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Arbitrability of Insolvency Disputes: An Analysis of The Indus Biotech Case

The author is Vinay Sachdev, fourth year student at Unitedworld School of Law, Karnavati University.


Introduction


The Interplay and Overlap between Arbitration and Insolvency has sparked a lot of debate. Recently, a Three-Judge Bench of the Hon'ble Supreme Court [hereinafter “SC”] in Indus Biotech (P) Ltd. v. Kotak India Venture (Offshore) Fund [hereinafter “Indus Biotech”, while dealing with a Section 11 application under the Arbitration and Conciliation Act, 1996 [hereinafter “Arbitration Act”] has finally decided the position of law as to the interplay between the Insolvency and Bankruptcy Code, 2016 [hereinafter “Code”] and Arbitration Act. The SC has held that when a Corporate Insolvency Resolution Process [hereinafter “CIRP”] petition under Section 7 is admitted, the dispute would be non-arbitrable. This article will seek to examine the legal implications of the overlap between arbitration proceedings and insolvency proceedings, unravel some patent flaws in the reasoning of the court and provide various alternatives to the SC's ruling.


Factual Background


In this case, the Kotak India Venture was a subscriber of Optionally Convertible & Redeemable Preference Shares (OCRPS) of the Indus Biotech company. While the dispute arose between both the parties with regard to the valuation of OCRPS, the redemption value became due and Indus Biotech failed in redeeming OCRPS. As a result, Kotak moved a Section 7 application under the Code for initiation of the CIRP claiming to be a financial creditor of Indus Biotech. As a counterblast to the said proceedings, Indus Biotech raised an application under the Arbitration Act stating that a Section 7 petition under the Code is not maintainable by virtue of the arbitration clause contained in the agreement. The NCLT Mumbai permitted the Arbitration Application filed by Indus and referred the parties to arbitration stating that there is no default,and as a consequence, the Section 7 petition stood dismissed. Being aggrieved by the order of the NCLT, Kotak filed a Special Leave Petition before the SC.


Understanding Competing Interest


The apparent conflict between the Arbitration Act and the Code cannot be studied in isolation to the interests which are embodied in them. The objective, nature, express provisions involved, and the implications must all be considered when studying these interests.


A. The Default Rule for Financial Debts


The ground “inability to pay” debts was one of six grounds for winding up under Section 271 of the Companies Act, 2013. The term "inability to pay " must be taken in the commercial sense of being unable to pay debts even if the company is solvent- an interpretation that was inefficient and time-consuming. Thus, the Code created the "default rule" to enhance predictability and corporate debtor value. Section 3(12) of the Code defines 'default' as non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor, as the case may be. The "default rule" means the debt is due and default has happened at the present moment. It allows the financial creditor to initiate the CIRP upon default as defined in the Code.


B. Timely Identification & Resolution of Assets


The Code's time-bound process protects a firm's financial creditors. The Code's Statement of Objects & Reasons states that it encourages entrepreneurship, stakeholder interests, and ease of doing business by amending insolvency laws. It aims to avoid a company's liquidation and maintain its existence to ensure creditor recovery. To achieve this, the Code provides timely CIRP for stressed assets and debt resolution, which prevents the decrease of market value of assets due to speculation and a high rate of depreciation.


C. Upholding Party Autonomy


On the contrary, Section 8 of the Arbitration Act requires the court to refer parties to the arbitration tribunal. The government realised that outmoded commercial dispute resolution laws will hinder economic reforms. The objective of the Arbitration Act is to reduce the function of courts as supervisors in order to encourage dispute resolution through arbitration. The Arbitration Act was amended to limit judicial intervention and strengthen party autonomy, as intended by the legislators.

ANALYSING THE POSITION TAKEN IN THE JUDGMENT


As discussed above, Arbitration and Insolvency systems represent conflicting interests. The arbitration regime aims to give the parties the option of using a private forum to settle their disputes. However, the insolvency regime seeks central adjudication for creditors of the corporate debtor. Thus the arbitrability of insolvency disputes under Section 7 of the Code was therefore referred to the SC for consideration. The SC made it clear in the case of Booz Allen that insolvency disputes cannot be arbitrated. The SC in the instance of Indus Biotech divided the case into two phases to shed light on this issue. In the first phase, the CIRP is between the corporate debtor and the creditor in the pre-admission phase (in personam). However, in the second phase after the admission, the CIRP turns against the world at large (in rem). The SC while referring to Vidya Drolia v Durga Trading Corporation stated that the admission of the Section 7 IBC petition results in the creation of third-party rights in all of the creditors and that the proceedings will start taking on an erga omnes effect. The SC further stated that once an insolvency petition is accepted under Section 7 of the Code, the matter is no longer subject to arbitration, therefore a Section 8 application cannot be permitted. The Corporate Debtor cannot either claim that the petition has been used to avoid arbitration proceedings or that the debt amount is in dispute. This draws attention to a loophole in the current system that prevents Corporate Debtors from bringing legitimate disputes. In instances such as the present case, where the dispute was regarding the interpretation of a contractual clause, arbitration could be invoked to determine the value of a debt, which would rather provide more clarity on the amount of total debt. The SC also concluded that Section 238 is a non-obstante provision of the Code, and has the authority to override all the other laws. This conclusion is in line with the rule that the later-enacted special statute will take precedence if two special statutes contain clauses that are incompatible.


The Next Step: Striking balance between the Code and the Arbitration Act


The question at hand is whether the Code's overriding effect on an arbitration clause based on the parties' consent violates the principle of party autonomy and is harmful to the growth of arbitration in the nation. Further, is there any approach to balance the interests of both acts? In Rakesh Malhotra v. Rajinder Kumar Malhotra, the Bombay High court examined a potential alternative and held the charges of oppression and mismanagement to be arbitrable in the case where the petition is found to be mala fide, vexatious, and "dressed up." The term "Dressed up Petition" refers to a petition that has been initiated with the explicit intent of removing the arbitration clause. In another case of Sonatarch v. Distrigas Corp, it was ruled that the arbitration proceedings would not be stayed when insolvency proceedings were intentionally initiated to interrupt the arbitration. This argument can be used to support arbitration in situations like the present case, where the dispute pertained to the valuation scheme and the Corporate Debtor was otherwise solvent.


Furthermore, the Code is a beneficial piece of legislation intended to revive the Corporate Debtor rather than providing a substitute for a recovery proceeding. Therefore, the questions that must be answered are firstly, whether the petition is "dressed up" or intended to avoid arbitration; secondly, whether the Corporate Debtor is otherwise solvent; thirdly, whether the dispute contains "non-core" insolvency issues- the term "non-core" refers to those disputes where parties can resolve the dispute through arbitration and insolvency proceedings are not required; and, lastly, whether arbitration processes will conflict with the purpose of the Code. Considering such findings on these, the NCLT may approve or reject a section 8 arbitration application. The adjudicating authority can balance the goals of both pieces of law in this way.


Conclusion


In Indus Biotech, the SC ruled that an Arbitration petition would not be maintainable after the insolvency petition under section 7 of the Code is admitted. In the author’s opinion, if insolvency applications are not permitted in certain circumstances as discussed above (on the satisfaction of the four conditions), financial creditors might use the Code as a weapon to avoid arbitration proceedings by choosing the forum that is most convenient for them, like the present case wherein the dispute was pertaining to the valuation scheme and the Corporate Debtor was otherwise solvent. Arbitration can be used to resolve disputes over the amount of financial debt when it is raised against a solvent company. To balance the objectives of the Arbitration Act and the Code to this end, this issue therefore needs to be addressed through either legislative or judicial action.

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