arbitration proceedings against X under the ICC Arbitration Rules, claiming that X had breached its obligations under the SPA and was not entitled to call in the bank guarantees. On 15 October 2010, X filed its Answer, arguing that, pursuant to Article 87 PIC, the arbitral tribunal did not have jurisdiction to decide the dispute between the parties, because of the insolvency proceedings in Portugal.
In an interim award of 23 November 2011, the arbitral tribunal, which had its seat in Geneva, ruled that it had jurisdiction over the dispute. The tribunal considered that the legal capacity of an entity was governed by the law at the place of incorporation of that entity (in this case, Portuguese law). The arbitral tribunal found that there appeared to be no definitive interpretation of Article 87 PIC in Portuguese case law or literature, at least in relation to the issue of legal capacity. Based on its own interpretation of the provision and of further provisions of the PIC, the arbitral tribunal concluded that an insolvent Portuguese entity still has legal capacity. It found that Article 87(1) PIC pertains to the validity of the arbitration agreement for an insolvent entity, not to the legal capacity of that entity.
X petitioned the Swiss Supreme Court to have the award set aside. X argued that the arbitral tribunal's interpretation of Article 87 PIC was inaccurate and that due to the declaration of insolvency, it was no longer capable of appearing in arbitral proceedings (that is, it did not have "subjective arbitrability" (subjektive Schiedsfähigkeit)).
Decision
The Supreme Court rejected the petition and confirmed the interim award of the arbitral tribunal.
The central issue was whether X, as an insolvent entity, had the capacity to appear as a party in an international arbitration seated in Switzerland.
The Supreme Court started by setting out a few general principles. It defined the notion of "subjective arbitrability" as the capacity to enter into an arbitration agreement, on the one hand, and the capacity to appear as a party (Parteifähigkeit) in arbitral proceedings, on the other. X's arguments mainly centered on the capacity to appear as a party in arbitral proceedings.
For arbitrations seated in Switzerland, the issue of subjective arbitrability is governed by the Swiss lex arbitri (that is, Chapter 12 PILA). However, whilst Article 177(2) PILA contains a specific provision governing the issue of subjective arbitrability in relation to states and state-controlled entities, there is no such provision for other parties. In the absence of any statutory provision, the Supreme Court resorted to a general procedural principle, according to which the capacity of an entity to be a party in proceedings (Parteifähigkeit) presupposes that the entity has legal capacity (Rechtsfähigkeit), that is, the capacity to have rights and obligations.
The law applicable to the issue of legal capacity
Referring to its findings in Vivendi SA and others v Deutsche Telekom AG and others, 4A_428/2008 (Vivendi v Elektrim) (discussed in Legal update, Ongoing international arbitration discontinued vis-a-vis insolvent co-respondent), the Supreme Court confirmed that the law applicable to the issue of legal capacity is determined according to the general conflict of laws provisions of the PILA. Pursuant to Article 155(c) PILA, the legal capacity of X was governed by Portuguese law as the law at the place of incorporation.
When it applied this approach in its Vivendi v Elektrim decision, the Supreme Court was criticised by some commentators, who argued that the reference to general conflict of laws provisions went counter to the status of Chapter 12 PILA as a "law within the law" or as an "arbitration act" of sorts. It was argued that applicable law should be determined according to Article 187(1) PILA, a conflict of laws provision specific to arbitration. The Supreme Court rejected this criticism, pointing out that the aim of Article 187(1) PILA is to determine the law applicable to the merits and that it does not apply to the issue of legal capacity.
Definition of legal capacity
The Supreme Court went on to define the notion of "legal capacity" (Rechtsfähigkeit) as the capacity to have rights and obligations. A foreign entity which is constituted as a "legal person" according to the law at the place of incorporation and which is capable of having rights and obligations according to that law is considered capable of being a party in Swiss proceedings (whether before state courts or an arbitral tribunal). Any provisions of the applicable foreign law which impose restrictions in relation to arbitral proceedings, but do not, of themselves, negate the entity's legal personality, cannot affect that entity's capacity to be a party in arbitral proceedings seated in Switzerland.
X argued that under Portuguese law, an entity has no legal capacity for acts which are prohibited by law. X interpreted Article 87(1) PIC as prohibiting an insolvent entity from taking part in arbitral proceedings initiated after the declaration of insolvency.
The Supreme Court considered this to be irrelevant. The only requirement for there to be "subjective arbitrability" under the Swiss lex arbitri is that the entity must (still) have legal personality and be capable of having rights and obligations. X did not deny that it still had legal personality under Portuguese law; it merely argued that its legal capacity was excluded for certain acts.
The Supreme Court held that, even if Article 87(1) PIC were to be interpreted as prohibiting an insolvent entity from taking part in an arbitration seated in Portugal, it could have no impact on the capacity of that entity to be a party in a Swiss-seated arbitration, as long as the entity still had legal personality.
In addition, the Supreme Court pointed to further provisions of the PIC according to which an insolvent entity still has legal personality, highlighting in particular the second sentence of Article 87, which presupposes that an insolvent company is still capable of being a party in arbitral proceedings initiated before the declaration of insolvency. Therefore, even if it were possible to deduce a type of "inarbitrability" from Article 87(1) PIC, this would have no influence on the capacity of an insolvent entity to be a party in proceedings according to the Swiss lex arbitri, as long as that entity still has legal personality.
Effect of foreign insolvency statute provision on legal capacity
X also relied on the Supreme Court's decision in Vivendi v Elektrim. It argued that the Supreme Court had "confirmed" in Vivendi v Elektrim that provisions of a foreign insolvency statute according to which the insolvency of an entity renders the arbitration agreement devoid of effect, also negate the capacity of that entity to be a party in arbitral proceedings.
In Vivendi v Elektrim, Polish bankruptcy law was applicable, in particular Article 142 of the Polish Bankruptcy and Reorganisation Act (PBRA), which provides:
"Any arbitration clause concluded by the bankrupt shall lose its legal effect as of the date bankruptcy is declared and any pending arbitration proceedings shall be discontinued.”
The Supreme Court had held that there was no reason to question the findings of the arbitral tribunal, according to which Article 142 PBRA governs a specific aspect of legal capacity, and that pursuant to that provision, an insolvent Polish entity is no longer capable of being a party in arbitral proceedings.
That finding was heavily criticised. Most legal commentators agreed that, if the premises of the Vivendi v Elektrim decision were accurate (namely that the issue was one of legal capacity and that Article 142 PBRA did, in fact, restrict the capacity of an insolvent entity to be a party in arbitration proceedings), then the Supreme Court's findings would also be accurate. However, those same commentators were almost unanimous in considering that the premises of the decision were not accurate. Rather, they contended that Article 142 PBRA concerns the validity of the arbitration agreement and is, therefore, irrelevant under the Swiss lex arbitri, given that this issue is governed exclusively by Article 178(2) PILA. They also pointed out that, under Swiss law at least, insolvency has no impact on the validity of the arbitration agreement.
The Supreme Court held that it was not necessary to address this criticism in detail as, in any event, its decision in Vivendi v Elektrim could not serve as a precedent for the case between X and Y. Contrary to the views expressed by X, Vivendi v Elektrim did not confirm in a general manner that an insolvent party is rendered incapable of being a party in an arbitration in Switzerland when, according to the law at the place of incorporation, the arbitration agreement becomes ineffective upon the declaration of insolvency. Rather, the decision was "to be seen in the specific context of Polish law and doctrine". The fact that neither the relevant Polish law nor Article 87(1) PIC expressly referred to "legal capacity" did not allow the inference that both provisions were to be interpreted the same way.
Conclusion
Based on those considerations, the Supreme Court confirmed the arbitral tribunal's findings. It reiterated that Article 87(1) PIC does not affect the legal personality of an insolvent Portuguese entity. That provision pertains to the issue of the validity of the arbitration agreement, an issue which, according to the Swiss lex arbitri, is governed exclusively by Article 178(2) PILA. Under Swiss law at least, the insolvency of a party does not have any impact on the validity of the arbitration agreement. Article 87(1) PIC could therefore have no effect in this regard.
Comment
This decision is to be welcomed.
After the Supreme Court's controversial decision in Vivendi v Elektrim, it was feared that Switzerland might be out of step with other European countries, where the insolvency of a foreign party does not, as a rule, affect pending arbitration proceedings. In particular, the English High Court came to the opposite conclusion when it had to rule on the same issue for an LCIA arbitration in which Elektrim was a party. Of course, there was a significant difference between the Swiss and English cases, given that Council Regulation (EC) 1346/2000 on insolvency proceedings (Insolvency Regulation) was considered applicable in the English case (see Legal update, Court of Appeal determines effect of party's insolvency in one EU jurisdiction on arbitral proceedings in another).
Given that the European Insolvency Regulation does not apply in Switzerland and that there is no specific provision in Chapter 12 PILA governing the issue of subjective arbitrability of non-state entities, the Supreme Court had to revert to general principles. It is interesting to note that the Supreme Court followed the same basic line of reasoning in the case between X and Y as it did in Vivendi v Elektrim. However, it seems to have taken a slightly different approach when examining the issue of legal capacity under Portuguese law than it did when examining the same issue under Polish law. Whether or not the result in Vivendi v Elektrim would have been the same, had this more recent approach been applied at the time, is open to speculation.
Whilst the Supreme Court's reasoning may seem rather elaborate, the end result sends an important signal that the insolvency of a foreign entity should not, as a rule, jeopardise arbitral proceedings seated in Switzerland. As long as that entity retains legal personality and at least some "residual" legal capacity according to the law at the place of incorporation, it will be considered capable of being a party in a Swiss-seated arbitration.