DOES INSOLVENCY PREVENT ARBITRATION UNDER NEW ARBITRATION ACT IN HUNGARY?

24 August 2018

The new Hungarian Arbitration Act, effective from 1st January 2018 introduced important changes in relation with commercial arbitration in Hungary. Whether the new law will change the former restrictive case law regarding the effect of insolvency to arbitration proceedings? We address this question in our latest article.

The effects of insolvency on commercial arbitration is a delicate issue.

European jurisdictions often give divergent answers to the same question, like in the noteworthy Elektrim c. Vivendi case, where the Swiss Federal Court held that the insolvency of the Polish defendant invalidated the arbitration agreement, while the English High Court ruled that it had no effect on the arbitration clause concluded by the parties.

Although the former arbitration law of Hungary has not regulated the effect of insolvency in arbitration, Hungarian courts favour the restrictive approach of the  Swiss courts.

Hungarian case law - insolvent debtor not bound by arbitral clause

The Regional Court of Appeal of Szeged rendered a decision in 2014[1], in which it held that by reason of the insolvency of one of the parties, the arbitration agreement becomes incapable of being performed.

The highly criticized decision justified the above conclusion by holding that the creditors can not intervene in the arbitration proceedings, which is closed for the public, the award cannot be subject of appeal and the judicial review is limited. Lastly, the court highlighted that in comparison with litigation, the arbitration procedure is more expensive, and the insolvent party cannot request cost-reliefs.

According to the court, these factors would hinder the effective exercise of rights of the insolvent party, who is, consequently not bound by the arbitral clause, and can start litigation in front of state courts.

New Arbitration Act

The new arbitration law, Act LX of 2017 on arbitration, effective from 1st January 2018 (“Arbitration Act”) deals with the effects of insolvency to arbitration proceedings more deeply, but some question remains still open.

Arbitration against insolvent debtor

The new Arbitration Act makes it clear when can arbitration be started against an insolvent debtor.

Based on the Arbitration Act[2], monetary claims can be enforced only in the insolvency procedure, so once the Hungarian insolvency procedure has been started, there is no place to start arbitration for monetary claims against the insolvent debtor.

The same rule provides that the above principle does not prevent the party from starting arbitration for non-monetary claims (eg. declaratory claims, specific performance, etc.) even after the debtor has been declared insolvent.

Party insolvency during arbitration

The fact that one of the parties becomes insolvent during arbitration, has no legal effect on the arbitration proceedings, since Act XLIX of 1991 on bankruptcy and liquidation proceedings provides that litigations and non-litigious proceedings started before the starting day of insolvency go on continuously in front of the competent court[3].

In this respect, the term “litigation” should be construed broadly to include arbitration proceedings.

It is another question, whether an insolvent debtor can comply with its payment obligations during the arbitration proceedings (e.g. advancing the fees of the tribunal, experts, etc.). Financial difficulties can prevent the party from effectively participating in the evidentiary procedure, or from property presenting its case, which may entail the risk of a potential setting aside procedure. However, this question must be assessed on a case-by-case basis in our opinion.

Can insolvent debtors disregard arbitration clauses?

It is a delicate question, whether the former Hungarian case law cited above, enabling insolvent debtors to disregard arbitral clause and start litigation in front of state courts still applies under the new Arbitration Act?

It must be highlighted that some of the arguments on which the above conclusion was built are no more valid in the new legal environment.

Firstly, the new Arbitration Act introduced the “intervention” of third parties in the arbitration proceedings. It means that a third party, who is interested in the victory of one of the parties, may intervene in the proceedings, if the arbitral tribunal so decides.[4]

Secondly, the Arbitration Act broadened the remedies against the arbitral awards, by introducing an extraordinary remedy, the retrial of the case.[5]

Thirdly, the Rules of Procedure of the Hungarian Arbitration Court attached to the Hungarian Chamber of Commerce introduced important changes in relation with the costs, according to which the parties have to advance the costs in 50-50%, and the claimant shall advance the costs in 100% only in case the defendant fails to do it.

Based on the above, in our opinion the above case law should not be maintained under the new Arbitration Act.