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Arbitration & Bankruptcy in Brazil

19 July 2010
Mayer Brown Article

Although in some jurisdictions arbitration is a long-established form of alternative dispute resolution, this mechanism has only recently been regulated in Brazil. The Brazilian Commercial Code, enacted in 1850, already included a few sparse provisions regarding commercial arbitration, but there were no references to specific rules. It was not until 1996 that Brazil passed its first specific arbitration statute, Law No. 9,307/96 (Arbitration Law). This legislation follows the main trends in international arbitration and is particularly influenced by the UNCITRAL Model Law on International Commercial Arbitration.

Brazil’s Arbitration Law allows any person capable of entering into contracts to elect to arbitrate disputes relating to disposable property rights. Whenever an arbitration clause is included in an agreement, any controversy arising out of this agreement must be arbitrated according to the rules established by the parties, and the arbitral award will be final and binding upon the parties. Thus, the arbitration award has the same effect as a decision rendered by the courts and it constitutes a document valid for filing an execution process, if the other party refuses to comply with the decision.

However, the Arbitration Law did not immediately find wide acceptance in Brazil. After its enactment, many Brazilian courts questioned the enforceability of arbitration agreements, arguing that they were a violation of the constitutional principle of free access to the judiciary. It wasn’t until 2001 that the Supreme Court confirmed the constitutionality of the Arbitration Law.1

Since then, the Arbitration Law has enjoyed increasing success, currently being widely recognized and adopted by most sectors of industry and commerce as a reliable and efficient mechanism of resolving disputes in Brazil. However, despite its success, the Arbitration Law is still rather new and there are many controversial issues yet to be explored in arbitration jurisprudence, including its relation to insolvency proceedings.

One of these controversial issues is the relationship between arbitration and bankruptcy within the Brazilian legal system - two areas of law guided by very distinct principles. The discussion becomes particularly intriguing given the lack of cases submitted to the consideration of Brazilian courts so far.

The main aim of Brazilian bankruptcy law2 (Bankruptcy Law) is to preserve and optimize the productive use of properties and assets of the insolvent companies throughout the liquidation process. When a company becomes bankrupt, its management must be surrendered to a court-appointed manager chosen by the bankruptcy court. The bankruptcy court is competent to hear and decide all claims and actions related to the properties, assets, interests and business of the bankrupt company.

Therefore, the Bankruptcy Law aims to centralize all matters related to the liquidation of an insolvent company under a sole judicial administrator able to make decisions in the best interests of creditors according to the preferences established by law. The centralization process is also intended to avoid fraud in the liquidation of the company, as all decisions taken throughout the procedure are open to all interested parties.

The basis of arbitration is profoundly different to that of bankruptcy. While arbitration relies on the decentralization and confidentiality of disputes, bankruptcy depends on the centralization and openness of all matters related to the liquidation of an insolvent company.

These differences become increasingly significant in situations where, for example, an arbitration is already underway and one of the parties goes bankrupt. Should the arbitration be immediately suspended or terminated and the dispute submitted to the bankruptcy court? Or should the arbitration proceed until the final award is rendered?

There are no clear-cut answers to these questions, since neither the Bankruptcy Law nor the Arbitration Law contains any express provisions on this subject. However, two recent cases decided by the Court of Appeals of the State of São Paulo explored the controversy after a comprehensive analysis of both laws.

The first case was decided in July 2008 on an interlocutory appeal filed by a creditor against a decision by the First Bankruptcy Court of São Paulo that denied his proof of claim on the ground that it was based on an arbitration award rendered after the bankruptcy declaration.3 The Court of Appeals decided that the creditor's proof of claim was valid and ruled that arbitration proceedings already in place should not be suspended or terminated by the supervening bankruptcy of a party.

The Court of Appeals held that when parties enter into an arbitration agreement there are no restrictions on their capacity to contract or limitations to the free disposal of their assets. Therefore, the arbitration agreement was legal and valid, and subsequent events did not affect this. The court concluded that when a party becomes bankrupt during the course of arbitration, the proceedings must continue, with the insolvent party being represented by the court-appointed manager.

The decision also considered article six of the Bankruptcy Law, which states that the course of all actions and executions against the debtor must be suspended as of the bankruptcy declaration, except for those lawsuits dealing with undetermined amounts. The court found that the arbitration should be encompassed by the exception, since the dispute was related to an unliquidated obligation due by the debtor.

The second case, decided in December 2009, considered circumstances very similar to the previous case. In this case, however, the arbitration notice had been issued after the bankruptcy adjudication. The bankrupt company (represented by the court-appointed manager) filed a collection action against the appellant, who refused to proceed with the payment and argued that the disputed debt had to be resolved by arbitration.4 The Court of Appeals dismissed this argument, holding that arbitration procedures could not be invoked after the bankruptcy adjudication.

The Court of Appeals held that an arbitration agreement is an ancillary agreement whose effects depend on the conditions precedent: that at the time it is invoked, the parties must have full capacity to contract and that the dispute concerns disposable property rights.

These cases make clear that the core question is whether the arbitration was commenced before or after bankruptcy proceedings were initiated. Once a party is declared bankrupt, all arbitration agreements to which the bankrupt company is a party become ineffective and the claims must be submitted exclusively to the bankruptcy court. On the other hand, arbitration proceedings already in progress must continue normally, and any award rendered in such proceedings will serve as a valid proof of claim before the bankruptcy court.

It is important to mention however that these issues have not yet been discussed by the Brazilian Superior Court. Even if the above two cases reveal a very reasonable interpretation of the Arbitration Law, there are very few other decisions to confirm a definitive position of the Brazilian courts on the relationship between arbitration and bankruptcy. Because the Arbitration Law is still very new in Brazil, additional court decisions will be required to further clarify.
1. STF – SE 5,206.
2. The Brazilian Bankruptcy Law was published on February 9, 2005 under the number 11,101.
3. TJ-SP. AI 531.020-4/3-00, Des. Manoel de Queiroz Pereira Calças. June 25, 2008.
4. TJ-SP. AI 658.014-4/2-00, Des. Roberto Solimene. December 10, 2009.

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