Supreme Court on Arbitrability of Insolvency Law Disputes: The Case of Indus Biotech

[By Akshita Totla]

Akshita is a 4th year law student at the Institute of Law, Nirma University.

Recently, the Supreme Court in Indus Biotech Private Limited v Kotak India Venture (26 March, 2021) (Indus Biotech),[i] elaborately discussed the arbitrability of the insolvency law disputes in India. The SC in this case categorically held that post the admission of petition under section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC), the dispute would be non-arbitrable.  In this article, the author examines the position of law in India and other major jurisdictions on arbitrability of insolvency matters and concludes by providing possible alternatives to the approach adopted by the SC.

Factual Background

A dispute arose between Kotak and Indus Biotech in relation to the valuation of Optionally Convertible Redeemable Preference Shares (OCPRS) while they were being converted into equity shares. On account of failure of Indus Biotech in redeeming OCRPS within the stipulated time, Kotak triggered the IBC by filing an application for initiation of Corporate Insolvency Resolution Process (CIRP). Before the admission of CIRP application, Indus Biotech filed an application under section 8 of the Arbitration and Conciliation Act, 1996 (Arbitration Act), contending that section 7 IBC petition is not maintainable by virtue of the arbitration clause contained in the agreement. NCLT, Mumbai in 2020 allowed an insolvency dispute to be settled by arbitration by dismissing section 7, IBC application filed by Kotak observing that there is no default. In this backdrop, a Special Leave Petition was filed before the SC. The SC observed that where an application seeking reference to arbitration is filed during pendency of section 7, IBC petition, the adjudicating authority needs to first decide upon the maintainability of CIRP application. And upon admission of section 7 IBC petition, any application under section 8 of the Arbitration Act would thereafter be not maintainable.

IBC Proceedings are in rem after CIRP application is admitted

The insolvency proceedings are proceedings in rem i.e., having effect on the world at large.[ii] The SC in Booz Allen,[iii] categorically held that insolvency matters are non-arbitrable.  To provide more clarity on this issue, the SC in Indus Biotech divided the proceedings into two stages- pre-admission and post-admission stage. In the pre-admission stage, the insolvency proceedings remain in personam. While post the admission of CIRP application, the proceedings become in rem. The SC while referring to Vidya Drolia v Durga Trading Corporation,[iv]  noted that on admission of Section 7, IBC petition, third party rights are created in all the creditors, and the proceedings will have erga omnes effect. Thus, it is only upon admission that the matter would become non-arbitrable. In pre-admission stage wherein, the petition is filed by a financial creditor, the NCLT is only required to ascertain the existence of default. The Corporate Debtor (CD) cannot either contend that the petition is used as a tool to bypass arbitration proceedings or there is a dispute regarding the debt amount. This highlights a lacuna in the current framework which disallows CDs to raise bona fide disputes. In circumstances like that of present case, where the dispute was regarding the interpretation of a contractual clause, arbitration can be used as mechanism for quantifying debt. This would rather provide more clarity on the amount of financial debt.

Foreign Jurisprudence

In the UK, insolvency proceeding does not bar a party to proceed with arbitration. This position was established in Fulham Football Club Ltd v Richards (2011),[v] where the court of appeal ruled in the favor of arbitrability of shareholder unfair prejudice claim. The court of appeal also observed that arbitrability of insolvency law disputes would depend on the whether the dispute involves third party rights or not. For instance, disputes relating to a) order for the payment of debts owed by the insolvent company; b) determination of assets of the estate; or c) determination of schedule of claims, would affect the third-party creditors and would not be arbitrable. Recently, in Riverrock Securities Limited v International Bank of St. Petersburg (2020),[vi] the English High Court held that avoidance claims brought under the Russian insolvency law were contractual in nature and are hence, arbitrable. The court also noted that “the presumption that an arbitration agreement should not extend to claims which only arise on a company’s insolvency” would not arise in English Insolvency cases. This judgment demonstrates the pro-arbitration approach of the English courts, even in cases involving foreign insolvency law.

The courts of the United States, emphasize on the policy favoring commercial arbitration than the domestic notions of arbitrability as stated by Justice Blackman in Mitsubishi Motors Corp. v Soler Chrysler-Plymouth Inc. (1985),[vii] In the U.S., the arbitrability depends on whether the matter involves “core” or non-core” issues of insolvency. “Core” bankruptcy proceeding matters are considered non-arbitrable. These proceedings involve determination of rights created by federal bankruptcy law which could only arise in bankruptcy proceedings or a proceeding that could not have existed outside of bankruptcy. On the other hand, in “non-core” matters the court has to compel arbitration. In In re Electric Machinery Enterprises, Inc. (2007),[viii] the eleventh circuit while ordering arbitration held that dispute regarding contractual claim for the money owed was not a “core” proceeding. Furthermore, even if it was a “core” proceeding, there was no evidence indicating that the arbitration proceedings would have conflicted with the object of the Bankruptcy Code. The above-mentioned judgments suggest that the courts of both UK and US have tried to bring coherence in laws and maintain an approach that is consistent with the legislative policy of their respective arbitration laws.

The way forward: Is Reconciliation between the IBC and the Arbitration Act Possible?

The legislative intent behind the Arbitration Act is to develop arbitration friendly environment in the country. While the IBC aims to rescue corporate debtor within a specified limit by balancing the interest of all the stakeholders involved. Now, the issue here is whether overriding effect of IBC over an arbitration clause based on the consent of the parties, violates the principle of party autonomy and is detrimental to the development of arbitration in the country.  Moreover, is there any other way to reconcile the interest of both the acts? The possible alternative was discussed by the SC in Rakesh Malhotra v Rajinder Kumar Malhotra (2020),[ix] where the oppression and mismanagement allegations were held arbitrable in case the petition is found to be mala fide, vexatious and “dressed up”. “Dressed up Petition” is used to describe a petition which has been purposely initiated to oust the arbitration clause. In another case, SONATRACH v Distrigas Corp (1987),[x] it was held that where insolvency proceedings have been initiated to deliberately disrupt the arbitration, the arbitration proceedings would not be stayed. This argument can be used to justify arbitration in the circumstances like that of present case, where the dispute was pertaining to the valuation scheme and the CD was otherwise solvent.

Furthermore, IBC is not intended to be a substitute to a recovery proceeding rather it is a beneficial legislation intending to revive the corporate debtor. The UN Legislative Guide on Insolvency Law provides that an insolvency application can be rejected if a creditor substitutes insolvency proceedings as a debt recovery procedure; or attempts to force a viable business out of the market place; or attempts to obtain preferential payments by coercing the debtor.[xi] Thus, the prima facie issue which needs determination is firstly, whether the petition is “dressed up” or intended to substitute the IBC as a recovery code; secondly, whether the corporate debtor is otherwise solvent and thirdly, whether the subject-matter of the dispute involves “non-core” matters of insolvency; and lastly, whether arbitration proceedings will be in conflict with the objective of the IBC. After such determination, the NCLT can either allow or disallow section 8 arbitration application. Through this way the adjudicating authority can reconcile the objectives of both the legislations.

Concluding Remarks

Unlike the U.S. and UK courts, the courts in India have taken a stricter approach on arbitrability of insolvency laws. In the author’s opinion, if arbitration applications are not allowed in specific circumstances as discussed above (on the satisfaction of the four-fold test), the financial creditors can use IBC as tool to bypass the arbitration proceedings by opting for forum shopping as per their convenience. Disputes relating to quantum of financial debt when raised by a solvent company, can be settled by way of arbitration. Instead of delaying the insolvency process, this will rather provide clarity on the amount to the adjudicating authority. This error needs to be remedied through either a legislative action or a judicial action to reconcile the objectives of both Arbitration Act and IBC.

Endnotes

[i] Arbitration Petition (Civil) No. 48/2019 (SC).

[ii] Swiss Ribbons v Union of India, 2019 SCC Online SC 73.

[iii] (2011) 5 SCC 17.

[iv] (2021) 2 SCC 1.

[v] (2011) EWCA Civ 855.

[vi](2020) EWHC 2483 (Comm).

[vii] 473 U.S. 614, 629 (1985).

[viii] 479 F.3d 791 (11th Cir. 2007).

[ix] (2015) 192 CompCas 516 (Bom).

[x] 80 B.R. 606 (D. Mass. 1987).

[xi] UN General Assembly, Resolution No.59/40, Legislative Guide on Insolvency Law of the United Nations Commission on International Trade Law (2 December 2004) <https://undocs.org/pdf?symbol=en/A/RES/59/40> accessed 2 November 2020.

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *

Contact Us

Kerwa Dam Road., 
National Law Institute University, Bhopal
Madhya Pradesh, India. 462044​.

write to us at – cbcl@nliu.ac.in