Are insolvency and arbitration like oil and water?

Formal insolvency law procedures are usually collective and centralised, overriding certain pre-insolvency agreements in order to achieve laid down objective(s) for the benefit of all creditors. In contrast, arbitration favours privity of contracts and party autonomy. Parties’ agreement to arbitrate their dispute is considered as sacrosanct regardless of the circumstances. There is therefore a potential for conflict when a dispute touches on these two regimes. In United States Line, 197 F. 3d 631 at 640 (1999), a US court described such as “a conflict of near polar extremes” given that the insolvency policy “exerts an inexorable pull towards centralisation while arbitration policy advocates a decentralised approach towards dispute resolution.” 

This article examines the possible legal implications of formal insolvency proceedings on arbitration agreements, as well as the possible impact of arbitration agreements on insolvency proceedings. The analysis is limited to compulsory winding-up proceedings and where the seat of arbitration and the place of opening of insolvency proceeding is Nigeria. Different considerations will apply in cross-border insolvencies and international arbitral proceedings.

The effect of an arbitration agreement on a compulsory winding-up proceeding.
Where a party commences a court action in breach of an arbitration agreement, the proceeding can be stayed by the court at the instance of the counterparty pending the conclusion of arbitration: sections 4 and 5 Arbitration and Conciliation Act (ACA); Sino-Africa Ind Co. Ltd v Ministry of Finance (2014) 10 NWLR (Pt 1416) 515 at 536G-H. Section 4(1) ACA provides that a court before which an action which is the subject of an arbitration is bought shall, if any party so request not later than when submitting his first statement on the substance of the dispute, order a stay of proceedings and refer the parties to arbitration. 

Further, section 5(1) ACA provides that if any party to an arbitration agreement commences any action in any court with respect to any matter which is the subject of an arbitration agreement, any party to the arbitration may, at any time after the appearance and before delivery of pleadings or taking any other steps in the proceedings, apply to the court to stay proceedings. Section 5(1) is subject to two conditions, one of which is that the court must be satisfied that there is no sufficient reason why the matter should not be referred to arbitration in accordance with the agreement: section 5(2)(a) ACA.

A company will be considered as being unable pay its debts under the Companies and Allied Matters Act (CAMA) where the company is indebted in a sum exceeding N2000 and has neglected to pay same after a requisite demand: section 409(a) CAMA. A creditor can file a winding-up petition based on this: section 410(b) CAMA. Where the transaction upon which a corporate debt is premised is subject to an arbitration agreement, filing the winding-up petition will constitute commencement of action under sections 4 and 5 ACA. In Ladejobi v Odutola Holdings (2002) 3 NWLR (Pt 753) 121 at 159F, it was held that “winding-up petition is a form of litigation in a court of law.” Whether or not a winding-up petition will violate an arbitration clause will depend on whether (i) the debt is not disputed or (ii) the debt is genuinely disputed. 

Where the debt is not disputed
Where the corporate debtor does not dispute the debt upon which a winding-up petition is hinged, it ought to be inferred that there is no dispute arising from the agreement which necessitates a resolution via arbitration. An application for stay of the winding-up proceedings by reason of either section 4 or 5 ACA will smack off a mere ruse to frustrate the winding-up proceedings. As previously noted, a precondition for grant of stay under the ACA is that the applicant must show that there is no sufficient reason why the matter should not be referred to arbitration in accordance with the agreement: section 5(2)(b) ACA. The absence of a genuine “dispute” clearly suggests the absence of “sufficient reason” which ought to persuade the court to refuse the application to stay the insolvency proceedings. In any event, it is trite that when a debt is established and a formal demand is made, the court has no discretion but to wind up the company: Tate Ind Plc v Devcom M.B. Ltd (2004) 17 NWLR (Pt 901) 182 at 217G-H; Oriental Airlines Ltd v Air Via Ltd (1998) 12 NWLR (Pt 577) 271 at 281G.

There are other policy justifications why courts ought to exercise their discretion in favour of granting winding-up petitions where debts are not genuinely disputed. First, the insolvency proceeding will provide a centralised forum for settlement of all claims against the debtor, thus promoting insolvency law’s cardinal objectives of collectivity and equal treatment of similarly ranked claims. Second, avoiding arbitration will reduce unnecessary expenses and ensure a quicker resolution as the liquidator will focus on a single procedure rather than dissipate time and resources in defending claims against the debtor at different proceedings. Third, the approach will ensure that the relevant provisions of the ACA are applied in a reasonable manner that is congruent with the policy objectives of insolvency law. 

Where the debt is genuinely disputed on substantial grounds
Where there is a bona fide dispute of the debt on substantial grounds, this may constitute sufficient reason for the court to exercise its discretion under section 5(2)(b) ACA for the winding-up proceeding to be stayed pending arbitration. In this regard, section 411(1) CAMA ought to be applied in a manner which ensures that both the insolvency law policy and the policy underlying the ACA are harmonised. On presentation of a winding-up petition, section 411(1) CAMA gives the court a wide discretion to either (i) dismiss the petition, (ii) adjourn the hearing conditionally or unconditionally, (iii) make an interim order or (iv) any other order that the court thinks fit. The appropriate order for the court in this circumstance would be to either dismiss the petition or adjourn hearing pending the conclusion of arbitration.

The above approach can be justified on at least four grounds. First, winding-up proceedings are not suitable for the resolution of disputed debt issues. Winding-up proceedings are commenced by petitions and parties will be unable to file pleadings or join issues to enable the court resolve disputations: Kapital Investment & Trust Co Ltd v 150 Estate Nig Ltd (1989) 1 CLRQ 1. Second, a winding-up petition ought not to be used to pressurise a company into paying debts, it may not be owing, to avoid potential damage to reputation and financial standing. Third, where a debt is being genuinely disputed, the petitioner cannot be considered to be a “creditor” as contemplated under sections 409(a) and 411(1) CAMA. Put differently, being a creditor is a condition-precedent for filing a winding-up petition under those provisions. Fourth, a winding-up petition is not a proper method for establishing a debt or the status of a creditor: Onochie v Alan Dick & Co Ltd (2003) 11 NWLR (Pt 832) 451 at 460C-D, 461E-G.

The effect of a winding-up proceeding on an arbitration agreement; arbitration by a counterparty/non-creditor 
There may be a conflict of policy considerations where a counterparty who is not a creditor in an ongoing insolvency proceeding opts to commence arbitration proceeding against the insolvent company. Section 417 of CAMA provides that upon the making of a winding-up order, no action or proceeding shall be proceeded with or commenced against the company except by leave of court given on such terms as the court may impose. Section 417 CAMA is identical to section 239 of the UK Companies Act 1948 wherein it has been held that the word “proceeding” encompasses arbitration proceedings: Re Exchange Securities & Commodities Ltd (1983) BCLC 186 at 192E. The power to grant leave under the provision is discretionary: Omaghoni v Nigeria Airways Ltd (2006) 18 NWLR (Pt 1011) 310 at 329D. This discretion gives courts the freedom to do what is right and fair in each circumstance: Re Aro Co Ltd (1980) Ch 196 at 209D-H. Accordingly, whether or not leave will be granted for the commencement or continuation of an arbitration proceeding depend on the facts of each case.

It is suggested that an instance where leave ought to be granted is where the essence of the arbitration proceedings is merely to determine the contractual rights and obligations of the parties. This will not by any means violate the collectivity or equality principles of insolvency law given that a prospective creditor’s claim (if any) is yet to crystallise. Preventing the commencement or continuation of the arbitration proceedings may effectively shut out a counterparty from ascertaining his claims to enable him formally lodge a proof in the insolvency proceedings. 

Arbitration by a creditor
There may also be a clash of policy considerations where a creditor seeks to refer a dispute arising from an ongoing insolvency proceeding to arbitration. This scenario may arise where a liquidator rejects a formal proof of debt put in by a creditor: section 91 of Companies Winding up Rules (CWR). Where the disputed debt is subject to an arbitration agreement, a case may be made for referral of the dispute to arbitration. In this case, the creditor would have to be the one to argue that a winding up proceeding is not the proper forum for the resolution of the dispute. This argument may not be tenable given that the creditor, having lodged a proof in the winding-up proceeding, will be deemed to have waived his right to refer the dispute to arbitration. 

Lodging of proof constitutes “taking steps in the proceedings”: section 5(1) ACA, and this ought to disentitle the creditor from applying for stay of proceedings and referring the matter to arbitration: Sino-Africa Ind Co. Ltd v Ministry of Finance (2014) 10 NWLR (Pt 1416) 515 at 536G-H. A creditor in this position may apply to court for the decision of the liquidator in respect of the proof to be varied or reversed: Rule 91 CWR.

Conclusion
Corporate debtors cannot use the ACA’s stay provision as a ruse to frustrate formal insolvency proceedings merely due to the existence of arbitration clauses in their contracts. No matter how well an arbitration agreement is drafted, there is no certainty that it would trump a compulsory winding-up petition or proceeding. Given that both the power to stay proceedings under the ACA and CAMA are discretionary, it is incumbent on courts to exercise these discretions in a manner that ensures a congruence of the policy objectives of these two dispute resolution regimes. Dr Udofia is an insolvency law expert and the head of Corporate and Commercial Law practice group at Fidelis Oditah & Co.