Addressing the issue of Arbitrability of Insolvency Disputes in India – By Adv. Nandita Bajpai & Nandini Shenai

Nandita Bajpai, Senior Associate at Khaitan Legal Associates & Nandini Shenai, 4th Year BBA.LLB (Hons) student at NMIMS School of Law, Mumbai

Addressing the issue of Arbitrability of Insolvency Disputes in India

The intersection of arbitration and insolvency has sparked a lot of debate. There existed a peculiar situation where it was unclear if a Corporate Debtor could challenge a Financial Creditor’s claim for insolvency by turning attention towards arbitration, being the means for resolution of disputes. This position of law has been clarified by the Hon’ble Supreme Court in the case of Indus Biotech Private Limited v Kotak India Venture Fund (2021) ibclaw.in 52 SC.  The Court has held that an insolvency proceeding stops being arbitrable from the point when a CIRP  petition under Section 7 is admitted.  The authors, by way of this article, review the legal standing of the overlap between arbitration proceedings and insolvency matters, while providing a comparative analysis with international jurisprudence on this topic, concluding with potential alternatives to the Hon’ble Supreme Court’s decision.

Factual Matrix of the case

The dispute between the parties arose due to the value of Optionally Convertible Redeemable Preference Shares (OCPRS) as while being exchanged into equity shares. Kotak invoked the provisions of the IBC by submitting an application for initiating a Corporate Insolvency Resolution Process after Indus Biotech failed to recover OCRPS within the deadline. As a counterblast to the said proceedings, Indus Biotech filed an application under Section 8 of the Arbitration and Conciliation Act, 1996  , stating that a petition under Section 7 of IBC cannot be filed  due to the existence of an arbitration clause in the contract. This application was filed before the commencement of the CIRP.

In 2020, the NCLT Mumbai permitted the CIRP Proceeding to be resolved through arbitration by rejecting Kotak’s Section 7 application of the IBC, stating that there was no default. In this context, a Special Leave Petition was filed before the Supreme Court. Kotak’s main argument was that the disagreement resulted from a right in rem, and therefore could not be arbitrable. Indus, however, claimed that the NCLT had taken the right stance, and that the case should be forwarded to arbitration because there was no default under IBC.

 Critique of the SC judgement

This decision presents viewpoints on two matters concerning the arbitrability of insolvency disputes.

Overriding Effect: Although this question of law was not in an unchartered territory, the Hon’ble Supreme Court reiterated Section 238 of the IBC has an overriding effect over other legislations. This finding is consistent with the maxim that if two special statutes contain clauses that are incompatible, the statute enacted later in time will take precedence. Notably, the Court later explained the implications of this overriding effect in terms of the insolvency-arbitration relationship.

Admission of Application: The SC also took a cautious view to the issue of arbitrability, relying on the principle that was laid down in the Vidya Drolia case to hold that an insolvency proceeding can only be in rem after being admitted. This admission results in the establishment of a third party right for all of the corporate debtor’s investors, resulting in an erga omnes outcome. As a result, the SC stated that if an insolvency petition is accepted under Section 7 of the IBC, the issue no more comes under the ambit of arbitration, and a Section 8 application cannot be upheld.

The insolvency cases are held in rem, which means they affect the whole world, as per the Swiss Ribbons judgement. In the case of Booz Allen, the Supreme Court stated unequivocally that insolvency disputes are not arbitrable. The SC in Indus Biotech categorised the case into two phases to provide insight on this question. In the first phase that happens pre-admission, the CIRP is between the corporate debtor and the creditor (in personam). However, in the second phase once the admission has taken place, the CIRP becomes against the world at large (in rem).

In the current case, the Hon’ble Supreme Court rightly stated that the NCLT’s determination of default must be centred around an impartial evaluation of the whole case and the evidence presented to it. If the NCLT determines that a default does not apply, it would widen the scope for the parties to appoint of the Arbitral Tribunal in a legally permissible proceeding.

 International Jurisprudence

In the case of Elektrim v Vivendi, a cross-border insolvency case with an arbitration clause, The Swiss courts followed Polish law, because the insolvent company was based in Poland. The Swiss Supreme Court ruled that the  arbitration tribunal had no authority because the arbitration clause was considered ineffective upon the initiation of insolvency proceedings under Polish law.

Disputes concerning an insolvent corporation that occur only upon the beginning of the insolvency process, such disputes, cannot undergo arbitration, according to Singaporean courts in the case of Larsen Oil and Gas Pte Ltd v Petroprod Ltd. However, where the issue concerns the company’s interests prior to insolvency, it can be resolved by arbitration.

In the United Kingdom, an insolvency proceeding would not exclude a party from pursuing arbitration. This position was founded in the case of Fulham Football Club v. Richards, where the appellate court found that a shareholder unfair discrimination lawsuit can be arbitrated. The appellate court has noted that the arbitrability of insolvency law cases is contingent on its effect on third parties.

Conclusion

Following an analysis of the Indus Biotech decision, the dilemma that emerges is whether there is any alternative way to accommodate the goals of both statutes?  The Bombay High Court addressed this possibility in the case of Rakesh Malhotra, where oppression and mismanagement claims were included within the ambit of arbitration if the claim was found to be false, frivolous, and “dressed up” i.e. formulated with a view to avoid the an arbitration clause. The SC, in Indus Biotech, arguably established a mechanism that would prohibit the “dressing up” of claims in insolvency proceedings by maintaining that on admission, an insolvency claim transforms into a right in rem.  After initiating an Insolvency Application, a financial creditor will not be able to avoid or weasel out of the arbitration agreement.

The IBC is not meant to be a replacement for a recovery suit; rather, it is designed to help the insolvent company get back on its feet. Consequently, the first question to be answered is if the appeal is “dressed up” or meant to replace the IBC as a restitution code. The second one being whether an arbitration  would be in contrast with IBC’s purpose.

 

Disclaimer: The Opinions expressed in this article are that of the author(s). The facts and opinions expressed here do not reflect the views of IBC Laws (http://www.ibclaw.in). The entire contents of this document have been prepared on the basis of the information existing at the time of the preparation. The author(s) and IBC Laws (http://www.ibclaw.in) do not take responsibility of the same. Postings on this blog are for informational purposes only. Nothing herein shall be deemed or construed to constitute legal or investment advice. Discussions on, or arising out of this, blog between contributors and other persons shall not create any attorney-client relationship.

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