Home » 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

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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]

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