RELATION BETWEEN ARBITRATION AND INSOLVENCY DISPUTES

This article has been written by Akshita Mohilay & Shrishti Mishra, 4th year Students pursuing B.A. LL.B (Hons) from Institute of Law Nirma University, Ahmedabad.



Introduction

The Supreme Court has recently settled a long standing question relating to arbitrability of insolvency disputes in Indus Biotech Private Limited v. Kotak India Venture Fund & Ors. The petitioner, Indus Biotech moved to the Supreme Court under Section 11(3) of the Arbitration and Conciliation Act, 1996 for appointment of an arbitrator on behalf of the Respondents Kotak India and others. The Court answered the question on whether parties that are involved in insolvency proceedings can resort to arbitration as a dispute settlement mechanism. This blog post is an attempt to decode the decision of the Court.


Facts

Kotak India and others had subscribed to Optionally Convertible Redeemable Preference Shares (‘OCRPS’) in the Petitioner company through a Share subscription and Shareholders’ Agreement (‘SSSA’). The SSSA also contained an Arbitration Clause to resolve disputes arising out of the agreement. According to the agreement, the Respondents had to convert their preference shares to equity shares on a rate that would be decided between the parties.


The dispute in question pertained to calculating the formula to convert the Respondents’ preference shares to equity shares. The Respondents calculated the amount to be 30 percent of the total paid up share capital in equity shares while the Petitioner found it to be 10 percent. The Respondents contended that on redemption of the preference shares, the Petitioner became liable to pay the amount calculated by them, failing which the Petitioner had committed default. This gave the Respondents a cause of action to initiate corporate insolvency resolution process (‘CIRP’) against the Petitioner company under Section 7 of the Insolvency and Bankruptcy Code, 2016 (‘IBC’).


The Petitioner on the other hand, contended that the dispute was not relating to payment of any amount but rather it was pertaining to calculation of the amount, the Petitioner was not liable to pay the Respondents any amount. They further contended that they cannot be declared insolvent until an amount gets settled between the Petitioner company and the Respondents. Also, since the Petitioner company was a profit making company involved in day-to-day business, they cannot be said to commit default.


Meanwhile, the Petitioner invoked Section 8 of the Arbitration and Conciliation Act, 1996 to refer the dispute to an Arbitral Tribunal. The Respondents, therefore, objected to the current arbitration petition filed by the Petitioner on the ground that Arbitration cannot commence after insolvency proceedings have been initiated.


Court’s Decision

The Supreme Court noted that the insolvency petition of the Respondents under Section 7 of the IBC was not admitted by the Adjudicating Authority. In fact, it had been rejected by the National Company Law Tribunal (‘NCLT’). NCLT had observed that the Petitioner was a profit making entity and that to settle on an amount, they have applied to arbitration. The Respondents had the option to appeal against the decision however, the fact of the matter remained that the CIRP had not been admitted by the Adjudicating Authority. Hence, the Court noted that the insolvency proceedings had not assumed the status of proceedings ‘in rem’. The Court referred to its decision in Vidya Drolia and Others v. Durga Trading Corporation wherein it had laid down 4 conditions for non-arbitrability of disputes-

  1. When the dispute relates to an action in rem;

  2. When the dispute involves third party rights or erga omnes obligations;

  3. When the dispute pertains to sovereign state functions and involves public rights that would render mutual adjudication unenforceable; and

  4. When the dispute is expressly or impliedly rendered non-arbitrable by statutes.

The Court noted that the first condition, that is, non-arbitrability of disputes that relate to proceedings or actions in rem becomes applicable in this situation. The Court stressed that proceedings under IBC assume the status of in rem only after the petition is admitted by the Adjudicating Authority upon application of mind and after finding that a ‘default’ has been committed. Simply, initiating CIRP by filing a petition does not trigger the status of proceeding in rem. The reason for this is that after admission of the insolvency petition, third party or erga omnes rights are created against all creditors of the defaulter company. The natural consequence of creation of erga omnes rights is that it automatically renders the option of arbitration between two parties invalid. In a situation, where the Adjudicating Authority finds that a default has been committed by the Corporate Debtor and the petition for CRIP is therefore admitted, the dispute between the parties becomes non-arbitrable regardless of an Arbitration Agreement made between them.


The Court was also quick to remind that the overriding nature of IBC as contained under Section 238 of the Code must be maintained at all times. Section 238 contains a non-obstante clause and states that provisions of IBC shall be fully applicable notwithstanding anything inconsistent contained in any other law in force. This section, therefore, requires the Adjudicating authority to independently consider petitions for CIRP and determine if the default is a true default or not. The consideration of the Adjudicating Authority must not be swayed by what the Court called a “moonshine defense” by the corporate debtor in the name of initiating arbitration proceedings.


Conclusion

On applying the laws and reasons stated above, the Court found that it was a fact that the NCLT which was the Adjudicating Authority had not admitted the CIRP petition of the Respondents. Hence, the proceedings cannot be called to be in rem and no third party rights have been created yet. Hence, the question of non-arbitrability of proceedings in rem does not arise in the present case and the Arbitration Petition filed by the Petitioner was allowed.

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