6 April 2021
The conflict between Insolvency and Arbitration is almost of near polar extremes. The difference in focus of the two was well illustrated in Re United States Lines Inc[1] as a:
“… conflict of near polar extremes: bankruptcy policy exerts an inexorable pull towards centralization while arbitration policy advocates a decentralized approach towards dispute resolution”.
Thus, while insolvency/ bankruptcy aims to centralise all the proceedings against a debtor to one jurisdiction and give rise to a proceeding in rem (against the world at large) thereby creating third party rights for all creditors of the debtor, arbitration on the other hand advocates a decentralised approach and promotes party autonomy in dispute resolution resulting in a proceeding in personam (against a particular person).
It has been fairly settled through judicial precedents[2] that if the subject matter of a dispute forms part of a proceeding in rem, then the same is not arbitrable. Hence, once an insolvency proceeding is commenced, it becomes non-arbitrable. In this regard, reference may be made to the Supreme Court decision in the case of Vidya Drolia & Ors. vs. Durga Trading Corporation[3]:
“76. … we would like to propound a fourfold test for determining when the subject matter of a dispute in an arbitration agreement is not arbitrable:
76.1 (1) when cause of action and subject matter of the dispute relates to actions in rem, that do not pertain to subordinate rights in personam that arise from rights in rem.
76.2 (2) when cause of action and subject matter of the dispute affects third party rights; have erga omnes effect; require centralized adjudication, and mutual adjudication would not be appropriate and enforceable;
…
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Applying the above principles to determine non-arbitrability, it is apparent that insolvency or intracompany disputes 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. They are also actions in rem.”
The aforesaid position finds support even under the provisions of the Insolvency and Bankruptcy Code, 2016 (“Code”) whereby the legislature has stipulated an automatic moratorium[4] resulting in a stay of legal proceedings (including arbitration proceedings) in favour of insolvency proceedings. The rationale being that the interests of all creditors can properly and appropriately be reflected in the insolvency proceedings, rather than in a consensual arbitration between one creditor and the insolvent debtor.
However, a question remains on identifying/ understanding when such an insolvency proceeding in rem is said to have commenced to result in it being non-arbitrable under the Arbitration Act. The Hon’ble Supreme Court was seized with this very issue in the recent case of Indus Biotech Pvt. Ltd. vs. Kotak India Venture (Offshore) Fund (earlier known as Kotak India Venture Ltd.) & Ors[5] (“Arbitration Petition”). However, before analysing the Supreme Court judgment, it is relevant to refer to the proceedings before the National Company Law Tribunal, Mumbai (“NCLT”), where Kotak India Venture (Offshore) Fund (“Kotak India”) had filed an application under Section 7 of the Code seeking initiation of insolvency proceedings (“Insolvency Application”) against Indus Biotech Pvt. Ltd. (“Indus Biotech”) for its alleged default in redeeming the Optionally Convertible Redeemable Preference Shares (“OCRPS”) subscribed by Kotak India under the Share Subscription and Shareholders Agreement (“Agreement”).[6]
However, while the said Insolvency Application was sub-judice, Indus Biotech filed an application under Section 8 of the Arbitration Act seeking directions from the NCLT to refer parties to arbitration for settling their disputes[7] (“Section 8 Application”), and simultaneously also filed the Arbitration Petition under Section 11 of the Arbitration Act before the Supreme Court seeking appointment of arbitrators.
On June 9,. 2020, the NCLT pronounced its judgment on the Insolvency Application and the Section 8 Application and disposed of both the applications (“NCLT Judgment”). The NCLT observed that under the Code, it is mandated to ascertain and record satisfaction as to the occurrence of ‘default’ before admitting the insolvency application, for which a judicial determination of ‘default’ was needed. Based on facts and contentions of the parties, the NCLT held that it was not satisfied that a ‘default’ had occurred. Simultaneously, the NCLT also observed that Courts have a mandatory duty to refer the parties to arbitration where an arbitration clause exists. Since the subject matter of the dispute was arbitrable and an arbitration clause existed under the Agreement an attempt to reconcile the differences between the parties and their respective perceptions was in order. . Consequently, the NCLT allowed the Section 8 Application and dismissed the Insolvency Application, while noting that Arbitration Petition is pending adjudication before the Supreme Court.
The aforesaid NCLT pronouncement, however, raised a lot of eyebrows, particularly from the view-point of accuracy of the decision to allow a Section 8 Application in an in rem insolvency proceeding much less in absence of specific powers under the Code to refer parties to arbitration (see a contrary stand by NCLT, Ahmedabad[8]), and to top that seeing the same as one of the reasons to not admit the Insolvency Application. As a consequence, Kotak India assailed the NCLT Judgment, but instead of filing a statutory appeal before the Appellate Tribunal under Section 61 of the Code, it filed a Special Leave Petition (“SLP”)[9] before the Supreme Court, which eventually came to be tagged with the pending Arbitration Petition.
On March 26, 2021, Hon’ble Supreme Court disposed of both the Petitions vide a common judgment. In its judgment, the Supreme Court justified the NCLT Judgment and upheld the dismissal of the Insolvency Application against Indus Biotech, however, with a modified reading of the NCLT judgment and the reasoning involved therein. In a nutshell, the Supreme Court justified (a) the NCLT’s observation on reference of the dispute to arbitration under Section 8 Application, and (b) dismissal of the Insolvency Application despite it being done as a corollary to allowing the Section 8 Application.
A. NCLT’s reference of dispute to arbitration under Section 8 Application
In its judgment, the Supreme Court held that insolvency proceedings are not in rem until the Adjudicating Authority has applied its mind, recorded a default and admitted the insolvency petition. It observed that mere filing of the petition and its pendency before admission cannot be construed as the trigger for a proceeding in rem as only after admission that third party right is created in all the creditors of the corporate debtors and will have erga omnes effect. It stated that the admission of the petition is the relevant stage which would decide the status and the nature of the pendency of the proceedings and mere filing cannot be taken as the reason to trigger the insolvency process in rem. Therefore, the reference to arbitration by the NCLT prior to the insolvency proceedings being admitted in rem against Indus Biotech is justified and sustainable.
The aforesaid observation of the Supreme Court is consistent with the earlier pronouncements, more specifically, the decision in Swiss Ribbons vs. Union of India,[10] wherein while interpreting the constitutionality of Section 12A, the Supreme Court had held that once an application to trigger insolvency is admitted, the proceeding becomes a proceeding in rem and it becomes necessary to have the approval of the committee of creditors before any individual claim may be settled. However, the Supreme Court clarified that where the committee of creditors has not been constituted, a party can approach the NCLT directly for withdrawal/ settlement, which the NCLT may, in exercise of its inherent powers under Rule 11 of the NCLT Rules, 2016, allow or disallow. Thus, in other words, the Supreme Court acknowledged that insolvency proceedings remain in personam till the claims of the creditors are received and a committee of creditors is constituted.
B. Determination of Insolvency Application would befall the Section 8 Application, not vice versa
In its judgment, the Supreme Court instead of recording its observation on the issue of the NCLT’s power to decide on Section 8 Application directly, took a different view and observed that the NCLT need not independently consider the Section 8 Application outside the scope ofthe Insolvency Application as NCLT is first dutybound to advert to contentions put forth in Insolvency Application, examine the material provided alongwith it and basis that record a satisfaction as to whether there is a ‘default’ or not. In either of the situations, the Supreme Court held that the consequence of the determination of the Insolvency Application would befall on the Section 8 Application in as much as:
a. In case of a determination of a ‘default’ and the debt being payable, a natural consequence would be to admit an insolvency application and initiate proceedings in rem against the debtor, due to which the question of arbitrability of the inter se dispute between the parties would not arise, and the Section 8 Application would not be maintainable.
b. In case of a determination that there is no ‘default’, the Insolvency Application will stand rejected and the parties will have the autonomy to secure appointment of the Arbitral Tribunal in an appropriate proceeding as contemplated in law, and the need for the NCLT to pass any orders on Section 8 Application would not arise.
Thus, it was made clear that the NCLT must first consider the Insolvency Application while keeping the Section 8 Application pending for consideration as the outcome of the Insolvency Application will ipso facto determine the Section 8 Application.
Although the aforesaid was not followed in the instant Indus Biotech case, the Supreme Court upheld NCLT’s dismissal of the Insolvency Application. Supreme Court observed that the NCLT’s consideration of the Section 8 Application as the lead application and dismissal of the Insolvency Application as a corollary to it, can be construed in reverse here considering the facts and situations and the express determination of no ‘default’ on the part of Indus Biotech. Accordingly, the SLP challenging the NCLT Judgment was dismissed and the Arbitration Petition for appointment of arbitrators was allowed.
For further information, please contact:
Bishwajit Dubey, Partner, Cyril Amarchand Mangaldas
bishwajit.dubey@cyrilshroff.com
[1] 197 F.3d 631, 640 (2d Cir. 1999)
[2] Booz Allen and Hamilton Inc. v. SBI Home Finance Ltd, AIR 2011 SC 2507.
[3] 2021 2 SCC 1.
[4] Ref. Section 14 of the Code.
[5] Arbitration Petition (Civil) No. 48/2019, Supreme Court of India.
[6] CP (IB) No. 3077/2019, NCLT Mumbai.
[7] IA No. 3597/2019 in CP (IB) No. 3077/2019, NCLT Mumbai.
[8] Shalby vs. Dr. Pranav Shah, 2018 SCC OnLine NCLT 137.
[9] Civil Appeal No.1070/ 2021 @ SLP (C) No. 8120/ 2020.
[10] 2019 SCC OnLine SC 73.
