Maintainability of application under section 8 of the Arbitration and Conciliation in Insolvency Proceedings Act 1996
The Supreme Court in a recent judgment of Indus Biotech Pvt. Ltd. v Kotak India Venture (Offshore) Fund [AIR 2021 SC 1638] settled an important question of law: ‘whether a claim filed under section 8 of the Arbitration and Conciliation Act, 1996 (‘A&C Act‘) can be considered to be upheld in proceedings initiated under the Insolvency and Bankruptcy Code, 2016 (‘IBC ‘)‘.
The Supreme Court of India has been seized of two related cases. The first case was filed by the applicant, Indus Biotech Pvt. Ltd. (‘Indus‘), under Article 11 of the A&C Law, requesting the appointment of an appointed arbitrator of the defendants 1 to 4, which were 4 different companies of the Kotak group (‘Kotak Group‘). While one of the entities was a Mauritius-based company, the other entities, although Indian, were its sister companies. The second case was an appeal arising from the judgment of 09.06.2020 issued by NCLT, Mumbai. NCLT Mumbai had allowed an application filed by Indus under section 8 of the A&C Act, in insolvency proceedings brought under section 7 of the IBC by one of the companies in the Kotak group against Indus.
IN SHORT :
Indus and Kotak Group have entered into various share subscription agreements and share purchase agreements, for the subscription of preferential shares redeemable and convertible as an option in Indus. Due to Indus’ decision to make a Qualified Initial Public Offering (QIPO), the Kotak Group was required to convert its preferred shares into shares in accordance with the SEBI Regulation of 2018.
In this process, a dispute arose between the parties concerning the calculation and application of the conversion formula to be applied for the conversion of the preference shares into equity shares as well as the payment to be made by Indus by virtue of this conversion. Indus relied on the report of its auditors and argued that the Kotak Group was entitled to approx. 10% of the total paid-up share capital only. Whereas Kotak Group argued that it was entitled to 30% of the total paid-up share capital in shares and claimed an amount of Rs. 367,08,56,503 / – from Indus.
Indus invoked the arbitration clause contained in the agreements in his letter of 15.10.2019 and appointed Judge VN Khare (former Chief Justice of India) as appointed arbitrator. However, due to the dispute between the parties, the arbitral tribunal could not be constituted. Therefore, Indus approached the Supreme Court of India under Section 11 of the A&C Act to request the appointment of an appointed arbitrator on behalf of Kotak Group. In the meantime, one of the entities of the Kotak group has filed an application under Article 7 of the IBC (‘Request under section 7) before NCLT Mumbai seeking to initiate insolvency proceedings against Indus on the grounds that Indus was in default of its debt of Rs. 367,08,56,503 / -. Indus, however, filed an application under Section 8 of the A&C Act (‘Request under section 8‘) urging NCLT, Mumbai to refer the parties to arbitration, as all agreements contained an arbitration clause.
Kotak Group argued before NCLT, Mumbai that since Indus was in default on its debt, the insolvency proceedings could therefore stand against such default. Accordingly, they asserted that the dispute was not arbitrable and that the application of Article 8 was liable to be rejected.
NCLT, Mumbai, while allowing the application of Article 8 of Indus, referred the matter to arbitration and rejected the application of Article 7. NCLT Mumbai also considered that since the process of conversion was not completed, so there had been no debt or default on Indus’ part. The aforementioned judgment was appealed to the Supreme Court directly, instead of preferring an appeal to the National Company Law Appeals Tribunal. The Kotak group maintained that the judgment under appeal dated 09.06.2020 was an order on the application of Article 8 and as IBC provides for an appeal against such an order, the appeal was therefore filed directly with the Court. supreme. Said Kotak Group appeal was bludgeoned with the Section 11 motion filed by Indus.
FINDINGS OF THE SUPREME COURT:
Whether a direct appeal to the Supreme Court was the only remedy available with the Kotak group has been decided against Kotak. The Supreme Court ruled that the judgment of 09.06.2020 not only authorized the application of Article 8, but also rejected the application of Article 7 of the Kotak Group and, therefore, the appeal to the National Company Law Appeal Tribunal was available under Article 61 of the IBC.
The Supreme Court then discussed the scope of “debt” and “default” under various provisions of the IBC and ruled that in order to maintain a claim under section 7 of the IBC, the four following factors are essential:
- there should be a “debt”;
- “Default” should have occurred;
- the debt should be owed to the “financial creditor”; and
- such a default which has occurred should be the act of a “debtor undertaking”.
The court further held that, since the process of calculating and converting shares was not completed and the parties were still deliberating on the same subject, there was therefore no “debt” due and payable by Indus, and therefore there was no “default” as defined under IBC. The tribunal then considered the issue of arbitrability of a dispute under the provisions of the A&C, Act. In this regard, the Court reiterated the legal position established in its previous judgment of Vidya Drolia v Durga Trading Corporation [(2021) 2 SCC 1], whereby the Supreme Court proposed a four-part test for determining the arbitrability of an object and found the following disputes not to be arbitrable:
- Litigation relating to actions in rem, and do not concern subordinates rights in person which arise from real rights;
- Disputes affecting the rights of third parties; to have erga omnes (towards all) effect; require centralized arbitration, and mutual arbitration would be neither appropriate nor enforceable;
- Disputes relating to the inalienable functions of sovereignty and public interest of the State; and
- Disputes which are expressly or by necessary implication not arbitrable in accordance with mandatory laws.
The above criterion was proposed on the basis of previous Supreme Court decisions in Booz Allen and Hamilton v SBI Home Finance Ltd. [(2011) 5 SCC 532] and A. Ayyasamy v A. Paramasivam [(2016) 10 SCC 386]. The court further explained that insolvency cases, internal company affairs, issuance of patents and trademarks, criminal cases, matrimonial disputes, estate and testamentary cases, etc. are non-arbitrable disputes.
Based on the above legal position, the court decided that in order to admit a Section 7 claim, NCLT must apply its mind and record a finding that a default has occurred. As soon as the request is admitted, the rights of third parties become active for all the creditors of the debtor company with a erga omnes effect, thus making the insolvency proceedings a proceed in rem. However, the court clarified that the mere filing of an application under Article 7 of the IBC does not amount to a proceed in rem. NCLT is also required to adhere to the deadlines set out in the IBC, so that the purpose of the IBC is not defeated when a debtor company files a Section 8 claim for the purpose of delaying proceedings.
The court, while relying on Section 238 of the IBC, further held that if a debtor company files a claim under Section 8 of the A&C, Act in a proceeding brought under Article 7 of the IBC, it is the duty of the NCLT to rule on the application of Article 7 first. Article 238 provides that the provisions of the IBC will have a preponderant effect over other laws. It was further observed that if the NCLT admits the application of Article 7 and the insolvency of a debtor company is initiated, the proceedings become proceed in rem, and therefore not arbitrable. However, if in deciding on the application of section 7, NCLT concludes that no default has occurred and therefore rejects the application of section 7, then NCLT is not bound to adjudicate on the application of Article 8 because the parties are free to resort to other remedies available to them by law.
In light of the above, the Supreme Court, while dismissing the appeal filed by the Kotak Group, upheld the rejection of the insolvency claim by NCLT, Mumbai, however concluded that NCLT, Mumbai would not have had to authorize the section 8 application filed by Indus. The court then allowed the Article 11 petition filed by Indus and appointed Judge RM Lodha (former Chief Justice of India) as appointed arbitrator on behalf of the Kotak group. The two referees then had to decide on the name of the third referee. The court subsequently, relying on its earlier judgment of Duro Felguera v Gangavaram Port Ltd. [(2017)9SCC 729], ordered that since there was more than one contract, separate arbitral tribunals should be constituted for each contract, although the members of the tribunal could remain the same.
The above judgment has settled an important question of law and it is clear from the judgment that a claim made under section 8 of the A&C, Act is not at all sustainable in an insolvency proceeding initiated. under Article 7 or Article 9 of the IBC. Although in the judgment the court dealt only with a proceeding initiated under Article 7 of the IBC, however, from the discussion and conclusion reached in the judgment, one can conclude without risk that the position of the law will remain the same in proceedings initiated under Article 9 of the IBC. Therefore, the above judgment is a welcome step for insolvency law, which would discourage futile attempts by a debtor company to delay IBC proceedings by resorting to an arbitration clause when there was no of debt litigation against him and that he is in default in terms of IBC.