This article has been authored by Saisha Bajaj, a fourth year student pursuing B.A.,LL.B at Amity Law School, Delhi (Affiliated to GGSIP University.
The relationship between insolvency and arbitration has been a contentious point in the legal forum owing to their respective characteristics. Both provide ways for aggrieved parties to get their dues, albeit with altered approaches. While arbitration is a long-standing conventional way of resolving disputes before succumbing to litigation, the Insolvency and Bankruptcy Code, 2016 (the Code) can be seen as more of an unrelenting remedy in the way it operates.
A common question which centres around the above mentioned subjects is the arbitrability of insolvency disputes.
On 26 March 2021, the Supreme Court (SC) in Indus Biotech Private Limited v. Kotak India Venture Fund ruled that an arbitration petition can only be considered after an insolvency application under Section 7 of the Insolvency and Bankruptcy Code, 2016 is rejected by the Adjudicating Authority. This verdict of the SC can be seen as a pioneering judgment as it provides succinct clarity on whether the IBC has overriding effect on arbitration in actuality.
Kotak had subscribed to equity shares and Optionally Convertible Redeemable Preference Shares (OCRPS) in Indus Biotech via the share subscription and shareholders agreement. Thereafter, Indus Biotech decided to make a Qualified Initial Public Offering (QIPO). However, it could not do so under Regulation 5(2) of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements), Regulations 2018, as the same forbids a company which has any outstanding convertible securities or any other right which would entitle any person with an option to receive equity shares of the issuer, to make QIPO.
As a result of this it became obligatory for Kotak to convert their OCPRS into equity shares. In the process that followed, a dispute with regard to the calculation and conversion formula to be applied in the conversion process, had arisen.
While Kotak contended that it would be entitled to 30% of the total paid-up share capital, Indus Biotech claimed that Kotak would be entitled to 10% of the total paid-up share capital.
Kotak further claimed that on redemption of the OCPRS, an amount of INR 367.08 crores becomes due and payable to them. Kotak argued that the redemption value shall constitute a ‘debt’ owed by Indus, as the same was provided for in the agreement. The date of redemption was fixed in the agreement and was made payable within 15 days from that date. Kotak on these grounds contended that the said amount not having been paid by Indus within the contractually mandated period, clearly constituted debt, which led to it filing an insolvency application under Section 7 of the Insolvency and Bankruptcy Code, 2016 before the NCLT, Mumbai Bench.
Subsequently, Indus filed an application under Section 8 of the Arbitration and Conciliation Act, 1996 (Arbitration Act) before the NCLT to refer the parties to arbitration for the resolution of the said dispute.
The NCLT, Mumbai Bench on 9 June 2020 through its order allowed the application filed by Indus seeking arbitration, and dismissed the insolvency petition filed by Kotak.
In this regard, Kotak alleged NCLT to have made a serious error by considering an arbitration petition when it was duty bound to consider the insolvency application solely/exclusively and therefore stood as an aggrieved party before the Supreme Court in the special leave petition filed by it. This judgment deals with the arbitration petition filed by Indus Biotech under Section 11 of the Arbitration Act, 1996 seeking appointment of an arbitrator on behalf of Kotak, and the special leave petition filed by Kotak.
Analysis of the Judgment
A. ‘DEFAULT’ UNDER THE CODE: THE IMPORTANCE OF AN OBJECTIVE ASSESSMENT
The Supreme Court while dealing with Kotak’s contention on how a section 7 petition under the Code must be treated with utmost importance by the Adjudicating Authority with no scope for consideration of any other petition, approved the NCLT’s handling of the same.
With regard to the contentions made by Kotak concerning the redemption value, date and how the same was to constitute a debt as was provided for in the agreement, the Supreme Court analysed whether the same debt could be made to constitute ‘default’ under the Code. References were made to the Board meetings held in March and April of 2018 wherein discussions took place regarding the conversion of shares and related issues, with the same being attended by representatives of Indus Biotech. The Court was of the view that such attempts at conversion having commenced before the redemption date were indicative of the fact that negotiations regarding the appropriate formula and conversion were in process. The mere fact that the parties could not reach a conclusion on the percentage of the paid-up share capital that Kotak would be entitled to, could not be seen as constituting a default and thereby lead to the presumption of an unpaid debt under the Code. The admission of an insolvency petition merely on the basis of the redemption date being breached/not met, could not be held tenable on the basis of the above mentioned facts.
The Supreme Court went on to emphasise the importance of the process of consideration the Adjudicating Authority is liable to undertake in accordance with the Code before admitting an application; and in the process of determining whether a default has actually occurred, importance must be given to the facts and circumstances of every case, even if a debt exists in the strict sense of the word. The SC opined that this practise was executed in the correct manner by the NCLT when dealing with the insolvency application before it.
The Supreme Court further went on to state the significance of an objective assessment while admitting or rejecting an application under the Code. The Court rightly contended that if the same was not done, then in all cases where there is debt, default would be automatically assumed, which would lead to pushing competent companies discharging their debts and efficiently running their administration, into the Corporate Insolvency Resolution Process (CIRP). Therefore in order to safeguard the rights of such solvent and debt-free companies it becomes necessary to take a considered decision through an objective assessment of the admissibility of insolvency petitions.
B. ARBITRABILITY OF INSOLVENCY DISPUTE: WHETHER AN INSOLVENCY PETITION TRUMPS AN ARBITRATION PETITION?
The central theme which this case was based upon was the question regarding the arbitrability of insolvency disputes.
Kotak argued that the NCLT had made a grave error by observing in its order that the invocation of arbitration in this case was justified. The Supreme Court rightly observed that the stage of proceedings in which such decision was taken will be of relevance.
Kotak contended that an insolvency proceedings is an action in rem and therefore not arbitrable. The Court referred to the case of Vijay Drolia and Others v. Durga Trading Corporation, (“Vijay Drolia”) to briefly encapsulate the determinants of arbitrability of a dispute. The fourfold test propounded in Vijay Drolia for determining when the subject matter of a dispute in an arbitration agreement is not arbitrable includes actions in rem as inarbitrable. The Court correctly applied this principle in the present case and observed that insolvency disputes are actions in rem and have to be addressed by a centralised forum, be the court or a special forum, which would be more efficient and has complete jurisdiction to efficaciously and fully dispose of the entire matter. It went on to further state that such actions in rem have erga omnes effect and therefore are non arbitrable.
Kotak relied on the case of Swiss Ribbons Private Limited vs. Union of India and Pioneer Urban Land and Infrastructure Limited vs. Union of India & Ors., wherein the entire scope and ambit of the of the Insolvency and Bankruptcy Code, 2016 was analysed, resulting in the validity of its provisions being upheld.
The Supreme Court taking note of all the above referred decisions concluded that in order for a petition under Section 7 of the Code to be considered as a proceeding in rem, it is necessary that the Adjudicating Authority “ought to have applied its mind, recorded a finding of default and thereafter admitted the petition”. Only after being satisfied by the evidence on record that the Adjudicating Authority would decide on the existence of default and thereafter proceed to either admit the application under sub section 5(a) of Section 7 of the Code or dismiss it under sub section 5 (b) of Section 7 of the Code. The Supreme Court stated that the mere filing of an insolvency petition and its pendency before admission cannot be construed as a proceeding in rem. It is only on admission of such petition that third party right is created in all the creditors of the corporate debtor and shall have erga omnes effect. Hence an insolvency petition can be considered as a proceeding in rem only once it is admitted by the Adjudicating Authority under the Code and not before that.
The Supreme Court was also conscious of the fact that arbitration can be used as a moonshine defence by the corporate debtor to unnecessarily delay the Corporate Insolvency Resolution Process. To provide against such occurrings, the Adjudicating Authority is duty bound to first consider an application under Section 7 of the Code, even if an application under Section 8 of the Arbitration Act is pending before it. It is only after considering the application under Section 7 of the Code and ascertaining the existence of a default that such application would either be admitted or rejected under the Code. If the adjudicating authority is satisfied on the existence of a default, it will admit the application therefore rendering the arbitration petition as non-maintainable. However, if no default is found the application will stand rejected under the Code, which opens the gateway for the arbitration petition. Put simply, an insolvency application will have precedence over an arbitration application and the latter shall be considered only after the former is dealt with and subsequently rejected.
In the light of these arguments, the Supreme Court held that the petition filed by Indus under Section 11 of the Arbitration Act seeking constitution of an arbitral tribunal was justified.
The author agrees with the Supreme Court’s stance to the end that the dispute in the present case was centred on the interpretation of the agreements entered into between the parties. The Supreme Court rightly concluded that in this case there was no ‘default’ on the part of Indus Biotech and the dispute mainly constituted a disagreement regarding the percentage of paid-up share capital that Kotak would be entitled to. Such dispute would appropriately come under the ambit of arbitration. The author is also in agreement with this line of reasoning by the Supreme Court and believes that the current facts of the case did not in any way necessitate the initiation of the CIRP against a debt-free and solvent company like Indus Biotech. Therefore, the Supreme Court was right in allowing the section 11 petition filed by Indus Biotech seeking constitution of arbitration tribunal.
The Supreme Court while agreeing with the order of the NCLT, Mumbai Bench has given a much defined and unarguably precise guideline to determine on the arbitrability of insolvency disputes. While agreeing with the point that an insolvency dispute is an action in rem and thereby abiding by the various tests propounded in the judgments presented before it, the Supreme Court has ruled that such application doesn’t automatically constitute an action in rem. It has with great clarity emphasised upon the importance of the triggering point of the Section 7 application under the Code and how the same needs to be admitted before rendering an arbitration petition non-maintainable. The mere existence of a Section 7 application will not render the dispute inarbitrable. The Supreme Court has rightly observed that even though the insolvency application will have precedence over the arbitration application in terms of its consideration, just the filing of the former would not constitute an action in rem having erga omnes effect, thereby terminating the possibility of arbitration. The author agrees with the approach adopted by the Supreme Court in as much as the same gives a very logical and rational argument keeping in line with the objectives of both the IBC and the Arbitration Act.
To conclude, in the present case even though arbitration won the battle, in actuality it has lost the war against the IBC, inasmuch as once an insolvency application is admitted under the Code, the question of arbitration comes to an end.