A company under liquidation cannot initiate arbitration proceedings

In one of its recent decisions, the Court of Appeal of Szeged ruled that a company under liquidation cannot initiate arbitration proceedings because this would be contrary to the purpose of the liquidation and the creditors’ interest. The Hungarian Supreme Court published this decision as guidance for other Hungarian courts. (Case no. EBH 2014.G.4., Szegedi Ítélőtábla Gf.I.30.014/2012.)

1. The case

In the specific case the parties concluded a subcontractor agreement in which they submitted all their disputes related to the contract to the jurisdiction of the Permanent Court of Arbitration attached to the Hungarian Chamber of Commerce. The plaintiff went under liquidation and subsequently wished to enforce a claim of HUF 186 million (about EUR 600,000) against the defendant based on the contract. However, instead of initiating arbitration proceedings as stipulated in their agreement, the plaintiff started litigation before the ordinary Hungarian courts.

2. Decision of the court

The first instance Court ruled that it would not hear the case, based on the parties’ arbitration agreement. The plaintiff appealed and succeeded: the Court of Appeal of Szeged annulled the first instance court’s decision and ordered the first instance court to carry out the procedure on the merits. Thus, notwithstanding the arbitration clause, ordinary courts have jurisdiction for the dispute.

3. Reasoning of the court

The Court of Appeal of Szeged relied on Section 8(1) of the Hungarian Arbitration Act, according to which the ordinary court does not reject the claim “if it finds that the arbitration agreement (…) is incapable of being performed”. This rule originates in the UNCITRAL Model Law on International Commercial Arbitration (Art. 8 (1)). According to the court, arbitration proceedings would be contrary to the purpose of the liquidation and the creditors’ interest. (The purpose of liquidation is to terminate an insolvent company and satisfy its creditors.) In order to support this finding, the court refers to the following features of arbitration proceedings:

• it is not possible for the company’s creditors to intervene in order to support the claimant;
• the proceedings are not public;
• no appeal lies against a potentially unlawful award;
• a setting aside action provides a limited remedy against the award;
• the costs of the proceedings exceed the costs of an ordinary court case;
• the claimant has to pay the advance on arbitration costs, and cannot request suspension of this obligation.

For the Court of Appeal of Szeged, the above facts hinder the enforcement of the plaintiff’s claim to such an extent that the arbitration clause became “incapable of being performed”.

4. Comments

The decision will certainly give rise to fierce debates in Hungary. The court’s conclusion, according to which arbitration is less effective than ordinary court procedure, is at least disputable. In any event, most of the arguments brought forward by the court are unconvincing:

• No intervention: it is difficult to see how the lack of intervention by the creditors would “basically hinder the enforcement of the plaintiff’s rights” (as the court put it).

• Confidentiality: the mere fact that the arbitration hearings are not public cannot be seen as a hindrance to the plaintiff’s claim.

• One instance procedure: the lack of appeal and limited judicial review are two of the main advantages of arbitration and some of the main reasons for its efficiency. A one instance arbitration procedure is typically finished in a much shorter time than an ordinary Hungarian court case, which may be heard in three instances.

• Costs: While it is true that the costs of arbitration may exceed the costs of an ordinary Hungarian court case, it is a widely known fact that arbitration tribunals are more willing to award full compensation of legal costs. Thus, ultimately a successful claimant may be better off in terms of costs if it arbitrates a dispute rather than litigates it. In addition, in the Hungarian appeal system both the appeal court and the Supreme Court have the competence to annul a judgement and to order a new procedure so, as a result, the costs of a prolonged litigation may even exceed the costs of a short arbitration.

The only reason mentioned by the Court of Appeal of Szeged which can really hinder the access to justice is the necessary payment of the advance on arbitration costs. In the ordinary court system, the procedural fees are lower and the plaintiff may request the court to suspend the payment of the fees until the judgment. Thus, if the company under liquidation cannot advance the arbitration costs, it will be denied justice. However, the published decision of the Court of Appeal of Szeged does not contain anything which would suggest that the court would have investigated the plaintiff’s ability to pay the advance on arbitration costs.

5. An example from Germany

The German Federal Supreme Court (BGH) was faced with a similar case, where a bankrupt company brought its claim before the ordinary courts notwithstanding a valid arbitration agreement (III ZR 33/00, CLOUT Case 404). Just like the Court of Appeal of Szeged, the BGH also concluded that for the bankrupt plaintiff, the arbitration clause “became incapable of being performed”. However, there is a fundamental difference between the decision in the German and the Hungarian case: the BGH actually investigated the plaintiff’s ability to pay, and concluded that the particular plaintiff was not in a position to pay the advance on arbitration costs. It is for this reason, and only this reason, that the BGH considered the arbitration clause to be “incapable of being performed”. The BGH did not go into the question as to whether arbitration or litigation is more effective. The BGH’s approach seems to be more appropriate for two reasons. Firstly, the BGH’s decision does not generally preclude arbitration for bankrupt companies, and does so only if the specific company cannot pay the advance on arbitration costs. Secondly, the BGH could convincingly establish the ordinary court’s competence without calling into question the efficiency of arbitration in general.