Month: May 2011

The Singapore Court of Appeal issued a decision recently articulating a principled framework for the arbitrability of insolvency-related claims. It provides useful guidance on when an insolvency-related claim would be considered non-arbitrable under Singapore law. In seeking to strike the delicate balance between its robust pro-arbitration stance and its insolvency regime, the Court’s underlying philosophy strives to give the private consensual model of arbitration as much effect as possible, whilst using the tool of non-arbitrability to draw a clear line in the sand only when third-party interests are implicated under the insolvency regime.

In Larsen Oil and Gas Pte Ltd v Petroprod Ltd (in official liquidation in the Cayman Islands and in compulsory liquidation in Singapore) [2011] SGCA 21, the Singapore liquidators of an insolvent Cayman Islands company, Petroprod, sought to avoid a number of payments made by Petroprod to the appellant, Larsen, on the statutory grounds that those payments amounted to unfair preferences or undervalue transactions and/or was made with the intent to defraud. Larsen applied for a stay of those avoidance proceedings on the basis of an arbitration agreement between the parties that stipulated Singapore as the seat of arbitration.

After a comparative jurisprudential analysis characteristic of prevailing judicial practice, VK Rajah JA writing for the Court of Appeal astutely laid down three key principles:

1)    Disputes involving an insolvent company that arise only upon the onset of the insolvency regime, such as disputes concerning transaction avoidance and wrongful trading, are non-arbitrable.

2)    Disputes involving an insolvent company that stem from its pre-insolvency rights and obligations are non-arbitrable when the arbitration would affect the substantive rights of other creditors.

3)    Disputes involving an insolvent company that stem from its pre-insolvency rights and obligations are arbitrable when the arbitration is only to resolve prior private inter se disputes between the company and other party.

In so far as the first principle is concerned, the Court incisively reasoned that many of the statutory provisions in the insolvency regime are enacted to recoup for the benefit of the company’s creditors losses caused by the former management, and this objective would be compromised if a company’s pre-insolvency management had the ability to restrict the avenues by which the company’s creditors could enforce the very statutory remedies which were meant to protect them against the company’s management. Some of these remedies may include claims against former management who would not be parties to any arbitration agreement.

There is perhaps another way which the Court could have arrived at the same result.

One could say that the insolvency provisions the Court was concerned about, such as transaction avoidance due to unfair preference, are not claims that are derivative of the debtor’s rights; they can only be brought by a liquidator (or a trustee or debtor in possession; or one of their assignees), none of whom were parties to the arbitration agreement: see In re Bethlehem Steel Corp. v. Moran Towing Co., 390 B.R. 784 (Bankr. S.D.N.Y. 2008), citing Allegaert v. Perot, 548 F.2d 432 (2d Cir. 1977); Hagerstown Fiber Ltd. P’ship v. Carl C. Landegger, 277 B.R. 181 (Bankr. S.D.N.Y. 2002); Hays and Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 885 F.2d 1149 (3d Cir. 1989); OHC Liquidation Trust v. American Bankers Insurance Co. (In re Oakwood Homes Corp.), 2005 WL 670310 (Bankr. D. Del. 2005); Pardo v. Pacificare of Tex., Inc. (In re APF Co.), 264 B.R. 344 (Bankr. D. Del. 2001).

This is not novel and has already been foreshadowed by the Court in its earlier precedent of Ho Wing On Christopher and ors v ECRC Land Pte Ltd (in liquidation) [2006] SGCA 25, albeit in a different context concerning the recovery of costs by a successful litigant against an insolvent company in liquidation.

Indeed, in the present case the Court expressly considered the origin of the claim in elucidating the next two principles set out above. The Court observed that there were two policies militating against giving effect to arbitration agreements for disputes stemming from pre-insolvency rights and obligations.

First, because the insolvent regime is for the benefit of creditors who are not parties to the arbitration agreement, it is difficult to justify why the liquidator (or trustee) who represents the creditors should be compelled to arbitrate instead of pursuing the statutory remedies.

Second, allowing an insolvent company’s creditor to arbitrate its claim against the company in effect allows the creditor to contract out of the proof of debt process. It arguably falls foul of the principle that a company cannot contract with some of its creditors for the non-application of certain insolvency rules.

Weighing the competing policies, the Court took the final position that the right balance to be struck for disputes involving an insolvent company that stem from its pre-insolvency rights and obligations was to hold that if the resolution of a dispute through arbitration would “affect the substantive rights of other creditors”, then the dispute is non-arbitrable. Conversely, the dispute is arbitrable when it does not.

The Court reasoned that circumvention of the proof of debt process is tolerable because the process does not create new rights in the creditors or destroy old ones. Even if the claim is subsequently proved to be valid and enforceable against the liquidator (or trustee), the pool of assets available to all creditors at the time of the liquidation of the company is not affected.

The Court’s view that the proof of debt process should not operate as a complete barrier against arbitrability must be right as a matter of legal symmetry and consistency, since the Court has been granted the statutory power to permit certain actions or proceedings against a company in a liquidation, thereby allowing those creditors to derogate from the proof of debt process: see s 262(3) Companies Act (Cap. 50, 2006 Rev. Ed.) and s 148A Bankruptcy Act (Cap. 20, 2009 Rev. Ed.).

Darius Chan

Darius Chan graduated from NYU with a LL.M. in International Business Regulation, Litigation & Arbitration. He is qualified in Singapore and New York. Upon graduation he clerked at the Supreme Court of Singapore and was concurrently appointed an Assistant Registrar. He was also adjunct faculty at the law schools of National University of Singapore and Singapore Management University. Prior to the LL.M., he practised international arbitration at the chambers of Michael Hwang SC.

Professor Franco Ferrari, Executive Director of the Center for Transnational Litigation and Commercial Law, will give a talk at the New York State Bar Association Global Week, International Section. He will speak on “Drafting International Contracts”. The event will take place on 10-13 May, 2011, at the Yale Club.

Professor Franco Ferrari co-edited (with Professor Fracnesco Galgano et al.) and co-authored the fifth edition of a book in Italian entitled “Atlas of Comparative Private Law”. The book collects articles on twenty topics in the area of private law, ranging from transfer of property to tort law, from contract formation to bankruptcy.

In the past decade, conflict of laws rules relating to corporations have undergone a dramatic change in Europe. At the outset of this development, many European countries, such as Germany, France or Austria followed the real seat doctrine. This doctrine makes applicable to a pseudo-foreign corporation the law of the real seat and thus imposes on the corporation a different law than the one under which it had been founded. The results can be dramatic and mostly lead to the loss of the shareholders’ limited liability. From 1999 onwards, the European Court of Justice was faced with three landmark cases on cross-border mobility of corporations (all of them concerning inbound mobility, i.e. from the perspective of the country of arrival), the “Centros” case of 1999 (Case C-212/97, ECR 1999 I-1459), the “Überseering” case of 2002 (Case C-208/00, ECR 2002 I-9919) and the “Inspire Art” case of 2003 (Case C-167/01, ECR 2003 I-10155). The essence of these cases is that, at least for intra-European fact patterns, the application of the real seat doctrine or substantive laws for pseudo-foreign corporations that impose minimal capital requirementsviolate the corporation’s freedom of establishment, Art. 43, 48 (now: 49, 54) of the Treaty and cannot be applied any more to corporations arriving at the borders of the new host state. Instead, the relevant conflict of laws rule for inbound mobility within Europe has to be the theory of incorporation. Yet, one unclarity remained: In 1988, in the “Daily Mail” case (Case C-81/87, ECR 1988 I-05483), the ECJ had decided that the freedom of establishment does not, in the present state of European law, confer to a corporation founded under the laws of a member State the right to relocate its real seat to another member State. This decision concerned the perspective of the country of departure, and the ECJ essentially argued that the country of departure, i.e. the country of incorporation, had given life to a corporation and thus was allowed to take it away again when the corporation intended to relocate to another country. The three above-mentioned cases (Centros, Überseering and Inspire Art) did not overturn Daily Mail as they explicitly referred to inbound fact-patterns.

Nevertheless, most commentators criticized the distinction between outbound mobility and inbound mobility. In particular, a corporation’s freedom of establishment and the changes brought by Überseering and Inspire Art depend on the interplay of the laws of both countries, and this interplay can effectively block outbound mobility, thus making the right to inbound mobility in the new host state virtually useless. Let us illustrate this with a short example: A corporation is incorporated in country A, a real seat country, and shifts its real seat to country B, a country that follows the theory of incorporation. On the conflict of laws level, the real seat theory refers us to the law of country B, but the conflict rule of country B (theory of incorporation) refers us back to country A, whose substantive corporate rules then apply. However, many real seat countries consider, on the substantive level, a corporation’s decision to relocate to another country as a decision to liquidate. Thus, country B cannot welcome the corporation; instead the corporation has to liquidate and be created anew in country B. In 2008, in the “Cartesio” case (Case C-210/06, ECR 2008 I-9641), the ECJ was faced with the very same fact pattern: A Hungarian partnership wanted to relocate its real seat – not its place of incorporation – to Italy yet remain incorporated in the Hungarian commercial register. This was not possible according to Hungarian substantive corporate law. The Hungarian appellate court, tough not being entirely clear whether it meant the real seat or the place of incorporation, referred the case to the ECJ. Contrary to what the final remarks of the General Advocate Poiares Maduro had suggested, the ECJ confirmed its solution of Daily Mail, yet also added another layer of distinction between two different constellations of outbound mobility: On the one hand, a corporation, such as in Cartesio, might wish to preserve its legal identity and remain organized under the laws of its country of origin. In this respect, the ECJ essentially repeated the reasons mentioned in “Daily Mail” (items 104 et seq.). On the other hand, an outbound corporation might wish to relocate and adopt one of the legal forms of the new host state. In this case, according to the ECJ, national substantive law or conflict of laws are not “immune” against the corporation’s freedom of establishment. In such a situation, the requirement of a prior winding up falls within the scope of Art. 43, 48 (now 49, 54) of the Treaty and could only be justified by compelling general interests (items 110 et seq.). In the meantime, the European Commission had thought about a new directive that would allow a corporation to shift its place of incorporation – not its real seat – to another European country. Yet, prior to Cartesio, these plans were abandoned because the directive on cross-border mergers was considered as a viable alternative.

In the aftermath of Überseering and Inspire Art, many authors suggested a situation of competition between the different national legislators in Europe and alluded to the situation in the United States, whose corporate law is dominated by the law of Delaware. Given the massive rise in numbers of British Limited companies in the German territory, the German legislator decided to reform the German law on limited liability companies. Essentially, the traditionally strict capital requirements of German law have been eased and a new, “slim” form of limited corporation (Unternehmergesellschaft) has been created for start-ups and small business founders. This new forms seems to be very successful among its target group and is about to outnumber the pseudo-foreign British Limited companies in Germany. Moreover, the German legislator, in an attempt to make the “export” of German law possible, abolished substantive limitations similar to the Hungarian ones of the “Cartesio” case and now – although not being required to do so by European law – allows corporations founded under German law to move to another country and take their German legal form with them, see § 4a GmbHG (German law on limited liability companies).

Gunnar Groh

Gunnar Groh, an Arthur T. Vanderbilt Scholar and LL.M. candidate in Corporate Law of New York University School of Law, graduated from Ludwig-Maximilians-University of Munich. Mr. Groh also holds a licence and maîtrise en droit from Université Panthéon-Assas (Paris II), with distinction. From 2007 to 2010, he worked as a research assistant and lecturer at Ludwig-Maximilians-University of Munich, Institute of Comparative Law.