This article has been written by Sai Manoj Reddy. L, pursuing the Certificate Course in Advanced Civil Litigation: Practice, Procedure and Drafting from LawSikho. This article has been edited by Zigishu Singh (Associate, Lawsikho), and Smriti Katiyar(Associate, Lawsikho).
We all know that insolvency proceedings are non-arbitrable in India as they are the proceedings in rem and involve the rights of third parties. But if an issue arises when there is an application for institution of insolvency proceedings and an application to refer the same dispute to arbitration, then what happens in such cases? In this article, we will be answering this issue based on the latest judgment by the Supreme Court in Indus Biotech Private Limited v Kotak India Venture Fund.
Arbitrability of disputes in India
In India, even though we have a good Arbitration Act, it is being amended often to make India an arbitration-friendly country, there is no express definition or categorization of what kind of disputes are non-arbitrable. The jurisprudence and guidance regarding this topic have largely been through various judicial decisions by the apex court of the country. The judgement in Vidya Drolia v Durga Trading Corporation pronounced by the Supreme Court in December 2020 is the latest and most comprehensive one in determining what kind of disputes are non-arbitrable.
The Supreme Court in this case was required to determine the arbitrability of the disputes between a landlord & tenant which are solely determined in accordance with the Transfer of Property Act. Earlier a two-judge bench in Himangni Enterprises v Kamaljeet Singh Ahluwalia had decided this issue in negative in 2017. Later in 2019, a different two-judge bench in the Supreme Court disagreed with the ratio laid down in the Himangni Enterprises case and referred the case to be decided by a larger bench which led to the judgment in the Vidya Drolia case. The Supreme Court in this case has framed two main issues to be answered which are as follows:
- The meaning of the word non-arbitrability and when the subject matter of the dispute is not capable of being resolved through arbitration.
- The conundrum – ‘who decides’ – whether the court at the reference stage or the arbitral tribunal in the arbitration proceedings would decide the question of non-arbitrability.
To address these issues, the Supreme Court has come up with a fourfold test to determine what is arbitrable and what is not. The Supreme Court held that when the subject matter or cause of action in any dispute:
1. Relates to actions in rem that do not pertain to subordinate rights in personam that arise from rights in rem;
2. Affects third party rights, have erga omnes effect, require centralized adjudication, and mutual adjudication would not be appropriate;
3. Relates to the inalienable sovereign and public interest functions of the State; and
4. Is expressly or by necessary implication non-arbitrable under a specific statute.
In simple words, if an award is to be granted in a dispute against the world (Right in rem) or if their award affects third party rights or a sovereign function of a state or if it is expressly made clear in any statute that the dispute is non-arbitrable then in all such cases the disputes are non-arbitrable and have to be decided by the public forums (Courts/Tribunals etc.) only.
Arbitrability of insolvency disputes and major issues
In India, insolvency disputes are considered non-arbitrable because the resolution of an insolvency dispute involves the rights of third parties. This position has been created through many judicial decisions like Swiss Ribbons Private Limited v. Union of India, P. Anand Gajapati Raju v. PVG Raju and Booz Allen and Hamilton v. SBI Home Finance Limited where the courts have made a distinction between the right in rem and right in personam and decided that insolvency disputes are non-arbitrable. In simple words, when the insolvency proceedings begin against a person, all the other legal proceedings against such person will have stayed till the disposal of the insolvency proceedings which includes any pending arbitration proceedings as well.
The interplay between insolvency and the arbitration proceedings became more prominent in recent times. This is mainly because of the enactment of the new Insolvency & Bankruptcy Code in 2016 (IBC) which changed the entire regime of insolvency disputes in India. With this change in insolvency law, it can be seen that India is still at the nascent stage in incorporating this new insolvency code and also there are no provisions in the code that deals with the impact of the insolvency proceedings on the arbitrations except for the imposition of the moratorium. Similarly, there are no provisions in the Arbitration and Conciliation Act, 1996 that deal with the impact of the corporate insolvency resolution process (CIRP) on arbitrations.
It is also interesting to note that both the IBC, 2016, and the Arbitration Act, 1996 have certain overriding provisions. As both of these are special statutes a new issue needs to be decided as to which statute will prevail over the other. All these issues have been answered in the latest judgment by the apex court in Indus Biotech Private Limited v Kotak India Venture Fund.
Factual background and judgment of Supreme Court in the Indus Biotech case
In 2007, Kotak Venture Fund (Kotak) had subscribed to Optionally Convertible Redeemable Preference Shares (OCPRS) issued by Indus Biotech Pvt. Ltd. (Indus). Later Kotak decided to convert the OCPRS into equity shares and a dispute arose between Indus and Kotak regarding the valuation and calculation of OCPRS into equity shares. Indus had referred the dispute to arbitration and Kotak has filed an application under Section 7 of the IBC initiating Corporate Insolvency Resolution Process (CIRP) before the NCLT against Indus. Challenging this, Indus had contended that the dispute was bound to be referred to arbitration as the scope of dispute resolution clause covers the dispute raised. Indus had further argued that the current application under Section 7 is a ‘dressed-up’ application filed by Kotak to circumvent the arbitration proceedings and is a pressure tactic to extort money from Indus.
The NCLT applied the ‘test of arbitrability’ in this case and observed that the judicial authorities have to refer the matter to the arbitration if the dispute falls within the scope of the arbitration agreement/clause. Observing that the disputes related to valuation and calculation of converting the OCPRS and all other disputes in the current case falls within the scope of the arbitration agreement/clause, the NCLT has passed the order in favour of Indus and referred the matter to arbitration.
Aggrieved by the decision of the NCLT, Kotak has filed a special leave petition before the Supreme Court. The Supreme Court allowing the special leave petition filed by Kotak held that the insolvency proceeding stops being arbitrable from the point when the application under Section 7 of IBC for initiation CIRP is admitted by the NCLT. Further, the Supreme Court has observed that there is nothing wrong in NCLT dismissing the Section 7 application and the mere filing of the petition and its pendency cannot be construed as a trigger for an insolvency proceeding to be treated as proceedings in rem and only after the admission of such application the matter becomes non-arbitrable.
The Supreme Court further, without going into the issue regarding whether the NCLT has the power to refer the parties to arbitration has observed that the role of NCLT is to decide based on the material before it that, whether there is any default and debt payable by the company. If there is a default then naturally the application under Section 7 of IBC will be admitted and the matter becomes non-arbitrable. In case if there is no default then the application will be dismissed and the parties can go to arbitration. Thus the Supreme Court has upheld the dismissal of the Section 7 application by the NCLT but observed that the NCLT has to first decide the admissibility of the Section 7 application without looking if a section 8 application is pending or not. The admission or dismissal of the Section 7 application will by itself be construed whether the dispute is arbitrable or not.
Further, the Supreme Court while deciding the issue regarding the conflict between the non-obstante clause under Section 5 of the Arbitration Act and the overriding effect under Section 238 of the IBC stated that, as both are the special statutes the one which is enacted at a later date will prevail over the other.
This by the apex court makes it clear that once insolvency proceedings are admitted then the dispute becomes non-arbitrable. The biggest mistake made by the NCLT, in this case, was to refer the matter to arbitration when the correct thing to do would have been to see whether there is any default on part of Indus and if yes, then continue with the CIRP or else dismiss the case. Dismissing the Section 7 application under IBC based on the pendency of the Section 8 application under the Arbitration Act by the NCLT is not correct in my opinion.
The legislative intent behind enacting the Arbitration Act and amending it regularly is to make India an arbitration-friendly nation. The IBC is not meant to be a replacement for a recovery suit, rather it is enacted to help the insolvent and struggling companies to get back on their feet, at the same time balancing the interests of creditors. The judgment in the Indus case makes it clear that only after the admission of the CIRP application, the dispute becomes non-arbitrable. With the onset of COVID-19 and suspension of IBC for more than a year, it will be interesting to see the developments in the progress of insolvency proceedings and their impact on arbitration proceedings. There needs to be a balance between the interests of the corporate debtors and the parties who are proceeding with arbitration to resolve their disputes with such corporations. With the huge financial stress and failing business environment due to COVID-19, we will see an increase in the number of cases where arbitral proceedings will be marred due to the onset of insolvency proceedings against the corporate debtors and moratorium on all the arbitration proceedings.
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