Between the Lines | Supreme Court: Insolvency process maintainable against Corporate Guarantor even if principal borrower is not a ‘Corporate Person’

The Supreme Court (“SC”) has in its judgment dated March 26, 2021, in the matter of Laxmi Pat Surana v. Union Bank of India and Another [Civil Appeal No. 2734 of 2020], held that a principal borrower need not be a ‘corporate person’ where insolvency proceedings are initiated against a company which acted as the corporate guarantor of the principal borrower.

Facts

The Union Bank of India (“Respondent”) had extended credit facilities to M/s. Mahaveer Construction (“Principal Borrower”), a proprietary firm belonging to Mr. Laxmi Pat Surana (“Appellant”), through two loan agreements entered into in the years 2007 and 2008 for term loans of INR 9.6 crores and INR 2.45 crores respectively.

M/s. Surana Metals Limited (“Corporate Debtor”), of which the Appellant was a Promoter/Director, had issued guarantees with respect to the aforementioned loan facilities of the Principal Borrower. Subsequently, on January 30, 2010, the said loan accounts were declared as being non-performing assets (“NPA”). Consequent to this, the Respondent issued a recall notice to the Principal Borrower on February 19, 2010, as well as the Corporate Debtor demanding repayment of the outstanding loan amount of INR 12,35,11,548/-. The Respondent also filed an application under Section 19 of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (“RDB”), against the Principal Borrower before the Debt Recovery Tribunal at Kolkata.

During the pendency of the above, the Principal Borrower repeatedly assured the Respondent of payment of the outstanding amount, but failed to do so, consequent to which, the Respondent issued a notice of payment dated December 3, 2018, to the Corporate Debtor under Section 4(1) of the Insolvency and Bankruptcy Code, 2016 (“Code”). In reply to the said notice dated December 3, 2018, the Corporate Debtor addressed a letter dated December 8, 2018, to the Respondent stating that it was neither the Principal Borrower nor did it owe any financial debt to the Respondent nor had it committed any default in repayment of the stated outstanding amount.

Pursuant to the above, the Respondent proceeded to file an application under Section 7 of the Code on February 13, 2019, towards initiating corporate insolvency resolution proceedings against the Corporate Debtor before the National Company Law Tribunal, Kolkata (“Adjudicating Authority”). The said application was resisted by the Corporate Debtor on several counts including on the preliminary ground that it was not maintainable as the Principal Borrower was not a “corporate person”. This ground was however rejected by the Adjudicating Authority by its judgment and order dated December 6, 2019, where under it held that the aforesaid application under Section 7 of the Code had been initiated against the Corporate Debtor as it was coextensively liable to repay the debt of the Principal Borrower and upon it having failed to do so despite the recall notice, the Corporate Debtor became liable to be proceeded against under Section 7 of the Code. The Appellant thereafter preferred an appeal before the National Company Law Appellate Tribunal, New Delhi (“Appellate Tribunal”) which, by the impugned judgment and order dated March 19, 2020, dismissed the appeal and affirmed the conclusion reached by the Adjudicating Authority under its judgment and order dated December 6, 2019. Aggrieved by the above, the Appellant approached the SC in the present appeal.

Issue

• Whether insolvency process is maintainable against a corporate guarantor even if the principal borrower is not a ‘corporate person’.

Arguments

Contentions raised by the Appellant:

The Appellant, inter alia, contended that Section 7 of the Code plainly ordains that an application can be filed by a financial creditor only against the corporate debtor. A corporate debtor can either be a corporate person who had borrowed money or a corporate person, who gives guarantee regarding repayment of money borrowed by another corporate person. In other words, the Code cannot apply in respect of “debts” of an entity who is not a “corporate person”. The Appellant further contended that this position is further reinforced by the fact that initiation of insolvency of firms and/or individuals in terms of Part III of the Code has still not been notified. Also, Section 2 of the Code came to be amended to clarify that partnership firms and proprietorship firms would fall within Part III of the Code on the basis of the differentiation made in the report of the Insolvency Law Committee in February, 2020. It was argued by the Appellant that any other view would inevitably result in indirectly enforcing the Code even against entities, such as partnership firms and proprietorship firms and/or individuals, who are governed by Part III of the Code, without notification thereof. It was further argued by the Appellant that a corporate guarantee extended in respect of a loan given to a “corporate person”, comes within the purview of Part II of the Code. This was reinforced by the insertion of the definition of “corporate guarantor” in the Code by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, which came into effect from June 6, 2018 (“Amendment Act”). The Appellant contended that since an application under Section 7 of the Code could not be maintained against the Principal Borrower itself, who was not a “corporate person”, it should follow that in respect of such transaction, no action under Section 7 of the Code could be maintained against a company or corporate person, merely because it had extended guarantee thereto.

Contentions raised by the Respondent:

The Respondent on the other hand contended that the liability of the Principal Borrower and of the Corporate Debtor was coextensive and coterminous, as predicated in Section 128 of the Indian Contract Act, 1872. Section 7 of the Code enabled the financial creditor to initiate corporate insolvency resolution process against a principal borrower if it was a corporate person, including against the corporate person being a guarantor in respect of loans obtained by an entity not being a corporate person. Aside from placing reliance on Section 7 of the Code, the Respondent also relied on the definitions of “corporate debtor” in Section 3(8), “debt” in Section 3(11), “financial creditor” in Section 5(7), and “financial debt” in Section 5(8) of the Code. The Respondent argued that upon conjoint reading of these provisions, it was crystal clear that a “financial debt” includes the amount of any liability in respect of any guarantee or indemnity for any money borrowed against interest. Consequently, the money borrowed by the sole proprietorship of the Appellant against payment of interest for which the Corporate Debtor stood guarantor, was also a “financial debt” of the Corporate Debtor and for that reason, the Respondent could proceed under Section 7 of the Code. It was further argued that the definition of “corporate guarantor” introduced by way of the Amendment Act was to define a corporate guarantor in relation to a corporate debtor against whom any corporate insolvency resolution process was to be initiated. The objection regarding maintainability of the application against a corporate guarantor was therefore devoid of merit.

Observations of the Supreme Court

The SC observed that Section 7 of the Code propounded the manner in which corporate insolvency resolution process may be initiated by the “financial creditor” against a “corporate person being the corporate debtor”. The expression “default” is expounded in Section 3(12) of the Code to mean non-payment of debt which had become due and payable and was not paid by the debtor or the corporate debtor, as the case may be. Section 7 of the Code is an enabling provision, which permits the financial creditor to initiate corporate insolvency resolution process against a corporate debtor. The corporate debtor could be the principal borrower and it could also be a corporate person assuming the status of corporate debtor, having offered guarantee, if and when the principal borrower/debtor (be it a corporate person or otherwise) committed default in payment of its debt.

The SC further observed that, the term “financial creditor” had been defined in Section 5(7) of the Code, which read with the expression “creditor” in Section 3(10) of the Code would include a person to whom a financial debt was owed and thereby comprise a person to whom such debt has been legally assigned or transferred to. This means that the applicant should be a person to whom a financial debt is owed. The SC noted that the expression “financial debt” has been defined in Section 5(8) of the Code. Amongst other categories specified therein, it could be a debt along with interest, which was disbursed against the consideration for the time value of money and would include the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub clauses (a) to (h) of the same clause. It has been provided in sub clause (i) of Section 5(8) of the Code to take within its ambit a liability in relation to a guarantee offered by the corporate person as a result of the default committed by the principal borrower. Further, the expression “debt” has been defined separately in Section 3(11) of the Code to mean a liability or obligation in respect of “a claim” which is due from any person including a financial debt and operational debt. The SC also observed that the expression “claim” would certainly cover the right of the financial creditor to proceed against the corporate person being a guarantor, due to the default committed by the principal borrower. It noted that the expression “claim” has been defined in Section 3(6) of the Code, to mean a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured or unsecured. It also means a right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment in respect of specified matters. Undoubtedly, a right or cause of action would enable to the lender (financial creditor) to proceed against the principal borrower, as well as the guarantor, in equal measure in case they commit default in repayment of the amount of debt acting jointly and severally. The SC noted that it would still be a case of default committed by the guarantor itself, if and when the principal borrower fails to discharge his obligation in respect of the amount of debt.

The SC also observed that the obligation of the guarantor was coextensive and coterminous with that of the principal borrower to defray the debt, as laid down in Section 128 of the Indian Contract Act, 1872. As a consequence of such default, the status of the guarantor metamorphosed into a debtor or a corporate debtor, if it happened to be a corporate person. If the guarantor was a corporate person (as defined in Section 3(7) of the Code), it would come within the purview of the expression “corporate debtor”, within the meaning of Section 3(8) of the Code. Further, the generic provision contained in Section 3(37) of the Code postulates that the words and expressions used and not defined in the Code, but defined in enactments referred to therein, shall have the meanings respectively assigned to them in those acts. Drawing support from this provision, it would follow that the lender would be a financial creditor within the meaning of the Code. The SC further observed that the principal borrower may or may not be a corporate person, but if a corporate person extends guarantee for the loan transaction concerning a principal borrower not being a corporate person, it would still be covered within the meaning of the expression “corporate debtor” under Section 3(8) of the Code. Thus, it was not possible to countenance the argument of the Appellant that as the Principal Borrower was not a corporate person, the Respondent could not have invoked the remedy under Section 7 of the Code against the Corporate Debtor who had merely offered guarantee for such loan account. The action could still be proceeded against the guarantor being a corporate debtor consequent to the default committed by the Principal Borrower.

The SC observed that Section 5(5A) of the Code, which defines the expression “corporate guarantor” to mean a corporate person, who is the surety in a contract of guarantee to a corporate debtor, was inserted by way of the Amendment Act to empower the national company law tribunals to deal with the insolvency resolution or liquidation processes of the corporate debtor and its corporate guarantor in the same tribunal pertaining to the same transaction. That, however, does not mean that proceedings under Section 7 of the Code cannot be initiated against a corporate person in respect of guarantee to the loan amount secured by a person not being a corporate person in case of default in payment of such a debt. Accepting the aforementioned argument of the Appellant would therefore result in diluting or constricting the expression “corporate debtor” occurring in Section 7 of the Code.

The SC also observed that the expression “corporate debtor” is defined in Section 3(8) of the Code which applies to the Code as a whole. Whereas, the expression “corporate guarantor” in Section 5(5A) of the Code, applies only to Part II of the Code. Upon harmonious and purposive construction of the governing provisions, it is not possible to extricate the corporate person from the liability (of being a corporate debtor) arising on account of the guarantee given by it in respect of a loan given to a person other than a corporate person. The liability of the guarantor is therefore coextensive with that of the principal borrower.

Decision of the Supreme Court

Dismissing the appeal, the SC found no substance in the argument advanced that since the loan was offered to a proprietary firm (not a corporate person), action under Section 7 of the Code could not be initiated against the corporate person even though it had offered guarantee in respect of that transaction. Accordingly, the present appeal was disposed of.

VA View:

The SC has, in arriving at its judgment in the instant matter, aptly interpreted the applicable provisions/sections of the Code and the Indian Contract Act, 1872, to determine that obligations of guarantors are coextensive and coterminous with those of principal borrowers to repay a debt. Accordingly, default on repayment of money loaned would change the position of a guarantor to that of the principal debtor within the meaning of Section 3(8) of the Code, if it happens to be a corporate person.

As has been rightly upheld by the SC, if credence is given to the argument that where the principal borrower is not a corporate person, then the financial creditor cannot invoke its remedy under Section 7 of the Code against the guarantor, it would lead to limitation of the intended width and application of Section 7 of the Code, which permits the initiation of corporate insolvency resolution process against the corporate guarantor, if and when default is committed by the principal borrower.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | Supreme Court: An application seeking reference to arbitration under Section 8 of the Arbitration and Conciliation Act is not maintainable, if filed after admission of an insolvency resolution petition under Section 7 of the Insolvency and Bankruptcy Code

The Hon’ble Supreme Court (“SC”) has in its judgment dated March 26, 2021 (“Judgement”), in the matter of Indus Biotech Private Limited v. Kotak India Venture (Offshore) Fund and Others [Arbitration Petition No.48 of 2019 with Civil Appeal No.1070/2021 arising out of SLP (C) NO. 8120 OF 2020], held that an application seeking reference to arbitration under Section 8 (Power to refer parties to arbitration where there is an arbitration agreement) of the Arbitration and Conciliation Act, 1996 (“Act”) is not maintainable if it is filed after admission of insolvency resolution petition under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of the Insolvency and Bankruptcy Code, 2016 (“IBC”).

Facts

The arbitration petition was filed by Indus Biotech Private Limited (“Petitioner”) under Section 11 (Appointment of arbitrators) of the Act, for appointment of an arbitrator on behalf of the respondents (defined below) so as to constitute an arbitral tribunal to adjudicate upon the disputes that arose between the parties. The petition was filed before the SC as the ambit of the dispute qualified as international arbitration, since the respondent no.1, Kotak India Venture (Offshore) Fund, was based in Mauritius. The respondents no. 2 to 4 were Indian entities and sister ventures of respondent no.1 (respondents no. 1 to 4 are collectively referred to as “Respondents”). The said petition seeking constitution of the arbitral tribunal emanated from the share subscription and shareholders agreements dated July 20, 2007, July 12, 2007, January 09, 2008 and the supplemental agreements dated March 22, 2013 and July 19, 2017 (“Agreements”). The Agreements undisputedly provided for an arbitration clause to settle any dispute that arose between the parties. Further, the Petitioner stated that since the subject matter involved was the same under the Agreements, therefore, the arbitration could be conducted by a single arbitral tribunal even in respect of similar disputes that arose with the abovementioned respondents no. 2 to 4. Hence a common petition was filed before the SC.

The Respondents, through the Agreements, had subscribed to equity shares and optionally convertible redeemable preference shares (“OCRPS”) of the Petitioner. During the business operations, a decision was taken to make a qualified initial public offering (“QIPO”) by the Petitioner. However, under Regulation 5(2) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”), a company was not entitled to make QIPO, if it had any outstanding convertible securities or any other right which would entitle any person with an option to receive equity shares of the issuer. Therefore, it was necessary for the Respondents to convert their OCRPS into equity shares. In the process of negotiations, as per the formula applied by the Respondents, it was claimed that they would be entitled to 30% of the total paid-up share capital in equity shares. The Petitioner relied on the reports of the auditors and valuer to state that the Respondents would be entitled only to 10% of the total paid-up share capital paid by the Respondents as per their conversion formula. Therefore, there was a dispute on the formula that had to be applied for the conversion of the OCRPS.

The Respondents stated that, on redemption of OCRPS, approximately INR 367 crores was due and payable by the Petitioner. Therefore, the Respondents had demanded the said amount, and since the same had not been paid by the Petitioner, it was stated that it constituted default. Therefore, respondent no. 2 had filed a petition under Section 7 of the IBC before the National Company Law Tribunal, Mumbai (“NCLT”). In the said petition, the Petitioner filed a miscellaneous application under Section 8 of the Act, seeking a direction to refer the parties to arbitration. The NCLT, by its order dated June 09, 2020 (“Impugned Order”), allowed the application filed under Section 8 of the Act by the Petitioner. Consequently, the petition filed by the Respondent under Section 7 of the IBC was dismissed. This appeal before the SC was filed against the Impugned Order along with the arbitration petition.

Issue

• Whether an application seeking reference to arbitration under Section 8 of the Act is maintainable, if it is filed after admission of an insolvency resolution petition under Section 7 of the IBC.

Arguments

Contentions raised by the Petitioner:

The Petitioner submitted that the dispute in question was with regard to the appropriate formula to be adopted to arrive at the actual percentage for the conversion of the OCRPS into equity. The Petitioners referred to the board meetings held on March 14, 2018, April 06, 2018 and April 10, 2018, wherein matters related to QIPO and the conversion of the OCRPS were discussed. It was noted that the nominee director representing the Respondents also attended the meeting. It was submitted that, the said events prima facie indicated that the process of converting the OCRPS into equity shares and the allotment thereof was an issue which had already commenced a while before the redemption date agreed upon, that is, December 31, 2018, had arrived.

The Petitioner submitted that, until an amicable decision was taken, there arose no liability to repay the amount. Hence, there was no ‘debt’ nor ‘default’ on part of the Petitioner. It was further submitted that, it was not a case that the Petitioner was unable to pay, rather, the Petitioner was a profit-making company. Therefore, the Petitioner contended that the said dispute was to be resolved through arbitration by the arbitral tribunal.

Contentions raised by the Respondents:

It was submitted that, the fact that the Respondents had subscribed to the OCRPS was not in dispute and a sum of approximately INR 367 crores constituted a debt that was due and payable by the Petitioner. The Respondents had demanded the said amount and since the same had not been paid by the Petitioner, it constituted default. The Petitioner having defaulted, a cause of action arose for the Respondents to invoke the jurisdiction of the NCLT for initiation of corporate insolvency resolution process (“CIRP”) under Section 7 of the IBC.

The NCLT should have proceeded strictly in accordance with the procedure contemplated under Section 7 of the IBC. A serious error had been committed by the NCLT, that is, the consideration of an application filed under Section 8 of the Act, as it was without jurisdiction. The dispute sought to be raised was not arbitrable after the insolvency proceeding had commenced. The Respondents contended that, when it was shown that the debt was due and the same has not been paid, the NCLT should have recorded default and admitted the petition. Further that, even in such a situation, the interest of the Petitioner was not jeopardised inasmuch as the admission order of the NCLT was appealable to the National Company Law Appellate Tribunal and thereafter to the SC, where the correctness of the order in any case would be tested.

The ratio as laid down in Swiss Ribbons Private Limited and Another v. Union of India and Others [(2019) 4 SCC 17] was referred, to contend that when the petition under Section 7 of the IBC was triggered, it becomes a proceeding in rem and even the creditor who had triggered the process would lose control of the proceedings as CIRP was required to be considered through the mechanism provided under the IBC and that the insolvency and winding up matters are non-arbitrable.

Observations of the Supreme Court

The SC took note of the scope of proceedings provided under Section 7 of the IBC and referred to the observations made in the case of Innoventive Industries Limited v. ICICI Bank and Another [(2018) 1 SCC 407] and observed that, the provision contemplated that, in order to trigger an application, four factors should be in existence: (i) there should be a ‘debt’ (ii) ‘default’ should have occurred (iii) debt should be due to ‘financial creditor’ and (iv) such default which has occurred should be by a corporate debtor. The SC noted that a duty was cast on the NCLT to ascertain the existence of a default, if shown from the records/evidence furnished by the financial creditor.

The SC noted that, even if there was a debt in strict sense of the term, the facts in a particular case must be taken into consideration by the NCLT before arriving at a conclusion as to whether a default had occurred. The SC noted that the Petitioner was entitled to point out that the default had not occurred and that the debt was not due. Resultantly, if there was no default proven and if the NCLT was satisfied that the Petitioner was a profit-making company, the NCLT consequently had to reject the application as provided under Section 7(5)(b) of the IBC. However, if it was found that there was default, the NCLT had to admit the application under Section 7(5)(a) of the IBC and the CIRP would commence. The SC observed that in such an event, it would become a proceeding in rem on the date of admission of the application and from that point onwards the matter would not be arbitrable. The SC noted that the only course to be followed thereafter would be the resolution process under the IBC. Therefore, the trigger point for a proceeding to become a proceeding in rem, would not be the filing of an application under Section 7 of the IBC, but admission of the same on determination of default. The SC observed that it could not be said that by the procedure prescribed under the IBC it meant that the claim of the creditor, if made before the NCLT, more particularly under Section 7 of the IBC, was sacrosanct and the Petitioner was denuded of putting forth defence contending that the default had not occurred.

The SC noted that, in the present case when the process of conversion had commenced and certain steps were taken in that direction, and a clause in the Agreements provided that the redemption value shall constitute a debt outstanding, however, certain aspects of the transactions were still being negotiated between the parties. The SC specifically noted that, the parties had not concluded which formula had to be applied for the conversion of OCRPS, that is, whether conversion percentage was 30% or 10% of the equity shares. The SC noted that it would not have been appropriate to hold that there was default and to admit the petition merely because a claim was made and a petition was filed by the Respondents. The SC cautioned that, if in every case where there was debt, if default was also assumed and the process became automatic, a company which was running its administration and discharging its debts in planned manner could be pushed into CIRP and entangled in a proceeding with no point of return.

As contended by the Respondents, the SC noted that, the order of the NCLT to admit or reject the application filed under Section 7 of the IBC was appealable. The issue to be analysed was, whether a grave error was committed by the NCLT in the Impugned Order. The SC observed that, if the case had reached the status/stage of a proceeding in rem, only then an observation to allow parties to invoke arbitration would not be justified and sustainable. In the instant case, the SC noted that, the petition under Section 7 of the IBC was yet to be admitted and, therefore, had not assumed the status of a proceeding in rem. For purposes of understanding the tests to be applied to determine as to when the subject matter was not arbitrable, that is, the actions in rem was not arbitrable, the SC referred to the exhaustive consideration and the ratio laid down in the case of Vidya Drolia and Others v. Durga Trading Corporation [2021 2 SCC 1] wherein it clarified that a dispute will be non-arbitrable when a proceeding is in rem. A proceeding under the IBC is to be considered in rem only after it was admitted. On admission, third-party right will be created in all creditors of a corporate debtor and will have erga omnes effect, that is, it affects the rights and liabilities of persons who are not bound by the arbitration agreement. The SC observed that in the instant case the position was otherwise.

The SC observed that the underlying principle, as noted in Swiss Ribbons (supra) was that, for a petition under Section 7 of the IBC to be considered as proceedings in rem, it was necessary that the NCLT ought to have applied its mind, recorded a finding of default and admitted the petition. The SC observed that the admission of the petition and commencement of the CIRP was the relevant stage which would decide the trigger of a proceeding in rem. The SC with regards to the instant case, noted that, the issue for consideration arose in a petition filed under Section 7 of the IBC, before it was admitted. Therefore, it was not yet an action in rem. The SC noted that in such an application, the course to be adopted by the NCLT, if an application under Section 8 of the Act was filed seeking reference to arbitration, required consideration. The SC noted that, the position of law that the IBC shall override all other laws as provided under Section 238 of the IBC needed no elaboration. In that view, notwithstanding the fact that the Petitioner filed an application under Section 8 of the Act, the independent consideration of the same dehors the application filed under Section 7 of the IBC and materials produced therewith would not arise. The NCLT was duty bound to advert to the material available to indicate default. This is for the reason that, keeping in perspective the scope of the proceedings under the IBC and there being a timeline for the consideration to be made by the NCLT, the process cannot be defeated by a corporate debtor by raising moonshine defence only to delay the process.

The SC observed that, even if an application under Section 8 of the Act was filed, the NCLT had a duty to advert to the contentions raised to determine if there is substance in the defence in the application filed under Section 7 of the IBC, and further to examine the material placed before it by the financial creditor so as to arrive at the conclusion whether default existed or not. If the irresistible conclusion by the NCLT was that there was default and the debt was payable, due to which the NCLT proceeded to pass an order to admit the application, the proceedings would then get itself transformed into a proceeding in rem having erga omnes effect, due to which the question of arbitrability of the inter se dispute sought to be put forth would not arise and thereby the bogey of arbitration to delay the process would not arise. The SC further observed that, on the other hand, on such consideration made by the NCLT if the conclusion was that there was no default committed, the petition would stand rejected. Consequently, the parties could secure appointment of the arbitral tribunal in an appropriate proceeding as per applicable law and the need for the NCLT to pass any order on such application under Section 8 of the Act would not arise.

The SC reverted to the fact situation in this case, and perused the Impugned Order. The SC noted that, the NCLT though had taken up the application filed under Section 8 of the Act, as the lead consideration, the petition filed under Section 7 of the IBC was also taken alongside and made a part of the consideration. A further perusal of the Impugned Order disclosed that, the NCLT was conscious of the fact that consideration of the matter before it, any further, would arise only if there was default and the debt was payable by the Petitioner. The Impugned Order of the NCLT could not be faulted, since a reference was made to the documents produced along with the application and it was concluded that the allotment of equity shares against the OCRPS, in view of the QIPO, was still a matter of negotiation between the parties and no conclusion had been arrived at so as to term it as default. The SC further noted that, in paragraphs 5.14 and 5.15 of the Impugned Order, the NCLT categorically recorded that, from the material available on record, they were not satisfied that a default had occurred and had rightly, in that context, held that the claim of the company by invoking the arbitration clause was justified and had left it for further consideration of the SC.

The SC noted that, in a letter dated November 21, 2018, addressed by the Petitioner to the Respondents, it was mentioned that the fundamental issue that had to be considered was conversion of OCRPS into equity shares, since the process of QIPO initiated could not move forward without such conversion. The letter dated December 17, 2018, addressed to the Petitioner by the Respondents referred to the stake in conversion and the dispute being as to whether it should be 10% of the share capital as offered by the Petitioner or 30% as claimed by the Respondents. It was that aspect of the matter, contended to be in dispute between the parties, regarding which the arbitration was sought by the Petitioner.

In such a situation, the SC opined that it would be premature at this point to arrive at a conclusion that there was default in payment of any debt until the said issue was resolved and the amount repayable by the Petitioner to the Respondents with reference to equity shares was determined. The SC observed that subsequently in the process, if such determined amount was not paid, it would amount to default at that stage. The SC therefore observed that, the prayer made by the Petitioner for constitution of the arbitral tribunal as made in the instant petition filed under Section 11 of the Act, was justified.

Decision of the Supreme Court

The SC held that though in the operative portion of the Impugned Order the application filed under Section 8 of the Act was allowed and as a corollary the petition under Section 7 of the IBC was dismissed, in the facts and circumstances of the present case, it should be construed in the reverse. Hence, the SC upheld the conclusion arrived at by the NCLT that there was no default, hence the dismissal of the petition under Section 7 of the IBC at that stage was justified. Though the application under Section 8 of the Act was allowed, the same in any event would be subject to the consideration of the petition filed under Section 11 of the Act, before the SC. The SC then proceeded to allow the instant arbitration petition filed by the Petitioner.

VA View:

The SC through this Judgement has rightly observed that in any proceeding which was pending before the NCLT under Section 7 of the IBC, if such petition is admitted by the NCLT, then any application under Section 8 of the Act made thereafter will not be maintainable, since the proceedings would be in rem and would create third party rights.

In a situation where the petition under Section 7 of the IBC was yet to be admitted and, in such proceedings, if an application under Section 8 of the Act was filed, the NCLT was duty bound to first decide the application under Section 7 of the IBC, even if the application under Section 8 of Act is kept along for consideration. Therefore, in such an event, the natural consequence of the consideration made therein on the Section 7 application would befall on the application under Section 8 of the Act.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | Supreme Court: The parties to a contract who are Indian nationals or companies incorporated in India can choose a forum for arbitration outside India

The Hon’ble Supreme Court (“SC”) has in its judgment dated April 20, 2021 (“Judgement”), in the matter of PASL Wind Solutions Private Limited v. GE Power Conversion India Private Limited [CIVIL APPEAL NO. 1647 OF 2021], held that the parties to a contract who are Indian nationals or companies incorporated in India can choose a forum for arbitration outside India.

Facts

PASL Wind Solutions Private Limited (“Appellant”) and GE Power Conversion India Private Limited (“Respondent”) were companies incorporated under the Companies Act, 1956. In 2010, the Appellant had issued 3 purchase orders to the Respondent for supply of certain converters. Subsequently, disputes arose between the parties in relation to the expiry of the warranty of the said converters. Therefore, the parties entered into a settlement agreement dated December 23, 2014 (“Agreement”). Under the Agreement, it was provided that Zurich will be the seat for the arbitration and the arbitration proceedings shall be conducted by a sole arbitrator. Further, the Respondent agreed to provide certain delta modules along with warranties on these modules for the working of the converter panel. However, disputes arose again between the parties, whereby the Appellant claimed that, warranties for converters were not given. The Respondent argued that the warranties covered only the delta modules. Thus, on July 03, 2017, the Appellant issued a request for arbitration to the International Chamber of Commerce.

On August 18, 2017, the parties agreed to resolve disputes by way of arbitration and for that, the substantive law applicable would be the Indian law. The Respondent filed a preliminary application challenging the jurisdiction of the arbitrator on the ground that two Indian parties could not have chosen a foreign seat of arbitration. The Appellant contended that there was no bar in law. By Procedural Order No. 3 dated February 20, 2018 (“Order”), the arbitrator dismissed the Respondent’s preliminary application. The Order stated that the seat of arbitration was Zurich. The Respondent suggested Mumbai as a convenient venue to hold arbitration proceedings . At the Management Conference dated June 28, 2018, the arbitrator decided that even though the seat was Zurich, all hearings would be held in Mumbai.

An award dated April 18, 2019 (“Award”) was passed, rejecting the Appellant’s claim. As the Appellant failed to pay the amounts granted by the Award, the Respondent initiated enforcement proceedings under Sections 47 (Evidence) and 49 (Enforcement of foreign awards) of the Arbitration and Conciliation Act, 1996 (“1996 Act”) and an interim application under Section 9 of the 1996 Act before the Gujarat High Court (“GHC”), within whose jurisdiction the assets of the Appellant were located. The GHC in the impugned judgment allowed the enforcement proceedings. Further, it was held that the Section 9 (Interim measures, etc., by Court) application was not maintainable since it is available for international commercial arbitrations (“ICA”) as specified in the proviso to Section 2(2) of the Act, and ICA as defined under Section 2(1)(f) of the 1996 Act requires at least one foreign party. This judgement of the GHC was challenged before the SC.

Issue

Whether two Indian companies can choose a neutral forum for arbitration outside India. In doing so, does the public policy of India interdict the party autonomy of such persons.

Arguments

Contentions raised by the Appellant:

• A seat of arbitration cannot be designated outside India by 2 Indian parties as it would be contrary to Section 23 (Considerations and objects that are lawful) of the Indian Contract Act, 1872 (“Contract Act”), read with Sections 28 (Rules applicable to substance of dispute) and 34 (Application for setting aside arbitral award) of the Act. Further, by designating a seat outside India, it will also be open to the Indian parties to opt out of the substantive law of India, which would be contrary to the public policy of India.
• The foreign awards contemplated under Part II of the 1996 Act arise only from ICA. “ICA”, is defined in Section 2(1)(f) of the1996 Act and requires a foreign element when parties arbitrate outside India, that is, at least one of the parties is, inter alia, a national of a country other than India, or habitually resident in a country other than India, or a body corporate incorporated outside India. In the instant case, due to lack of a foreign element, the Award cannot be designated as a foreign award.
• The proviso to Section 2(2) of the 1996 Act was referred to state that, it furnished a bridge that joined Part II to Part I, as a result of which it became clear that Section 44 (Part II, Chapter I, Definition) of the 1996 Act refers only to ICA, as is stated in the said proviso. The 1996 Act is a self-contained code. In the absence of a foreign element, the Award cannot be the subject matter of challenge or enforcement either under Part I or Part II of the Act.
• It was argued that, there is a conflict between Section 10(3) of the Commercial Courts, Commercial Division and Commercial Appellate Division of High Courts Act, 2015 (“CCA”) and Section 47 of the Act. Further, by relying upon the non-obstante clause in Section 21 of the CCA, it was mentioned that the CCA must prevail. It was finally submitted that, the impugned judgment made by the GHC was made without jurisdiction because the present was not a case of an ICA but instead fell under the second category of “other than ICA”, as a result of which only a ‘district court’ would have jurisdiction.

Contentions raised by the Respondent:

• The Respondent first pointed out that the Appellant argued the exact opposite of what it itself sought under the Order, thus, it would now not be open to the Appellant to argue the exact opposite before the SC.
• Part I and Part II of the 1996 Act have been held to be mutually exclusive.
• Section 44 of the 1996 Act is modelled on the New York Convention which only requires “persons”, both of whom can be Indian, having disputes arising out of commercial legal relationships, which are to be decided in the territory of a State outside India, which State is a signatory to the New York Convention. Any attempt to breach the wall created between Part I and Part II, as held to be mutually exclusive in Bharat Aluminium Co. v. Kaiser Aluminium Technical Services Inc. [(2012) 9 SCC 552] (“BALCO”), cannot be approved by the SC.
• Both in the proviso to Section 2(2) of the 1996 Act and Section 10 of the CCA, the phrase “ICA” is not governed by the definition contained in Section 2(1)(f) of the Act, but would only refer to arbitrations in which the seat is outside India.
• Unlike the definition of “ICA” in Part I, under Section 44 (Part II) of the Act, nationality, domicile or residence of parties are irrelevant. Further, this is no longer res integra as it has been expressly decided under the pari materia provisions of the Foreign Awards (Recognition and Enforcement) Act, 1961 (“FAA”), in Atlas Export Industries v. Kotak & Co. [(1999) 7 SCC 61], that 2 Indian parties can enter into an arbitration agreement with a seat outside India, and resultant award would then be enforced as a foreign award.
• Further, relying upon a commentary on ICA published by the United Nations Conference on Trade and Development in 2005, it was argued that parties from the same State can agree to have their disputes resolved in a State other than the State to which they belong, as a result of which the New York Convention will then apply to enforce the aforesaid foreign award.
• Neither Section 23 nor Section 28 of the Contract Act condemns the choice of a foreign seat in arbitration. As a matter of fact, the Section 28 of the Contract Act expressly provides an exception for arbitration from the clutches of Section 28 of the Contract Act, that is, an express approval to party autonomy.
• Further, in Section 23 of the Contract Act, mention of “public policy” must be confined to clear and incontestable cases of harm to the public. Reliance was placed on paragraph 118 of BALCO (supra) to argue that Section 28(1) of the 1996 Act would apply only when the arbitration takes place in India and not when the seat is outside India.

Observations of the Supreme Court

Parts of the 1996 Act are mutually exclusive, Scope of Section 9 application and Scope of ICA:

The SC noted the relevant provisions of the1996 Act and also relied on the case of BALCO (supra) to conclude that, Part I and Part II of the 1996 Act are mutually exclusive. The SC analysed that, Part I deals with arbitrations where seat is in India and has no application to a foreign-seated arbitration. Further that, Part I is a complete code governing various aspects of arbitration proceedings and that a recourse to a court against an arbitral award may be made by an application for setting aside such an award, inter alia, under Section 34(2A) of the Act. On the other hand, Part II is not concerned with the arbitral proceedings but with enforcement of foreign awards in India. Therein, Chapter I deals with the enforcements of awards to which the New York Convention applies. Only exception being Section 45 of the Act, that deals with referring the parties to arbitration in the circumstances mentioned therein. Therefore, the SC also concluded that, Part II does not apply to arbitral proceedings once commenced in a country outside India.

Further, Section 2(2) of the1996 Act specifically states that Part I applies only where the place of arbitration is in India. It is a settled law that a proviso cannot travel beyond the main enacting provision as held in a number of cases. Therefore, the argument of the Appellant that the proviso to Section 2(2) of the 1996 Act was a bridge which connected the two parts of the Act, was rejected.

The SC noted that, the Respondent, by way of cross objection, had challenged the finding of the GHC that, an application under Section 9 of the 1996 Act would not be maintainable. The SC further observed that, the judgment in Bhatia International v. Bulk Trading S.A. [(2002) 4 SCC 105] (“Bhatia”) had incorrectly held that Section 9 of the 1996 Act would apply to arbitrations which take place outside India without any express provision to that effect. It was noted that the judgment of Bhatia (supra) had been expressly overruled in BALCO (supra) and pursuant thereto, a proviso to Section 2(2) of the 1996 Act was inserted to clarify that, in an arbitration which takes place outside India, assets of one of the parties are situated in India and interim orders are required qua such assets, the courts in India may pass such orders. Consequently, this part of the impugned judgment of the GHC was set aside.

The SC noted that, the four sub-clauses contained in the definition of “ICA” in Section 2(1)(f) of the 1996 Act clarify that the expression “ICA” contained therein is party-centric in the sense that at least one of the parties should, inter alia, be a person who is a national/habitual resident in any country other than India. However, on the other hand, the expression “ICA” is specifically spoken of in the context of a place of arbitration being between two parties in a territory outside India, as provided by Section 44 of the Act. The New York Convention applying to such territory, thus makes it an ICA. The SC noted that, under Section 44 of the Act, for an award to be designated as a foreign award, the following criteria are required to be fulfilled:

• the dispute must be considered to be a commercial dispute under the law in force in India;
• it must be made in pursuance of an agreement in writing for arbitration;
• it must be a dispute that arises between “persons” (without regard to their nationality, residence, or domicile); and
• the arbitration must be conducted in a country which is a signatory to the New York Convention.

The SC observed that, all conditions mentioned above were satisfied in the facts of this case. Further, the context of Section 44 of the 1996 Act was party-neutral, having reference to the place at which the award was made. Therefore, the argument that the very basis of Section 44 of the 1996 Act should be altered when two Indians have their disputes resolved in a country outside India was rejected. The SC also noted that, the argument of the Appellant would involve bodily importing the expression “ICA” into Section 44 of the Act, which cannot be done because of the opening words of the said section, “In this Chapter”, that is, Chapter I of Part II, and then applying the definition contained in Section 2(1)(f) (Part I) of the 1996 Act, must now be applied to Part II. The SC observed that, no canon of interpretation would permit acceptance of such an argument.

Public Policy and Party Autonomy:

The SC referred to the judgment of Atlas (supra) wherein it was held that, “Merely because the arbitrators are situated in a foreign country cannot by itself be enough to nullify the arbitration agreement when the parties have with their eyes open willingly entered into the agreement”. Therefore, the SC categorically held that a foreign award cannot be refused to be enforced merely because it was made between two Indian parties, under pari materia provisions of the FAA. The SC therefore, was unable to accede to the contention that Atlas (supra) cannot be regarded as an authority for the proposition that Sections 23 and 28 of the Contract Act are out of harm’s way when it comes to enforcing a foreign award under the FAA, where both parties are Indian companies.

The SC noted that the expression “public policy” appearing in Section 23 of the Contract Act is a relative concept capable of modification. The freedom of contract needs to be balanced with clear and undeniable harm to the public, even if the facts of a particular case do not fall within the crystallised principles enumerated in well-established ‘heads’ of public policy. The SC noted that, exception 1 to Section 28 of the Contract Act specifically saves the arbitration of disputes between two persons without reference to the nationality of persons who may resort to arbitration. It was noted that, the SC in Atlas (supra), referred to the said exception to Section 28 of the Contract Act and found that there is nothing in Sections 23 and 28 of the Contract Act which interdicts two Indian parties from getting their disputes arbitrated at a neutral forum outside India. The SC observed that, the principle of party autonomy has been held to be the guiding spirit of arbitration and that nothing stands in the way of party autonomy in designating a seat of arbitration outside India even when both parties happen to be Indian nationals.

The SC in TDM Infrastructure Private Limited v. UE Development India Private Limited [(2008) 14 SCC 271] had held contrary to the ratio of Atlas (supra) that arbitrations between Indian parties was not ICA and, therefore, could not be allowed to choose a foreign seat in derogation of Indian laws. The SC by this Judgement overruled TDM (supra) having not appreciated the law in its correct perspective. The judgements that relied on TDM (supra) to arrive at a similar conclusion were also over-ruled by this Judgement. The SC rejected the argument of the Appellant, with specific reference to Sections 28(1)(a) and 34(2A) of the 1996 Act, that, since two Indian parties cannot opt out of the substantive law of India and, therefore, ought to be confined to arbitrations in India, Indian public policy, as reflected in these two sections, ought to prevail. The SC noted that, Section 28(1)(a) of the 1996 Act, read with Sections 2(2), 2(6) and 4 of the 1996 Act, clarifies that where the place of arbitration is situated in India, in an arbitration other than an ICA (that is, an arbitration where none of the parties, inter alia, happen to be a foreign national or habitually resident in a foreign country), the arbitral tribunal shall decide the dispute in accordance with the substantive law for the time being in force in India. The SC observed that, Section 28(1)(a) of the 1996 Act makes no reference to an arbitration being conducted between two Indian parties in a country other than India, and cannot be held, by any process of reasoning, to interdict two Indian parties from resolving their disputes at a neutral forum in a country other than India. The SC noted that, even otherwise, BALCO (supra) specifically indicated that Section 28(1)(a) of the 1996 Act will not apply where the seat is outside India, as, in that event, the conflict of law rules of the country in which the arbitration takes place would have to be applied.

Conflict between CCA and the Act:

The Appellant had relied upon Section 10 read with Section 21 of the CCA to argue that in all cases between Indian nationals which result in awards delivered in a country outside India, Section 10(3) of the CCA would apply, as a result of which the impugned judgment having been made by the GHC, is made without jurisdiction. However, the SC observed that, when the Award was sought to be enforced, the explanation to Section 47 of the 1996 Act, clarified that it is the jurisdiction of the GHC alone.

This was rebutted by the Appellant by stating that since the explanation to Section 47 of the 1996 Act is in direct collision with provisions of the CCA, therefore, by virtue of Section 21, Section 10(3) of the CCA would prevail over the explanation to Section 47 of the 1996 Act. Therefore, the SC analysed further and noted that, Section 10(1) of the CCA applies to ICA, and applications or appeals arising therefrom, under both Parts I and II of the Act. When applications or appeals arise out of such arbitrations under Part I, where the place of arbitration is in India, undoubtedly, the definition of “ICA” in Section 2(1)(f) 1996 Act will govern. However, when applied to Part II, “ICA” has reference to a place of arbitration taking place outside India. The SC thus construed that there is no clash at all between Section 10 of the CCA and the explanation to Section 47 of the 1996 Act, as an arbitration resulting in a foreign award, as defined under Section 44 of the Act, will be enforceable only in a ‘High Court’ under Section 10(1) of the CCA, and not in a district court under Section 10(2) or Section 10(3) of the CCA. The SC further noted that, the 1996 Act is a special act vis-à-vis the CCA which is general and that it applies to the procedure governing appeals and applications in cases other than arbitrations as well. The SC observed that, in R.S. Raghunath v. State of Karnataka, [(1992) 1 SCC 335], it was held that even a general law enacted late which contains a non-obstante clause does not override a special law. Therefore, the SC rejected the argument of the Appellant.

Decision of the Supreme Court

In conclusion, while answering the multiple issues in the observation, the SC held that there is no clear and undeniable harm caused to the public in permitting Indian parties/entities from designating a foreign seat of arbitration. Thus, parties to a contract who are Indian nationals or companies incorporated in India can choose a forum for arbitration outside India. The SC also upheld the impugned judgment of the GHC, except for the finding on the Section 9 application. The SC held that the application under Section 9 of the 1996 Act would be maintainable in the present case and disposed of the appeal accordingly.

VA View:

The SC in this Judgement noted that, terms of the contract have to be understood in the way the parties intended them to be, particularly in agreements of arbitration, where party autonomy is the grundnorm. The SC in this Judgement rightly observed that, the balancing act between freedom of contract and clear and undeniable harm to the public must be resolved in favour of freedom of contract as there is no clear and undeniable harm caused to the public in permitting two Indian companies/nationals, to avail of a challenge procedure of a foreign country when, after a foreign award passes muster under that procedure, its enforcement can be resisted in India on the grounds contained in Section 48 of the 1996 Act, which includes the ground of the foreign award being held contrary to the public policy of India.

The SC observed that, in agreeing to a neutral forum outside India, parties agree that instead of one opportunity under Section 34 of the 1996 Act [with the grounds for setting aside the award being available under Section 34(2A)], the parties also have a recourse to challenge the award in a court/tribunal of foreign seat for setting aside the arbitral award. Further, the parties also have an opportunity to resist enforcement in India under the grounds mentioned in Section 48 of the 1996 Act. However, the SC cautioned that, if it was found that two Indian companies/nationals have circumvented a law which pertains to the fundamental policy of India, such foreign award may then not be enforced under Section 48(2)(b) of the 1996 Act.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | Supreme Court: The provisions of the Limitation Act would apply mutatis mutandis to proceedings under the IBC in the NCLT or NCLAT

The Supreme Court (“SC”) has in its judgement dated March 22, 2021, in the matter of Sesh Nath Singh & Another v. Baidyabati Sheoraphuli Co-Operative Bank Limited and Another [Civil Appeal No. 9198 of 2019] (“Judgement”) held that provisions of the Limitation Act, 1963 (“Act”) would apply mutatis mutandis to proceedings under the Insolvency and Bankruptcy Code, 2016 (“IBC”) in the National Company Law Tribunal/National Company Law Appellate Tribunal. It further held that there was no bar to exercise by the court or tribunal, of its discretion to condone delay under Section 5 of the Act in the absence of formal application.

Facts

Debi Fabtech Private Limited (“Corporate Debtor”) was, inter alia, engaged in the business of export of textile and garments. In February, 2012, pursuant to the request made by the Corporate Debtor, the financial creditor, that is, Baidyabati Sheoraphuli Co-operative Bank Limited (“Respondent”) granted a cash credit facility of INR 1,00,00,000, after which the Corporate Debtor opened a cash credit account with the Respondent and executed a hypothecation agreement. On default in repayment by the Corporate Debtor, the Respondent declared the account of the Corporate Debtor as a non-performing asset (“NPA”). The Respondent on January 18, 2014, issued a notice to the Corporate Debtor under Section 13(2) (Enforcement of security) of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI”), calling upon the Corporate Debtor to discharge in full, its outstanding liability of INR 1,07,88,536 inclusive of interest as on September 28, 2019, to the Respondent, within 60 days from the date of notice, failing which action would be taken under Section 13(4) of the SARFAESI. The Corporate Debtor made a representation to the Respondent under Section 13(3A) of the SARFAESI, objecting to the notice, which the Respondent rejected and issued further notice requesting the Corporate Debtor to clear the outstanding dues and finally a notice under Section 13(4) of the SARFAESI to handover peaceful possession of the secured immovable assets. On December 19, 2014, the Corporate Debtor filed a writ application in the Calcutta High Court (“CHC”) under Article 226 of the Constitution of India challenging the said notices issued by the Respondent under Section 13(2) and 13(4) of the SARFAESI. During the pendency of the writ petition, the Respondent notified the Corporate Debtor, the guarantors and the public, that they had taken possession of the secured assets of the Corporate Debtor under Section 13(4) of the SARFAESI. On July 24, 2017, the CHC passed an interim order restraining the Respondent from taking any action against the secured assets of the Corporate Debtor to await further orders.

On July 10, 2018, the Respondent filed an application in the National Company Law Tribunal, Kolkata (“NCLT”) under Section 7 (Initiation of corporate insolvency resolution process by financial creditor) of the IBC, to initiate Corporate Insolvency Resolution Process (“CIRP”), which was admitted by the NCLT. The Corporate Debtor appeared through Shesh Nath Singh (“Appellant”). Aggrieved, the Corporate Debtor filed an appeal before the National Company Law Appellate Tribunal (“NCLAT”) under Section 61 (Appeals and Appellate Authority) of the IBC, contending that the application filed by the Respondent was barred by limitation. The NCLAT dismissed the appeal, with the observation that the ground of limitation had been taken by the Corporate Debtor for the first time in the appeal and not before the NCLT. It further held that the application of the Respondent under Section 7 of the IBC was well within the limitation period. Hence, aggrieved, the Corporate Debtor under Section 62 (Appeal to Supreme Court) of the IBC filed an appeal before the SC.

Issues
1.  Whether delay beyond three years in filing an application under Section 7 of the IBC can be condoned, in the absence of an application for condonation of delay made by the applicant (in the instant case, the Respondent) under Section 5 (Extension of prescribed period in certain cases) of the Act.
2.  Whether Section 14 (Exclusion of time of proceeding bona fide in court without jurisdiction) of the Act applies to applications under Section 7 of the IBC. If so, is the exclusion of time under Section 14 of the Act available only after the termination of proceedings before the wrong forum.

Arguments

Contentions raised by the Appellant:

The Appellant submitted that the application under Section 7 of the IBC by the Respondent was barred by limitation and ought to be dismissed. Reliance was placed on Ishrat Ali v. Cosmos Cooperative Bank Limited and Another [Company Appeal (AT) (Insolvency) No. 1121 of 2019] (“Ishrat Ali”), where it was held by the NCLAT that in an application under Section 7 of the IBC, the applicant is not entitled to the benefit of Section 14 of the Act in respect of proceedings under the SARFAESI. It was submitted that the account of the Corporate Debtor with the Respondent had been declared as NPA on March 31, 2013, on which date the cause of action accrued. Thus, the three-year period expired on March 31, 2016, due to which the application under Section 7 of the IBC, filed after five years and three months from the date of declaration of the account as NPA, was fatally time-barred. Further, the Respondent had not filed any application before the NCLT under Section 5 of the Act. The delay in filing the application under Section 7 of the IBC, could not, therefore, have been condoned. It was submitted that since the NCLT/NCLAT was not a forum for recovery of debt, Section 14 of the Act would not apply, as held in Ishrat Ali. Placing reliance on the Explanation to Section 14 of the Act, it was further contended that Section 14 of the Act could apply if any earlier proceedings initiated by the applicant were dismissed for want of jurisdiction or any other like reason, but since the proceedings initiated by the Respondent under SARFAESI were pending, the Respondent could not take benefit of Section 14(2) of the Act.

Contentions raised by the Respondent:

It was submitted that the Respondent had in its application filed in the NCLT under Section 7 of the IBC, enclosed a synopsis of relevant facts and significant dates, with supporting documents. The relevant dates revealed that the cash credit account of the Corporate Debtor was declared an NPA with effect from March 31, 2013. Proceedings under the SARFAESI commenced on January 18, 2014, when a demand notice was issued under Section 13(2) of SARFAESI, approximately 9 months and 18 days after the date of accrual of the right to issue. The proceedings under the SARFAESI were stayed by the CHC, in July 2017, on the ground of want of jurisdiction. About 11 months thereafter, while the writ petition filed by the Corporate Debtor was still pending in the CHC, and the interim stay of proceedings under SARFAESI still continuing, the Respondent initiated the application under Section 7 of the IBC.

Observations of the Supreme Court

The SC observed that the Insolvency Committee of the Ministry of Corporate Affairs, India, in a report published in March, 2018, stated that the intent of the IBC could not have been to give a new lease of life to debts which were already time barred. Thereafter, Section 238A (Limitation) was incorporated in the IBC by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, with effect from June 6, 2018. Section 238A of the IBC states that, “The provisions of the Limitation Act, 1963 (36 of 1963) shall, as far as may be, apply to the proceedings or appeals before the Adjudicating Authority, the National Company Law Appellate Tribunal, the Debt Recovery Tribunal or the Debt Recovery Appellate Tribunal, as the case may be.” There is no specific period of limitation prescribed in the Act for an application under the IBC before the NCLT. Hence, it is governed by Article 137 of the Schedule to the Act., where the period of limitation prescribed for such an application is 3 years from the date of accrual of the right to apply. Thus, applications under Sections 7 and 9 of the IBC have a limitation period of 3 years from the date of default.

As observed by the SC in B.K. Educational Services Private Limited v. Parag Gupta Associates and Others. [(2019) 11 SCC 633], the NCLT/NCLAT has the discretion to entertain an application/appeal after the prescribed period of limitation. The condition precedent for exercise of such discretion is the existence of sufficient cause for not preferring the appeal or the application within the period prescribed by limitation. The SC relied upon various precedents which held that “sufficient cause” must be construed liberally to advance substantial justice. The SC clarified that whether the explanation furnished for the delay would constitute ‘sufficient cause’ or not would depend on facts of each case and there is no straight jacket formula for accepting or rejecting the explanation furnished by the applicant/appellant for the delay in taking steps. Acceptance of explanation furnished ought to be the rule and refusal an exception, when no negligence or inaction or want of bona fides can be imputed to the defaulting party. The courts must strike a balance between the legitimate rights and interests of the respective parties.

Section 5 of the Act does not speak of any application. Section 5 of the Act enables the court to admit an application or appeal if the applicant satisfies the court that he had sufficient cause for not making the application and/or preferring the appeal, within the time prescribed. Although, it is the general practice to make a formal application under Section 5 of the Act in order to enable the court or tribunal to weigh the sufficiency of the cause for the inability of the applicant to approach the court/tribunal within the time prescribed by limitation, there is no bar to exercise by the court/tribunal of its discretion to condone delay, in the absence of a formal application. The SC was of the opinion that it is not mandatory to file an application in writing before relief can be granted under Section 5 of the Act. However, the SC clarified that no applicant or appellant can claim condonation of delay under Section 5 of the Act as of right, without making an application.

Section 238A of the IBC makes the provisions of the Act, as far as may be, applicable to proceedings before the NCLT and the NCLAT. The IBC does not exclude the application of Sections 6 or 14 or 18 or any other provision of the Act to proceedings under the IBC in the NCLT/NCLAT. All the provisions of the Act are applicable to the proceedings in the NCLT/NCLAT, to the extent feasible. The SC observed that there was no reason as to why Sections 14 or 18 of the Act should not apply to the proceedings under Section 7 or Section 9 of the IBC. Section 14 (2) of the Act provides that in computing the period of limitation for any application, the time during which the petitioner had been prosecuting, with due diligence, another civil proceeding, whether in a court of first instance, or of appeal or revision, against the same party, for the same relief, shall be excluded, where such proceeding is prosecuted in good faith in a court which, from defect of jurisdiction or other cause of like nature, is unable to entertain it. The conditions for exclusion are that the earlier proceedings should have been for the same relief, the proceedings should have been prosecuted diligently and in good faith and the proceedings should have been prosecuted in a forum which, from defect of jurisdiction or other cause of a like nature, was unable to entertain it. The SC relied on the judgement pronounced in Commissioner, M.P. Housing Board and Others. v. Mohanlal & Co. [(2016) 14 SCC 199], that Section 14 of the Act has to be interpreted liberally to advance the cause of justice. Section 14 of the Act would be applicable in cases of mistaken remedy or selection of a wrong forum.

The SC then addressed the argument that prior proceedings under the SARFAESI do not qualify for the exclusion of time under Section 14 of the Act, as they were not civil proceedings in a court. It further considered the question of availability of Section 14 of the Act under the IBC, that whether for proceedings initiated bona fide and prosecuted with due diligence under the SARFAESI, the exclusion of time under Section 14 of the Act, would only be available if the proceedings, which could not be entertained for defect of jurisdiction, or other cause of a like nature, had ended. The SC observed that Section 14 of the Act needed to be read as a whole. A conjoint and careful reading of Sections 14 (1), 14(2) and 14(3) of the Act makes it clear that an applicant who has prosecuted another civil proceeding with due diligence, before a forum which is unable to entertain the same on account of defect of jurisdiction or any other cause of like nature, is entitled to exclusion of the time during which the applicant had been prosecuting such proceeding, in computing the period of limitation. The substantive provisions of sub-sections (1), (2) and (3) of Section 14 of the Act do not state that Section 14 of the Act could only be invoked on termination of the earlier proceedings, prosecuted in good faith. The SC placed reliance on Bihta Co-operative Development Cane Marketing Union Limited. and Another. v. Bank of Bihar and Others [AIR 1967 SC 389], which held that the explanation must be read so as to harmonize with and clear up any ambiguity in the main section. It should not be so construed as to widen the ambit of the section. The SC opined that explanation (a) of Section 14 of the Act could not be construed in a narrow manner to mean that Section 14 of the Act can never be invoked until and unless the earlier proceedings have been terminated. The intent behind explanation (a) of Section 14 of the Act is clarificatory, to restrict the period of exclusion to the period between the date of initiation and the date of termination, and not any further. In the instant case, though the proceedings under the SARFAESI may not have formally been terminated, the proceedings have been stayed by the CHC by an interim order, on the prima facie satisfaction that the proceedings initiated by the Respondent, a co-operative bank, was without jurisdiction. The writ petition filed by the Corporate Debtor was not disposed of even after almost four years. The carriage of proceedings was with the Corporate Debtor. The interim order was still in force, when proceedings under Section 7 of the IBC were initiated, as a result of which the Respondent was unable to proceed further under the SARFAESI. The SC was of the view that since the proceedings in the CHC were still pending on the date of filing of the application under Section 7 of the IBC in the NCLT, the entire period after the initiation of proceedings under the SARFAESI could be excluded and hence the application in the NCLT was well within the limitation of three years.

Unlike the Arbitration and Conciliation Act, 1996, which expressly makes the provisions of the Act, as they apply to court proceedings, also applicable to arbitration proceedings, Section 238A of the IBC makes the Act applicable to proceedings in NCLT/NCLAT ‘as far as may be’ that is, to the extent they may be applied. The SC explained that the use of the words ‘as far as may be’, occurring in Section 238A of the IBC tones down the rigour of the words ‘shall’ in Section 238A of the IBC which is normally considered as mandatory. The expression ‘as far as may be’ is indicative of the fact that all or any of the provisions of the Act may not apply to proceedings before the NCLT or the NCLAT if they were patently inconsistent with some provisions of the IBC. At the same time, the words ‘as far as may be’ could not be construed as a total exclusion of the requirements of the basic principles of Section 14 of the Act, but permits a wider, more liberal, contextual and purposive interpretation by necessary modification, which is in harmony with the principles of Section 14 of the Act. The SC observed that if in the proceedings under Sections 7 and 9 of the IBC, Section 14 of Act were interpreted in a rigid and literal fashion, to hold that only civil proceedings in the court would enjoy exclusion, it would result in the applicant not even being entitled to exclusion of the time spent bona fide invoking and diligently pursuing earlier application under the same provision of the IBC for the same relief before an adjudicating authority, lacking territorial jurisdiction, which would not have been the legislative intent. Thus, the SC dissented from the NCLAT judgement of Ishrat Ali and emphatically laid down that proceedings under the SARFAESI were civil proceedings. The SC did not find any rationale behind excluding proceedings initiated by a secured creditor against the borrower under SARFAESI for taking possession of secured assets, from the category of civil proceedings. Thus, it could not be said that merely because the proceedings were not conducted in a civil court, they would be excluded from the ambit of Section 14 of the Act.

Decision of the Supreme Court

The SC affirmed the stance taken by the NCLAT. The SC ruled that, had Section 5 of the Act required the mandatory prerequisite of a written application, it would have expressly provided for the same. Thus, it held that the court is not precluded from condoning delay in the absence of a formal application. It held that Section 14 of the Act excludes the time spent in proceeding in a wrong forum, which is unable to entertain the proceedings for want of jurisdiction, or other such cause. Where such proceedings have ended, the outer limit to claim exclusion under Section 14 of the Act would be the date on which the proceedings ended. The Chief Metropolitan Magistrate or the Judicial Magistrate, as the case may be, exercising powers under Section 14 of the SARFAESI, functions as a civil court or executing court. Proceedings under the SARFAESI would, therefore, be deemed to be civil proceedings in a court. The expression ‘court’ in Section 14(2) of the Act would be deemed to be any forum for a civil proceeding including any tribunal or any forum under the SARFAESI. It was further held that the provisions of the Act would apply mutatis mutandis to proceedings under the IBC in the NCLT or NCLAT.

VA View:

The Judgement laid down by the SC throws light on the interplay between the IBC and the Act. The SC has categorically ruled that Section 14 of the Act applies to applications under Section 7 of the IBC. All the provisions of the Act are applicable to the proceedings carried out in the NCLT or NCLAT. Through this Judgement, the SC has furnished purposive interpretation to Section 238A of the IBC, by clarifying that the words “as far as may be” must be construed in a manner to further the legislative intent instead of curtailing it. Deeming SARFAESI proceedings to fall within the ambit of civil proceedings, the SC pronounced the Judgement in tandem with the legislative intent behind Section 14 of the Act which was to discount the calculation of the time period exhausted in bona fide prosecution.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | NCLT, Mumbai: Allows application seeking reliefs essential to run a corporate debtor sold as ‘going concern’ during liquidation

The National Company Law Tribunal, Mumbai bench (“NCLT”) has in its order dated March 09, 2021 (“Judgement”), in the matter of Gaurav Jain v. Sanjay Gupta [IA No. 2264 of 2020 in C.P.(IB)No. 1239/MB/2018], allowed an application seeking reliefs essential to run a corporate debtor sold as ‘going concern’ during liquidation.

Facts

The Bank of Baroda filed a petition under Section 7 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) against Topworth Pipes and Tubes Private Limited (“Corporate Debtor”/ “Company”). By an order of NCLT dated December 11, 2018, the Corporate Insolvency Resolution Process (“CIRP”) was initiated against the Corporate Debtor. Thereafter, on June 12, 2020, NCLT passed an order for liquidation of the Corporate Debtor under Section 33 of the IBC since no resolution plan was received in relation to the CIRP of the Company.

Subsequently, Mr. Sanjay Gupta (“Liquidator”) had invited bids by an e-auction process memorandum dated October 13, 2020, for the sale of the Corporate Debtor. The Liquidator published two addendums dated October 29, 2020 and November 03, 2020, to the e-auction process memorandum. The e-auction process memorandum stated that the sale of the Company was on a ‘going concern’ basis in accordance with the provisions of the IBC read with Regulation 32(e) of the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 (“Liquidation Process Regulations”) and the e-auction process memorandum. It further stated that the sale of the Company was proposed to be done on ‘as is where is basis’, ‘as is what is basis’, ‘whatever there is basis’ and ‘no recourse basis’. The reserve price fixed was INR 152 Crores. It was clarified that, the proposed sale of the Company on ‘going concern’ basis did not entail transfer of any other title, except the title which the Company had on its assets as on the date of transfer.

Among other information mentioned in the e-auction process memorandum, it was also stated that, “any liabilities, current or long term, contingent or not whether due or otherwise pertaining to the operations of Khopoli unit post liquidation commencement date and all current employees related liabilities including provident fund, employee state insurance and other retirement/terminal benefits shall be to the account of the successful bidder including any liabilities accruing post auction date, i.e. November 2nd, 2020.” Further, it was also mentioned that on payment of the total bid amount, and applicable taxes, registration fees, etc. the successful bidder shall be issued the letter for confirmation of sale, which was subject to the necessary approvals, if any, by various statutory and non-statutory authorities.

Mr. Gaurav Jain (“Applicant”) had participated in the e-auction process held on November 11, 2020 and had submitted a bid for INR 190.90 Crores to acquire the Corporate Debtor as a ‘going concern’ (“Sale Consideration”). The Liquidator confirmed the Applicant’s bid and issued letter of intent to the Applicant on November 12, 2020. Thereafter, the Applicant submitted his bid price before the Liquidator by depositing the earnest money deposit (“EMD”) of INR 15.2 Crores. Subsequently, on November 18, 2020, the Applicant deposited a sum of INR 32.52 Crores. Therefore, in total, the money deposited by the Applicant amounted to INR 47.72 Crores, that is, 25% of the Sale Consideration.

Issue
1.   To consider the sale of Corporate Debtor as a ‘going concern’ during liquidation.

Submissions

Submissions made by the Applicant:

The Applicant submitted that it was agreed between the Liquidator and the Applicant that on payment of the remaining 75% of the Sale Consideration to the Liquidator on December 11, 2020, the Corporate Debtor would be transferred to the Applicant in accordance with the provisions of the IBC and the Liquidation Process Regulations and that such a date of transfer would be considered as the date of acquisition.

The Applicant submitted that the mere purchase of the Corporate Debtor as a ‘going concern’ as per the Liquidation Process Regulations would not suffice to ensure smooth running of the business of the Corporate Debtor. Therefore, it was imperative that certain additional reliefs, concessions, relaxations and permissions be granted by the NCLT, which would be essential and necessary to run the business of the Corporate Debtor as a ‘going concern’, to achieve the purpose of revival and value maximization of the Corporate Debtor. The Applicant submitted that, the NCLT was empowered to grant necessary reliefs, as mentioned in the application, in favour of the Applicant, in relation to the Corporate Debtor sold as a ‘going concern’ under the provisions of the Liquidation Process Regulations and under Section 60(5)(c) of the IBC.

Submissions made by the Liquidator:

The Liquidator submitted that he had filed second progress report dated October 10, 2020, with the Registry of the NCLT, in accordance with Regulation 15(1)(b) of the Liquidation Process Regulations and informed that all the secured financial creditors had relinquished their security interest in liquidation estate of the Corporate Debtor. The Liquidator stated that the prayer (a) to permit the Applicant to pay/adjust the Sale Consideration in a two-fold manner such that, an investment of INR 40 Crores into the equity shares of the Corporate Debtor and the balance amount of INR 150.90 Crores in the form of unsecured debt, were in consonance with the letter and spirit of the e-auction memorandum.

The Liquidator further submitted that he did not have any objections in respect of the prayers (m), (n) and (o) of the application, that sought directions to be issued to the Liquidator to, (i) cooperate and provide assistance to the Applicant in amending, modifying, creating the land records in relation to the immovable properties and assets, (ii) write back all the liabilities which were not payable and reflect the total liabilities at the Sale Consideration, (iii) the assets which were not recoverable to be written down to their realizable value, in the financial statements of the Corporate Debtor and finally that the filing of necessary documents and returns along with said financial statements had to be prepared and filed with the relevant regulators and authorities, by the Liquidator.

Observations of the NCLT

The NCLT noted that while the Liquidation Process Regulations recognised ‘going concern’ sale as one of the methods of sale of the Corporate Debtor, however, there was no definition provided for the term ‘going concern’ either in the IBC or in the Liquidation Process Regulations. Therefore, a reference was made to paragraph 8.1 of the report of the Insolvency Law Committee dated March 26, 2018, wherein the committee observed the meaning of the term ‘going concern’ as follows “… that the Corporate Debtor would be functional as it would have been prior to the initiation of CIRP, other than the restrictions put by the Code.” Further, a reference was also made to paragraph nos. 7 and 8 of the Round Table of Insolvency and Bankruptcy Board of India (“IBBI”) held on May 21, 2018, wherein a note as published by IBBI defining ‘going concern’ was noted as follows, “‘Going Concern’ means all the assets, tangibles or intangibles and resources needed to continue to operate independently a business activity which may be whole or a part of the business of the corporate debtor without values being assigned to the individual asset or resource.” In view of the said definitions, the following options were considered by NCLT:

• The Corporate Debtor may be sold as a going concern, as provided in the Liquidation Process Regulations. Therefore, the legal entity of the Corporate Debtor would survive and, consequently, there would be no need for dissolution of the Company in terms of Section 54 of the IBC. The NCLT noted that the ownership generally is transferred by the Liquidator to the purchaser. Consequently, after the sale of the Corporate Debtor as a ‘going concern’, the Applicant would be carrying on the business of the Corporate Debtor.
• The business of the Corporate Debtor may be sold as a ‘going concern’, that is, sale of business only and not the Corporate Debtor. Therefore, the Corporate Debtor would be liquidated in accordance with the Liquidation Process Regulations. The NCLT noted that, the assets and liabilities relevant for the business are transferred to a new entity, and stakeholders are paid from proceeds of sale in accordance with Section 53 of the IBC and, thereafter, the Corporate Debtor would be dissolved. The NCLT observed that since the amount is paid to the creditors in terms of the IBC, the liabilities of the Corporate Debtor towards the creditors would be treated as settled.

The NCLT observed that, both the options required consent of the secured creditors to relinquish security interest. Further, if security interest was not relinquished, other modes of sale as available under the Liquidation Process Regulations would have to be considered.

The NCLT observed that the crux of the sale as ‘going concern’ is that the equity shareholding of the Corporate Debtor was extinguished and the acquirer would take over the undertaking. The undertaking included the business of the Corporate Debtor, assets, properties, licenses and rights etc. excluding the liabilities. The NCLT noted that, however, in the instant case the assets that were included in the e-auction memorandum only had to be taken over by the Applicant.

The NCLT observed the difference that, in the normal parlance ‘going concern’ sale would be transfer of assets along with the liabilities. However, as far as the ‘going concern’ sale in liquidation is concerned, there was a clear difference that only assets were transferred and the liabilities of the Corporate Debtor had to be settled in accordance with Section 53 of the IBC. Hence, the Applicant would take over only the assets without any encumbrance or charge and they would be free from the action of the creditors.

Conclusively, the NCLT observed that, selling the Corporate Debtor ‘as a going concern’ included the following advantages:

• The corporate debtor itself would be transferred.
  b.The equity shareholding would be transferred or extinguished and new shares would be issued.
• The purchaser would be expected to carry on the business of the corporate debtor after the sale of assets would be confirmed.
• The existing employees would have a chance to continue in their employment.

Decision of the NCLT

As a consequence, the NCLT allowed the application and granted the following reliefs that were considered essential and necessary to run the Corporate Debtor sold as ‘going concern’ during liquidation and to achieve the purpose of revival of the Corporate Debtor:

• The Applicant was permitted to bring in INR 40 crores as share capital and INR 150.90 crores as unsecured debt towards payment of Sale Consideration.
• All the rights, title and interest over whole and every part of the Corporate Debtor, including but not limited to contracts, free from security interest, encumbrance, claim, counter claim or any demur were to be transferred to the Applicant upon payment of the Sale Consideration. Further, that the Sale Consideration, when received, were to be distributed by the Liquidator in terms of Section 53 of the IBC.
• All the claims, demands, liabilities of the Corporate Debtor, in relation to any period prior to the date of acquisition, were to be written off in full and extinguished, qua the Applicant. The Applicant was not to be responsible for any other claims, liabilities, obligations etc. payable by the Corporate Debtor thereon, to the creditors or any other stakeholders.
• Any proceedings against or in relation to, or in connection with the Corporate Debtor (other than those against the erstwhile promoters or former members of the management of the Corporate Debtor) pending or threatened, present or future, as on date of the Judgement, with respect to its liabilities, enquiries, investigations, assessments, claims, disputes, litigations etc. would not have any bearing against the assets sold in the liquidation process. The said assets were free from any financial implications arising out of any pending proceedings before relevant authorities, if any.
• The existing share capital of the Corporate Debtor would stand cancelled without any consideration to the shareholders. The Liquidator in consultation with the Registrar of Companies (“RoC”) concerned shall take action to change the status of the Corporate Debtor in the records of the RoC from the status of “liquidation” to the status of “active”.
• The board of the Corporate Debtor could be reconstituted and necessary filings could be made with the RoC concerned.
• All subsisting consents, licenses, approvals, rights, entitlements, benefits and privileges whether under law, contract, lease or license, granted in favour of the Corporate Debtor or to which the Corporate Debtor was entitled to were deemed to be continued subject to payment of renewal fees, if any, from date of the Judgement, to the licensing authorities.
• The assets specified in the e-auction memorandum, on payment of the Sale Consideration would vest with the Applicant. The Applicant and Corporate Debtor shall have the right to review and terminate any contract that was entered into previously.
• The Applicant shall not be held responsible / liable for any of the past liabilities of the Corporate Debtor in inquiries, investigations, assessments, notices, causes of action, suits, claims, disputes, litigations, arbitration or other judicial, regulatory or administrative proceedings against or in relation to, or in connection with the Corporate Debtor prior to the date of the Judgement.
• The Applicant was entitled to get all the rights, title and interest whole and every part of the Corporate Debtor.
• The dues of all creditors of the Corporate Debtor would stand extinguished qua the Applicant.
• The non-compliance of provisions of any of the laws, rules, regulations, directions, notifications, circulars, guidelines, policies, licenses, approvals, consents or permissions, prior to the date of acquisition, stood extinguished qua the Applicant.
• All the assets specified in the e-auction memorandum would be continued as the assets of the Corporate Debtor on total payment of the Sale Consideration to the Liquidator.
• The Liquidator was directed to provide all support and assistance to the Applicant for the smooth functioning of the Corporate Debtor and to complete the acquisition.
• The Liquidator and Applicant would be at liberty to take all the steps required to make accounting entries for the smooth transmission and preparing the balance sheet.
• The Liquidator was directed to ensure completion of pending filings with the concerned RoC, Income Tax Authorities and any other government / statutory authorities.
• The Corporate Debtor was entitled to get the benefits of brought forward losses, if any, subject to permission of the appropriate authority under the relevant provisions of the Income Tax Act, 1961.
• The Corporate Debtor could apply for incentives under the ‘Package Incentive Scheme’, framed by the state government of Maharashtra, subject to the eligibility and other norms as provided in the said scheme.
• As far as the prayer for considering the bid submitted by the Applicant as resolution plan under Section 79 of Income Tax Act, 1961 was concerned, the Applicant could approach the relevant authority who would consider such request.

VA View:

It is rare that a company survives through the liquidation process as a ‘going concern’. In this Judgement, the NCLT granted reliefs to the Applicant that were necessary for allowing the Corporate Debtor to survive and run as a ‘going concern’ on completion of the sale under relevant provisions of the IBC and Liquidation Process Regulations. This Judgement is in line with and amplifies the main objectives of the IBC including maximization of value and revival of the Corporate Debtor. The Judgement has also analyzed the meaning of the term ‘going concern’ in view of lack of a definition under the IBC and Liquidation Process Regulations. This Judgement of the NCLT addresses various concerns of acquirers in general, including but not limited to apprehensions of being hit by unknown/uncertain liabilities or other contingencies and concerns related to the smooth functioning and continuity of business operations of the Corporate Debtor, that is sold as a ‘going concern’ during the liquidation process.

For more information please write to Mr. Bomi Daruwala at [email protected]

Between the Lines | Bombay High Court: Reiterated that a choice of seat is itself an expression of party autonomy and carries with it the legal effect of conferring exclusive jurisdiction on the courts of the seat

The Hon’ble Bombay High Court (“BHC”) has in its judgment dated January 29, 2021 (“Judgement”), in the matter of Aniket SA Investments LLC v. Janapriya Engineers Syndicate Private Limited and Others [Commercial Appeal No. 504/2019], held that a choice of seat is itself an expression of party autonomy and carries with it the legal effect of conferring exclusive jurisdiction on the courts of the seat.

Facts

Aniket SA Investments LLC (“Appellant”), a foreign investor and Janapriya Engineers and Syndicate Private Limited (“Respondent No. 1”) were shareholders of Janapriya Townships Private Limited (“Respondent No. 2”), a special purpose vehicle carrying out a real estate development project in Telangana. The Appellant, Respondent No. 1 and Respondent No. 2 had entered into a share subscription and shareholders agreement dated August 21, 2008 (“the Agreement”). The other respondent nos. 3 to 6, party to the petition, were the promoters of Respondent No. 1 (“Promoters”). Respondent No. 1, Respondent No. 2 and the Promoters are collectively referred to as “Respondents”.

Disputes arose between the Appellant and the Respondents in relation to the implementation and execution of the Agreement. Therefore, the Appellant issued a notice of default dated March 19, 2019. Subsequently, Appellant issued a notice to Respondent No. 1 exercising a ‘Put Option’ under the shareholders agreement dated July 08, 2019, and finally a dispute notice dated August 22, 2019, to invoke arbitration. The relevant clauses of the Agreement are Clause 20.3 (Governing Law and Jurisdiction) that provided jurisdiction to courts at Hyderabad (“Jurisdiction Clause”) and Clause 20.4 (Arbitration) that provided jurisdiction to courts at Mumbai (“Arbitration Clause”).

Thereafter, the Appellant had filed a petition under Section 9 (Interim measures, etc., by Court) (“Section 9 Petition”) of the Arbitration and Conciliation Act, 1996, (“Act”). Therein, by order dated October 22, 2019 (“Impugned Order”), the learned single judge, BHC, extensively relied on paragraph 96 of the decision of the Supreme Court (“SC”) in Bharat Aluminium Company v. Kaiser Aluminium Technical Services Inc [(2012) 9 SCC 552] (“BALCO”), among other judgements, and held that there was concurrent jurisdiction of court where the cause of action accrued and the court of the seat of arbitration. The Impugned Order further held that as a matter of party autonomy, the parties had made an express choice in conferring jurisdiction on the courts at Hyderabad and that to give effect to this plain commercial term of the Agreement, the expression ‘subject to’ must be read as ‘notwithstanding’ and that expression ‘seat’ must be read as ‘venue’. Therefore, the Impugned Order disregarded the choice of Mumbai as a ‘seat’. Hence, the appeal was filed under Section 37 of the Act to challenge the Impugned Order.

Issues
1. Whether the Impugned Order was correct in relying on paragraph 96 of BALCO to recognize concurrent jurisdiction under Section 2(1)(e) (definition of court) of the Act or whether a choice of seat of arbitration has the legal effect of conferring exclusive jurisdiction on the courts of that seat (“Issue 1”).

2.  If there is concurrent jurisdiction of two courts, is the Impugned Order correct to hold that as a matter of party autonomy, the parties have made an express choice in conferring jurisdiction on the courts at Hyderabad and that to give effect to this plain commercial term of the Agreement, the expression ‘subject to’ must be read as ‘notwithstanding’ and that expression ‘seat’ must be read as ‘venue’.

Arguments

Contentions raised by the Appellant:

The Appellant submitted that, even if it is to be assumed that by law, two courts had concurrent jurisdiction under the Act, the clear intent of the parties as gathered by the plain meaning of the clauses is that, choice of courts at Hyderabad in Jurisdiction Clause is made “subject to” Arbitration Clause that provides for the seat at Mumbai. Therefore, in the event of any conflict the latter must prevail in consonance with the well settled meaning of the expression “subject to”. There was no warrant for reading “subject to” as “notwithstanding” and giving it the very opposite meaning to the clear words chosen by the parties. The Appellant suggested that one way of reconciling both the clauses is that, the Jurisdiction Clause will apply in relation to a dispute that is not covered by arbitration, and in relation to all disputes under the arbitration agreement, the choice of seat being at Mumbai, the choice of court will also be at Mumbai even in a situation of concurrent jurisdiction with two court

The expression ‘seat’ could never have been read as a mere venue, rather the law in fact leans in favour of reading a reference to ‘venue’ as ‘seat’. When the parties make an express reference to a place as being the ‘seat’, that choice under the principles of party autonomy must be given full effect. The Appellant relied on the judgment of BGS SGS SOMA JV v. NHPC LIMITED [(2020) 4 SCC 234] (“BGS SGS”), being completely applicable to answer the Issue 1. The SC therein had held that paragraph 96 of BALCO must be read consistently with the entire judgment, that is, when properly construed, it was held that, the courts of the seat of arbitration would have exclusive jurisdiction in relation to disputes arising in relation to the arbitration. The SC in BGS SGS noted the ratio laid down in the case of Antrix Corporation Limited v. Devas Multimedia Private Limited [2018 SCC OnLine Del 9338] (“Antrix”), as relied upon in the Impugned Order, as incorrect and contrary to the ratio in BALCO. It was also observed in BGS SGS that, a reference to a ‘place’ or ‘venue’ in an arbitration agreement will generally be understood as being a reference to a ‘seat’ of the arbitration unless there is a clear indication to the contrary.

Contentions raised by the Respondents:

The SC’s decision in BGS SGS does not have a direct bearing on Issue 1. Further, the judgment in BGS SGS does not apply to the present situation, as while analysing precedents and considering ‘seat’ as being akin to exclusive jurisdiction, it did not consider possibility of an agreement stipulating different places being mentioned in respect of ‘seat’ in the arbitration clause and an exclusive jurisdiction provided generally in the contracts.

The Arbitration Clause should not be read as being a choice of ‘seat’ so as to displace an exclusive jurisdiction of the courts at Hyderabad, as stated expressly, as the choice in Jurisdiction Clause. The Impugned Order was correct in reading the expression ‘subject to’ as ‘notwithstanding’ so as to give effect to the intent of the parties as was apparent in the Agreement. The Promoters contended that in the year 2008, when the Agreement was entered into between the parties, the expression ‘seat’ was understood to mean ‘venue’. The expression ‘seat’ as it is now understood was unknown to the parties at that time. Therefore, for the purpose of vesting jurisdiction on courts, the phrase ‘exclusive jurisdiction’ was stipulated in the Jurisdiction Clause. It was submitted that, therefore, disregarding common usage at the relevant time will amount to disregarding the intent of parties.

The concept of ‘seat’ is relevant only to international commercial arbitration. In domestic arbitrations or international commercial arbitrations seated in India, parties would retain the right to vest exclusive jurisdiction with a court from amongst multiple courts which would naturally have jurisdiction over the subject matter or cause of action. It is submitted that reference to ‘seat’ in domestic arbitrations or international commercial arbitrations seated in India would not subsume within it an exclusive jurisdiction of courts of that ‘seat’.

Observations of the Bombay High Court

Jurisprudence laid down in BALCO and BGS SGS on exclusive jurisdiction of the courts at the ‘seat’:

The BHC extensively noted the observations made in the BGS SGS case by the SC. The BHC noted that the judgment of BALCO was previously understood by some high courts to recognize concurrent jurisdiction of the ‘cause of action’ court and the ‘seat’ court. It was noted that the conflicting observations made in the BALCO judgement were clarified in the case of BGS SGS by the SC. The BHC further observed that if, as laid down in paragraph 96 of BALCO, the concurrent jurisdiction was to be the order of the day, despite seat having been located and specifcally chosen by the parties, party autonomy would sufer. The BHC noted the observations of the SC that paragraph 96 of BALCO was not in consonance with other observations as made therein in the judgement. The BHC observed that, the very fact that the parties have chosen a place to be the seat would necessarily carry with it the decision of both the parties that the courts at the seat would exclusively have jurisdiction over the entire arbitral process.

The SC in BGS SGS upheld the ratio of Indus Mobile Distribution Private Limited v. Datawind Innovations Private Limited [(2017) 7 SCC 678] (“Indus Mobile”) wherein it was clarified that, the moment a seat is designated by agreement between the parties, it is akin to an exclusive jurisdiction clause, which would then vest the courts at the ‘seat’ with exclusive jurisdiction for the purposes of regulating arbitral proceedings.

The BHC observed that the Antrix case as relied upon by the Impugned Order, is no longer good law as it did not follow BALCO. The BHC observed that it is incorrect to state that the example given in paragraph 96 of BALCO reinforces the concurrent jurisdiction. The judgment in BALCO when read as a whole, applies the concept of ‘seat’ and harmoniously construes Section 20 (Place of arbitration) with Section 2(1)(e) of the Act to effectively broaden the definition of ‘court’, to take within its ken the courts of the ‘seat’ of the arbitration. It was observed that the narrow construction of Section 2(1)(e) of the Act was expressly rejected in BALCO.

The BHC further observed that an application under Section 9 of the Act may be preferred before a court in whose jurisdiction part of cause of action arises, in two situations, one, if parties have not agreed on the ‘seat’ of arbitration, and the other, before such ‘seat’ may have been determined on the facts of a particular case by the arbitral tribunal under Section 20(2) of the Act. In both these situations, the earliest application having been made to a court in which a part of the cause of action arises would then be the exclusive court under Section 42 (Jurisdiction) of the Act, which would have control over the arbitral proceedings.

Applicability of BGS SGS to Impugned Order:

The BHC observed that the Impugned Order in so far as it held paragraph 96 of BALCO to recognize concurrent jurisdiction of the ‘cause of action’ court and the ‘seat’ court could not be sustained as it was inconsistent with the judgment in BGS SGS. The BHC further rejected the contentions of Promoters that the judgment of BGS SGS did not apply to the instant case because the present case is an international commercial arbitration seated in India, while law laid down in BGS SGS was on a situation where it was a domestic arbitration. The BHC observed that, it would be incorrect and contrary to the reading of the judgment itself to restrict the application of the law it laid down, to apply only to some situations and not others as had been contended by Promoters. The BHC concluded that on a reading of the entire judgment, the judgement was clearly applicable to Issue 1 irrespective of whether it is a domestic arbitration or an international commercial arbitration seated in India, such as in the present case.

The BHC further observed that, in the case of BGS SGS it had been held that there is no concurrent jurisdiction of two courts under Section 2(1)(e) of the Act. The BHC further observed that the principles applied in the Impugned Order, that, as a matter of party autonomy the parties can choose one of the two courts and confer exclusive jurisdiction on one of those courts, by relying, inter alia, upon paragraph 96 of BALCO, would have no application in a situation where the parties had chosen a seat of arbitration. The BHC observed that a choice of seat, as the SC had also explained, is itself an expression of party autonomy and carries with it the effect of conferring exclusive jurisdiction on the courts of the seat.

The BHC rejected the contentions of the Promoters, that the choice of ‘seat’ in the year 2008 when the Agreement was entered into was not understood as a choice of courts of the ‘seat’ and that this could not be the intention attributed to the parties. The BHC observed that the law as laid down in BGS SGS to the effect of choice of ‘seat’ as conferring exclusive jurisdiction is by no means prospective or applicable only after a particular date. Even the judgment in BALCO, as explained in BGS SGS, must be understood as stating the legal position under the Act and which must be given effect to, even if the Agreement was executed a date prior to the judgment.

The BHC was of the opinion that, in view of the SC’s analysis of Indus Mobile in the case of BGS SGS, the Impugned Order was not correct in distinguishing Indus Mobile only because of the clauses in the agreement in Indus Mobile were conferring exclusive jurisdiction on the same court as that of the seat.

Interpretation of the clauses of the Agreement:

The BHC observed that it is a well settled rule of interpretation of agreements that the courts must give effect to the plain language used by the parties and that the intention of the parties must be gathered from the plain meaning of words used in the agreement. The BHC noted that, the Jurisdiction Clause conferred exclusive jurisdiction on the courts at Hyderabad, and that this was not part of the Arbitration Clause of the Agreement. The BHC noted that significantly, the choice of court at Hyderabad was made clearly ‘subject to’ Arbitration Clause. Therefore, the plain language used in the Agreement, was that Mumbai is chosen as the seat of arbitration proceedings.

The BHC commended the ratio of the judgment in South India Corporation Private Limited v. Secretary Board of Revenue [AIR 1964 SC 207], that the meaning of the expression ‘subject to’ is the opposite of ‘notwithstanding’ and, therefore, ‘subject to’ could never have been interpreted as ‘notwithstanding’ as had been done in the Impugned Order. The BHC, hypothetically analysed that, even if one were to accept that concurrent jurisdiction of two courts is possible, the choice of Mumbai as the seat of arbitration would in any view of the matter mean that the courts at Mumbai had concurrent jurisdiction to entertain disputes under the Agreement. The BHC emphasized that, the choice of courts at Hyderabad is made ‘subject to’ the seat at Mumbai, which implied prevalence of choice of courts at Mumbai, and therefore in the event of any conflict the latter clause should prevail. The BHC stated that this is the plain meaning, beyond any doubt, of the words ‘subject to’ and ‘seat’ and, therefore, this would have the effect of conferring exclusive jurisdiction on the courts at Mumbai.

The BHC observed that the Jurisdiction Clause and the choice of courts expressed therein would apply in a situation not covered by a dispute that is governed by the arbitration agreement in Arbitration Clause. In any view of the matter, even if Jurisdiction Clause does overlap with Arbitration Clause in determining which court would have jurisdiction to entertain applications made under the Act, since Jurisdiction Clause is made ‘subject to’ Arbitration Clause, the BHC observed that the court of the ‘seat’ would even under the Agreement have exclusive jurisdiction to entertain applications made under the Act.

The BHC noted that, the SC in BGS SGS had observed that, even when parties use the expression ‘venue of arbitration proceedings’ with reference to a particular place, the expression ‘arbitration proceedings’ would make it clear that the ‘venue’ should be read as ‘seat’. The BHC observed that thus, there is no basis for reading Mumbai as a ‘venue’, only because effect had to be given to the choice of courts at Hyderabad, which is itself ‘subject to’ the Arbitration Clause.

Decision of the Bombay High Court

The BHC held that the Impugned Order in so far as it related to the interpretation of the Agreement, could not be sustained. The BHC answered the first part of the Issue 1, in the negative; and the second part of the Issue 1 in the affirmative. Further, the issue 2 as mentioned above was answered in negative.

It thus held that, where a provision in the Agreement conferred exclusive jurisdiction on one place and another provision separately provided for a seat of arbitration in another place and the Agreement provides that the first provision is subject to the second provision, the courts at the latter place would have jurisdiction for entertaining the Section 9 Petition. Therefore, the BHC conclusively held that the Arbitration Clause would prevail over the Jurisdiction Clause and hence the courts at the seat, that is, at Mumbai, had the exclusive jurisdiction.

Therefore, the BHC set aside the Impugned Order and allowed the appeal. The Section 9 Petition was ordered to proceed on merits before the BHC and was accordingly restored.

VA View:

The BHC in this Judgement has analysed multiple precedents relied upon by the parties. The BHC relied on the case of BGS SGS to reiterate the clear position of law and reinforced the premise that the concept of juridical seat of arbitral proceedings had to be developed in accordance with the international practice on a case-by-case basis. The BHC after analysing various precedents, and provisions in agreement with the observations made by the SC, noted that it is too late in the day, to contend that the seat of arbitration is not analogous to an exclusive jurisdiction clause.

The BHC in this Judgement has clarified that, BALCO, did not hold that two courts, that is, the seat court and the court within whose jurisdiction the cause of action arises, had concurrent jurisdiction. The BHC noted that the various high courts missed the subsequent paragraphs in BALCO, which clearly and unmistakably stated that the choosing of a ‘seat’ amounted to the choosing of the exclusive jurisdiction of the courts at which the ‘seat’ is located.

For more information please write to Mr. Bomi Daruwala at [email protected]