A recently published ruling of a Hungarian regional court of appeal1 has held that the enforcement of claims by an insolvent claimant in arbitration is contradictory to the aims of the insolvency proceedings and to a creditor's interests. Consequently, an arbitration agreement may not be binding in Hungary in circumstances where a potential claimant is insolvent.
This conclusion is not inconsistent with the approach taken in some other European jurisdictions, on the basis of the significance of insolvency proceedings. Ongoing arbitral proceedings can be suspended or even terminated on the basis of insolvency, and parties may be prevented from commencing an arbitration once insolvency proceedings are underway against one of them. The question of whether this is justifiable in the arbitration context is debateable, but the extraordinary nature of insolvency proceedings often overrules contracts and property law. It is harder in those circumstances to make the case for arbitration being an exception to these rules.
The Hungarian Insolvency Act2 indirectly prohibits arbitral proceedings in circumstances where there is an outstanding monetary claim against the insolvent party. This is because once insolvency proceedings have been commenced against a debtor, any monetary claims against the debtor can only be enforced by lodging the claim with the administrator3. If the administrator does not recognise the claim then, as a general rule, the bankruptcy court has exclusive jurisdiction to decide the disputed claim. Since it has exclusive jurisdiction, it logically follows as a matter of Hungarian law that once liquidation proceedings have been commenced, no arbitration proceedings can be initiated against an insolvent debtor.
In contrast, there is no explicit provision in the Insolvency Act which prevents an insolvent debtor himself commencing arbitration proceedings in order to collect debts owing to him. Provided the parties have agreed to arbitration, previously there was apparently nothing to stop a debtor bringing an arbitration claim against a counterparty. Also, a party against whom an administrator has commenced litigation proceedings in the state courts was also previously able to rely on the provisions of the Arbitration Act4, which provides that the state courts must dismiss on a summary basis claims brought in breach of an arbitration agreement, the only exception being where the state court considers that the arbitration agreement is null and void, inoperative or ineffective5.
The recent decision of the regional court of appeal has now established that the commencement of arbitration by an insolvent debtor is incompatible with the aims of the liquidation process, which is to ensure that creditors are compensated from the estate of the debtor in accordance with the Insolvency Act.
The court focused on several considerations:
In contrast to litigation, creditors cannot intervene or participate in an arbitration to support the administrator, even if such an intervention would be in the best interests of the creditor.
The confidentiality of arbitration proceedings is contradictory to a creditor's best interests.
The award given by the arbitral tribunal cannot be subject to appeal, and the available remedies are limited to bringing proceedings in the state court to attempt to have the award set aside.
The costs of arbitration are higher than those for litigation, and in contrast to litigation, at the commencement of arbitration proceedings the insolvent debtor as claimant would have to deposit a fee for the arbitration.
The regional court of appeal held that these circumstances fundamentally prevent an insolvent debtor as claimant from enforcing its claims before an arbitral tribunal; therefore, the arbitration agreement is unenforceable.
Without commenting on the merits of the decision on the facts in this case, it is notable that the decision suggests that an arbitration agreement is generally unenforceable if the claimant becomes insolvent. However, the judgment as published does not make a finding on the question of whether an arbitration agreement remains enforceable in certain other circumstances, for example where the debtor has sufficient financial means to cover the costs of the arbitration, or the administrator considers that arbitration is more appropriate than litigation.
The decision is not binding precedent under the Hungarian legal system, but it does represent the view of one regional court of appeal. It remains to be seen if in the future this new approach is overruled by the Curia or whether it becomes the prevailing view of the state courts.
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1 Szegedi Ítélőtábla Gf. I.30 014/2012, published at BDT/7-8/130.
2 Act XLIX of 1991 on Reorganization and Liquidation proceedings ("Insolvency Act").
3 Section 38 (3) of the Insolvency Act; this provision does not prevent the parties from continuing those arbitrations which are pending at the time of the opening of the liquidation proceedings, see Section 38 (2) of the Insolvency Act.
4 Act LXXI of 1994 on Arbitration (Arbitration Act"). The Arbitration Act follows the model provided by the UNCITRAL Model Law.
5 Section 8 (1) of the Arbitration Act. In 1995 the Highest Court - on the basis of the rules applicable before the implementation of the Model Law - held that the parties need to take the costs of the arbitration into consideration when entering the contract and the fact that later on one of the parties goes bankrupt and consequently becomes unable to cover the arbitration costs may not establish the jurisdiction of the state courts. Case no. Legf. Bír. Gfv. VI. 30. 194/1994 sz., published under BH1995. 362.