Insolvency or Arbitration: A Fight Between Special Statutes

[By Injila Khan and Utkarsh Mishra]

Injila is a student at the Institute of Law, Nirma University, Ahmedabad and Utkarsh is a student at Symbiosis Law School, Noida.

The Insolvency and Bankruptcy Code 2016 was enacted to structure and amend laws relating to the reorganization of financial assets and insolvency resolutions relating to corporate persons. Part II of the code deals with Insolvency Resolution and Liquidation for Corporate Persons and accordingly financial creditors, operational creditors, and corporate debtors can initiate Corporate Insolvency Resolution Process.[i]On the other hand, the Arbitration and Conciliation Act, 1996 governs the procedure related to both domestic as well as international arbitration along with their relevant enforcement. However, recently, there has been an ample number of cases where a financial dispute between parties often overlooked arbitration and lead to the process of insolvency of the company that owned the money in the first place. This leads to the failure of the concept of an alternative dispute resolution mechanism as a whole. Moreover, insolvency proceedings create numerous problems for the company who might not be out of funds but simply disputes the existence or quantification of a financial obligation created on the basis of a contractual arrangement. This further leads to insolvency being used as a pressure tactic to strong-arm the debtor organization into unfair payments.

Ascertainment of the Term “Debt” under IBC

Section 7(5) of IBC states that to initiate Insolvency Proceedings by the Financial Creditor there has to be a judicial determination by the Adjudicating Authority (AA) as to whether there was a ‘default’ by the Financial Debtor. As soon as the AA is satisfied that default has occurred it should accept the application for initiation of CIRP. This was effectively reiterated by the NCLT in the case of Innoventive Industries Limited v. ICICI Bank[ii]which states that claim of default by the financial creditor must be followed by ascertainment of existence of default by the AA. Thus, to start insolvency, the only criteria is debt.

Wider Interpretation of the term “financial debt”

Sec. 3(12) of IBC defines ‘default’ as non-payment of debt either totally or in part. In the case of SGM Webtech Pvt Ltd. v. Boulevard Projects Pvt Ltd[iii]it was held by the AA that even Fully Converted Debentures (FCCD) are unequivocally treated as a Financial Debt under Sec. 5(8) of IBC and for this reason, FCCDs were considered as financial debt. Also, Sec. 5(8) of IBC mandates debt to be disbursed against the consideration for the time value of money and since interest on debentures increases, therefore, it subscribes to the concept of the time value of money. Therefore, non-payment of any outstanding FCDs will qualify as non-payment of a debt and will be counted as a Default. Thus, debt obligations created by Financial securities are also being considered as financial debt and hence, a chance to invoke insolvency.

Arbitration and Section 7 of IBC

Disputes falling under Section 7 of the IBC belong to the class of litigations which are deemed non-arbitral.[iv]Therefore even if the agreements entered into by the parties contained an arbitration clause, they hold no relevance as soon as the dispute falls under Section 7 of the Code and there is any debt owed, in part or whole.

The Supreme Courtin the case of Booz Allen & Hamilton v. SBI Home Finance Ltd[v]held that “generally and traditionally all disputes relating to ‘rights in personam’ are considered to be amenable to arbitration and all disputes relating to ‘rights in rem’ are required to be adjudicated by courts and tribunals”.Since the applications filed under Sec. 7 of IBC are matters relating to ‘right in rem’,[vi]therefore they are inherently incapable of being arbitrated. The Courts took a similar view in the case of Haryana Telecom v. Sterile Industries[vii]where an application under Sec. 8 of  Arbitration and Conciliation Act was not allowed in oppression and management cases under the Companies Act because it was a matter relating to ‘right in rem’. Therefore, it is sufficiently clear that the non-arbitrability of the class of disputes falling under section 7 of IBC makes the application liable to be rejected.

Furthermore, in the Booz Allen case[viii], it was specifically listed by the SC that “if the subject matter of a suit involved Insolvency and Winding up matters, then such cases were non-arbitral in totality.” Therefore, any dispute that falls out of the private fora of the two parties and causes a breach even unintentionally shall make arbitration impossible as it classifies as a matter related to right in rem.

The current stand of the case-law-based jurisprudence is sufficient to point towards an unstructured and unclear way of classifying a matter into the class of “right in rem” as there is no interpretation of the terms conclusively. The floodgates for divertive tactics in order to prevent arbitration comes from the fact that litigation is generally favourable to the party whose strategy is to prolong the dispute and the courts and tribunals having a huge backlog facilitates the same (A. Ayyasamy v. A. Paramasivam)[ix]. In the Booz Allen case[x], the court opened the floodgates to interpretational litigation when they stated that the subordinate rights related to personam that have arisen from a right in rem can be arbitrated. This comment over the flexibility of the right in rem vis a vis right in personam bifurcation has caused a lot of litigation since the court has to conduct a case-to-case evaluation of the dispute in question. Different interpretations by different High Courts and Supreme Court judges having to distinguish cases has made the questioning of the arbitrability of a dispute a favourable strategy to prevent payment of dues or as a pressure tactic against companies. Furthermore, the application of cases that interpreted the Arbitration Act 1940 such as Natraj Studios (P) Ltd. v. Navrang Studios[xi] has created further ambiguity since the 1996 A & C Act has a remarkable difference from the preceding statute and thus, precedents being used that have adjudicated the 1940 Act has also created huge jurisprudential inconsistencies.

Furthermore, IBC and the Arbitration Act are two totally different statutes operating in completely different fields. However, Sec. 238 of IBC is one such provision that gives the IBC an overriding power over all other statutes[xii]. Therefore, this overriding power of the IBC is evident enough to demonstrate its prevalence over the Arbitration Act.

Both the NCLT and the SC have interpreted both the IBC[xiii]and the Arbitration Act[xiv] respectively to be special laws. However, it has been held that when two special laws are in conflict then the one enacted later in time prevails.[xv] The prevalence of IBC is thus assured as it was enacted in 2016 while the Arbitration Act was legislated in 1996. Similar reiteration was seen in the case of ABG Shipyard Ltd v. ICICI Bank Ltd[xvi] where there was a conflict between Sec. 56 of the Electricity Act, 2003 and Sec. 14 of the IBC, the Supreme Court held that since both the statutes are special laws, IBC being later in time will prevail over the Electricity Act. Therefore, in the present case also IBC will prevail over Arbitration Act.

Keeping all the above arguments in mind, it can be concluded that there is no legal validity of arbitration in a case where Sec. 7 of IBC has been invoked. Although, in a recent judgment of Indus Biotech Private Ltd v. Kotak India Venture[xvii]the NCLT directed the parties to resolve their disputes through arbitration instead of accepting an application under Sec. 7 of IBC, however, the only reason that the AA favored arbitration was that it was not satisfied that a default has been done by the Corporate Debtor However, a stricter culture supporting and working towards an environment where arbitration is the norm and insolvency is the exception has to be created for a favorable environment for business organizations to thrive.

Endnotes:

[i]Lalit Ajmani, India: Application Under Section 7: A Brief Analysis, Mondaq (Dec. 05, 2020, 03:00 PM), https://www.mondaq.com/india/insolvencybankruptcy/623128/application-under-section-7-a-brief-analysis.

[ii]SCC OnLine NCLAT 70 (2017).

[iii]SGM Webtech Pvt. Ltd. v. Boulevard Projects Pvt. Ltd., (IB)-967(PB)/2018.

[iv]Vishesh Jain & Dhruv Sirpurkar, Arbitrability of Insolvency Disputes: A Case Study of the Kotak Group vs Indus Biotech Case, NUALSLAWJOURNAL (Dec. 05, 2020, 10:00 PM), https://nualslawjournal.com/2020/09/05/arbitrability-of-insolvency-disputes-a-case-study-of-the-kotak-group-vs-indus-biotech-case/.

[v]5 SCC 532 (2011).

[vi]Pioneer Urban Land & Infrastructure Ltd. v. Union of India, 8 SCC 416 (2018).

[vii]Haryana Telecom Ltd. v. Sterile Industries (India) Ltd., 5 SCC 688 (1999).

[viii]Supra note v.

[ix]10 SCC 386 (2016).

[x]Supra note v.

[xi]1 SCC 523(1981).

[xii]The Insolvency and Bankruptcy Code,2016, No. 31, Acts of Parliament, § 238, 2016 (India) – “The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.”.

[xiii]Jagmohan Bajaj v. Shivam Fragrances (P) Ltd., SCC OnLine NCLAT 413 (2018).

[xiv]Consolidated Engineering Enterprises v Principal Secretary, Irrigation Department & others, 7 SCC 169 (2008).

[xv]Suresh Babu vs Asst. Superintendent Of Police, (1) KLT 647 (2006).

[xvi]SCC OnLine NCLAT 30892 (2018).

[xvii]Indus Biotech Private Limited v. Kotak India Venture Fund-I, CP (IB) No.3077/2019.

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