Impact of arbitral disputes in the insolvency regime in India

In India, insolvency has become a preferred mode for creditors to enforce theirrights under a contract and/or a statute. The Insolvency and Bankruptcy Code, 2016 recognises these rights primarily for two types of creditors, financial and operational.

On admission of an application filed by any such creditor, the corporate insolvency resolution process commences. An order of initiation of the process declares the corporate to be insolvent against the world at large. Thus, such a judgment passed under the insolvency jurisdiction is a judgment in rem.

Under the Code, rights for a financial creditor become enforceable only on the existence of a default (Section 7 of the Code). However, for an operational creditor, in addition to the existence of default (Section 8 of the Code read with Section 9 of

the Code), non-existence of pre-existing dispute (Section 9 of the Code) is also to

be demonstrated.

Pendency of arbitral proceedings have a direct impact on the satisfaction of these tests. This article attempts to surface the extent of impact of such arbitration proceedings/disputes on the insolvency jurisdiction.

The impact of arbitral proceedings concerning determination of dispute under the

Code is quite clear. Dispute is defined under Section 5(6) of the Code to include a suit or arbitration proceeding relating to (a) existence of the amount of debt; (b) quality of goods or services; (c) breach of a representation or warranty. The Supreme Court in the case of Mobilox Innovation v. Kirusa Software, (2018) 1 SCC 353 while interpreting this provision has also recognised that pendency of arbitral proceedings with regar to the aforementioned or any other related ground amount to dispute under the Code. (See paragraph 54)

Default is non-payment of a whole or part of debt which has become due and payable. With regard to the impact of arbitral proceedings concerning ascertainment of default, the issue to be considered is whether determination of default (a) right in rem i.e. rights that bind the world large (b) right in personam i.e. inter-se rights (c) subordinate rights i.e. in personam rights subordinate to rights in rem. This is of relevance as rights in personam and subordinate rights are held to be arbitrable disputes as against pure rights in rem. These heads of rights were recognized by the Supreme Court in the case of Booz Allen and Hamilton Inc. v. SBI Home Finance Ltd, (2011) 5 SCC 532 in relation to arbitrability of intellectual property disputes (See paragraphs 37, 38)

2 The Supreme Court in the case of Kotak Venture v Indus Biotech Private Limited, [Arb P (Civil) 48 of 2019 with Civil Appeal No. 1070 of 2021 decided on 26/03/2021] has held that mere filing of the petition and its pendency before admission, cannot be construed a proceeding in rem and the same can be considered as a proceeding in rem only once the Adjudicating Authority recorded a finding of default and admitted a petition under the Code. Thus, one can safely conclude that determination of default is not a right in rem as it relates to the creditor(s) who have approached theAdjudicating Authority.

As a result, existence of dispute and ascertainment of default under the Code is an arbitral dispute and in my view would be in the nature of a subordinate right.

The law during the earlier days seems to have been that pendency of arbitral proceedings does not impact the initiation of corporate insolvency resolution process in a proceeding initiated by a financial creditor. In this regard, reference is made to the judgment of Adjudicating Authority, Delhi in the case of Reliance

Commercial Finance Limited v. Ved Cellulose Limited, (IB)156(PB)/2017; State Bank of India v. Sukam Power Limited, (IB)540(PB)/2017; (IB)1049/KB/2018; Shalby v. Dr. Pranav Shah (IA 285/17 in CP(IB) 123 of 2017).

However, then came the case of Indus Biotech Private Limited v Kotak India Venture Fund-I [IA No.3597/2019 in CP (IB) No.3077/2019] passed by Adjudicating

Authority, Mumbai. The application under Section 7 of the Code filed by Kotak

India Venture Fund-I was basis non-payment of Rs.367,08,56,503.00p by Indus Biotech Private Limited on account of invocation of right of redemption by Kotak Group under the share subscription agreement. Due to non-compliances by Indus

Biotech, it proposed to convert the Optionally Convertible Redeemable Preference

Shares invested by the Kotak Group into equity shares. The dispute centred around (a) the valuation of the Kotak’s Optionally Convertible Redeemable Preference Shares; (b) the right of the Kotak to redeem such Optionally Convertible

Redeemable Preference Shares when it had participated in the process to convert its

Optionally Convertible Redeemable Preference Shares into equity shares of the Indus Biotech; and (c) fixing of the Qualified Initial Public Offering date. Indus in this case preferred an application under Section 8 of the Arbitration and Conciliation

Act to refer the disputes to arbitration. The Adjudicating Authority, Mumbai while observing that the disputes raised were important determinates for ascertaining existence of default, it held that it was not satisfied that a default had occurred. Additionally, the Adjudicating Authority held 3 that “… … The invocation of arbitration in a case like this seems to be justified.” (See paragraph 5.14) The Adjudicating Authority, Mumbai while allowing the application under Section 8 of the Arbitration and Conciliation Act and dismissing the application under Section 7 of the Code also held that the Code mandates the Adjudicating Authority to ascertain and record satisfaction as to the occurrence of default before admitting the application. (See paragraphs 5.12, 5.13, 5.15, 5.16)

The judgment of Adjudicating Authority, Mumbai was challenged before the Honourable Supreme Court. Connected with it was an arbitration petition seeking appointment of an arbitrator to adjudicate upon the disputes that have arisen between Indus Biotech and the Kotak Group.

The Honourable Supreme Court upheld the decision of Adjudicating Authority,

Mumbai. With regard to the effect of filing of an application for reference of disputes under Section 8 of the Arbitration and Conciliation Act in a proceeding of insolvency initiated by a financial creditor under Section 7 of the Code, the Honourable Supreme Court observed that an application under Section 8 of the Arbitration and Conciliation Act would be maintainable in a situation where the petition under Section 7 of the Code is yet to be admitted. However, in a case where the application under Section 7 has already been admitted an application to refer disputes to arbitration would not be maintainable. Additionally, it was observed that in such a case, the Adjudicating Authority would be duty bound to first decide the application under Section 7 of the Code by recording a satisfaction with regard to there being default or not, even if the application under Section 8 of Act, 1996 is kept along for consideration. (See paragraph 27)

Thus, in the author’s view the Indus Biotech Case recognised the pendency of arbitral disputes impacting the existence of default in an application under Section 7 of the Code. It also recognised the maintainability of an application under Section 8 of the

Arbitration and Conciliation Act where an application under Section 7 of the Code is pending admission.

To conclude, (i) arbitral disputes impact applications under Section 7 and Section 9 of the Code; (ii) determination of default under the Code and existence of dispute under the Code are not in rem rights and are subordinate rights (iii) determinates of existence of default under the Code are arbitral disputes (iv) application under 4 Section 8 of the Arbitration and Conciliation Act, 1996 are maintainable prior to admission of an application under Section 7 of the Code.Ms. Eshna Kumar is an Advocate with commercial litigation before the Supreme Court of India, High Court of Delhi, National Company Law Tribunal, National Company Law Appellate Tribunal and other tribunals primarily relating to commercial matters. She regularly appears before various arbitral tribunals.

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