Vishesh Jain & Dhruv Sirpurkar
In June 2020, the Mumbai Bench of the National Company Law Tribunal (NCLT) pronounced its decision in the Kotak India Venture Fund vs Indus Biotech Pvt. Ltd. Case, dismissing the Section 7 IBC petition filed by Kotak. The court opined that the arbitration clause of the agreement was wide enough to cover the dispute going on between the two companies, hence the provisions of the Arbitration and Conciliation Act (ACA) will have an overriding effect over the Insolvency & Bankruptcy Code (IBC). This article aims to elaborate the position of law in India and abroad on arbitrability of Insolvency matters and further explains how the NCLT has erred in determining that the provisions of the ACA can prevail over the IBC.
Understanding the NCLT’s Judgement
In 2007, Kotak India venture fund subscribed to equity shares and Optionally Convertible Redeemable Preference Shares (OCRPS) issued by Indus Biotech Pvt. Ltd. Later, Kotak decided to convert these OCRPS into equity shares in accordance with their Share Subscription and Shareholders Agreement (SSSA). During the Qualified Initial Public Offering process, a dispute arose regarding the calculation and conversion formula to be followed while redeeming the OCRPS into equity shares. In view of resolving the dispute, Kotak decided to trigger the provisions of the SSSA, relating to the early redemption of the said OCRPS. Under the said SSSA, Indus Biotech chose to refer this dispute to Arbitration.
However, since Indus Biotech was unable to repay their debt, Kotak filed an application under Section 7 of the IBC to initiate a Corporate Insolvency Resolution Process (CIRP) against the corporate debtor. Challenging the said application, an Interim Application under Section 8 of the ACA, was filed by Indus, contending that the dispute in question was bound to be referred to Arbitration in accordance with the SSSA between the parties.
Indus Biotech contended that the arbitration clause provided in the SSSA is wide enough to cover the dispute between the parties. Since it’s a mere commercial dispute between the parties, it must be referred to arbitration following the provisions of the agreement. They further argued that it is a ‘dressed-up’ petition filed by Kotak to use the provisions of the IBC as a pressure tactic to extort money from profitable companies and drive them into insolvency. To substantiate these arguments, Indus relied on Rakesh Malhotra vs Rajinder Kumar Malhotra.
On the other hand, Kotak contended that a Section 7 IBC petition belongs to that class of litigation which falls out of the scope and ambit of arbitration as these matters are in rem. In Pioneer Urban Land and Infrastructure Ltd & another v Union of India & Others, the Supreme Court held that matters in rem inherently cannot be referred to arbitration. Further in Booz Allen and Hamilton Inc v SBI Home Finance Limited & others, the Apex Court has held that in matters where the subject matter is not arbitrable, Section 8 of the Arbitration and Conciliation Act would not be applicable even though the parties might have agreed to a valid arbitration clause for settling disputes.
The Hon’ble NCLT applied the “test of arbitrability” as provided in the Booz Allen judgement, and observed that judicial authorities have to refer the dispute to arbitration if an exhaustive arbitration clause is included in the SSSA. The court relied on Hindustan Petroleum Corporation Limited v Pinkcity Midway Petroleums, where the Supreme Court casts a duty on the courts to refer the disputes arising between contracting parties to the arbitration. The Supreme court also held that the language of Section 8 of the ACA is peremptory hence the judicial authorities have an obligation to refer parties to the arbitration.
Hence, the NCLT decided that pushing an otherwise solvent debt-free company into insolvency wouldn’t achieve any meaningful purposes. The disputes viz., valuation of shares and calculation and conversion formula and fixing of QIPO date are all arbitrable and hence the NCLT ruled in favour of Indus biotech Pvt. Ltd. and referred the matter to arbitration.
Are Insolvency Disputes Arbitrable
In India, the legislative policy has created a distinction between the proceedings in rem (such as winding-up) and proceedings arising out of right in personam (which are arbitrable). It has been established by the Supreme Court in Swiss Ribbons Private Limited and Another v. Union of India and Others that insolvency proceedings initiated under Section 7 of the IBC are proceedings in rem as they have an impact on the public at large. It is now pertinent to mention here that, in P. Anand Gajapathi Raju v. PVG Raju the court opined that judicial authority has an obligation to refer the disputes to arbitration between the contracting parties if such a clause exists. In the instant case, the court, while doing so, failed to consider the dicta in the Booze Allen and Hamilton Inc. v. SBI Home Finance Limited case, where the court noted that not all cases are arbitrable. The court specifically held that the proceedings which are in rem or can alter the position of public at large cannot be arbitrated and can only be decided by public fora.
Furthermore, if we look at the foreign jurisprudence concerning the issue of arbitrability of insolvency disputes, there seem to be many distinct observations. The English Court of Appeal in the Salford Estate (No.2) v. Altomart Ltd. while dealing with a disputed debt, which was subject to an arbitration agreement, observed that if the winding-up petition is not dismissed it will encourage the parties to bypass the arbitration clause by presenting winding up applications. However, the Singapore’s Court of Appeal in VTB Bank (Public Joint Stock Company) v. Anan Group ( Singapore) Pte Ltd. while opposing the view of the English decision in the Salford Case held that the “Salford approach is detrimental to the whole insolvency regime as it debars the creditors from recovering their legitimate dues from the debtor and will provide a way-out to the debtor from winding up petition, as they can transfer their dispute to arbitration”. In one of the most recent judgments of Sir Kwong Lam v. Petrolimex Singapore Pte Ltd, the Hong Kong Court of Appeal held that “it would make no sense to dismiss or stay an insolvency petition on the mere existence of the arbitration agreement”.
Thus, after a perusal of foreign jurisprudence, there appears to be a material irregularity among their observations on the issue of arbitrability of the insolvency disputes. On the other hand, the Indian jurisprudence makes it amply clear that insolvency proceedings being a proceeding in rem is not arbitrable per se.
Overriding Effect: IBC vis-à-vis Arbitration Act
In a case where the underlying debt relates to the contract where parties have decided to submit their disputes in arbitration, an overlap between arbitration and insolvency proceedings may arise. The judicial authority in that situation under Section 8 of the ACA has an obligation to refer the parties to the arbitration. At this juncture, it is pertinent to mention the dicta of the court in M/S Emaar Mgf Land Limited v. Aftab Singh where the court held that Section 8 of the ACA cannot be given such expansion where it besieges the intention of the special legislation.
However, the IBC under Section 238 itself provides for the overriding effect of IBC over any other law. Similarly, Section 5 of the ACA also provides for a non-obstante clause. Thus, making them both lex specialis. The question that arises then is which statute will prevail over the other as both the legislations are lex specialis. The Supreme Court in Shri Ram Narian v. The Shimla Banking and Industrial Co. Ltd., KLS and Industries Ltd. v. Arihant Threads Ltd. clarified the above mentioned situation and observed that lex posterior derogat priori i.e. when two statues lex specialis have provisions repugnant to each other, then the statue later in time shall prevail.
Thus, it is conclusively argued that the IBC will have an overriding effect over the ACA. Hence, the Hon’ble Mumbai bench of the NCLT has erred in dismissing the Section 7 IBC petition filed by Kotak Group.
Insolvency process is a time bound process which endeavours to revive the distressed companies and does not offer a recovery forum. As a matter of fact, insolvency proceedings are proceeding in rem impacting the public at large. Thus, if the NCLT prima facie observed that the company is solvent and the proceeding initiated against the company is not justifiable or just a proceeding for recovery, then the said application can be rejected by upholding the objective of the code, rather than submitting the dispute to arbitration. The NCLT has hence taken a contrasting view from the law laid down by the Apex Court in a catena of judgements and has set a wrong precedent by referring an insolvency dispute (which arises out of rights in rem) to the arbitration. It is hence concluded that the judgement of the NCLT is entitled to a review before the appropriate appellate forum i.e. NCLAT.
Vishesh Jain is a 4th year student and Dhruv Sirpurkar is a 3rd year student, both pursuing their law degrees from the National Law University, Odisha.