INSOLVENCY AND ARBITRATION: On the Horns of a Dilemma

Introduction

This article aims to briefly encapsulate the position of law in India vis-a-vis the conflict between insolvency law and arbitration law. The author gives an overview of the prevalent law in India relating to the moratorium period (and its purpose) in insolvency proceedings and thereafter analyses the impact of such moratorium on different stages of arbitration proceedings with the help of several case laws. Although arbitration proceedings are expressly barred during a moratorium u/s.14(1) of the Insolvency and Bankruptcy Code 2016 (hereinafter “IBC”), the author examines the few exceptions carved out to this rule by the judiciary. The article thus concludes that the position in law is still ambiguous in this regard and can only be clarified by a legislative intervention.

Important Legal Provisions

Brief Overview of Arbitration and Insolvency Law

Before delving into the topic, it is important for the reader to be familiar with some basic concepts of insolvency and arbitration laws:

Arbitration

The main purpose of arbitration is to provide an out-of-court alternative to resolve disputes according to the terms agreed upon by the parties in the arbitration agreement. Thus, arbitration is meant to be fast-track and party-oriented. Even so, the arbitration process is court-oriented to an extent, as

• Section 8 of the Arbitration and Conciliation Act 1996 (hereinafter “ACA”) states that the judicial authority shall refer the parties to arbitration if it is prima facie shown that there is a valid arbitration agreement. Thus, it is largely a court-annexed process
• The Courts can provide interim measures (such as injunction orders) during an arbitration proceeding, as provided u/s.9 of ACA.
• Further, the arbitral awards may be challenged before the courts under sections 34 or 36 of ACA
• Moreover, section 37 of ACA provides for appeals in the aforementioned case cases, i.e., for challenging the orders under sections 8, 9 or 34.

Insolvency

The main purpose of insolvency is to prioritise the interests of a creditor and to ensure smooth investor exit strategies. The aim is to maximise the asset value of the debtor/borrower so that the interests of various stakeholders can be balanced.

• It is pertinent to note that IBC deals only with: (A) the insolvency proceedings (liquidation), and (B) the restructuring (wherein capital structure, management, etc. are reorganised) of the company. It does not deal with debt recovery. Due to the nature of such proceedings, the rights of third parties are also triggered, and therefore, insolvency proceedings are deemed as proceedings in rem and not proceedings in personam (such as debt recovery).

• In India, the law has evolved such that on default (minimum default of Rupees One Crore), a creditor can file an insolvency petition against the debtor under sections 7 or 9 of IBC (depending on the type of debt, i.e., financial, or operational). Interestingly, even the corporate debtor itself can file an insolvency petition upon default, as laid down under section 10 of IBC.

• However, there is a distinction between the filing of a petition seeking insolvency, and the admission of such petition by the adjudicating authority, which has been clearly held by the Indian courts.[1]

The ‘Calm Period’: IBC on Moratorium

“Moratorium” generally means the legally authorised delay in discharging an obligation or undertaking an action.[2] For example, in a loan agreement, a moratorium period refers to the period during which the borrower need not make regular loan repayments. In an insolvency proceeding, however, moratorium is essentially a temporary break given to the debtor from any legal actions against him.

This moratorium was also provided for winding-up proceedings u/s.446(1) of the Companies Act 1956 (the “1956 Act”), and a similar provision is also incorporated as s.279 of the Companies Act 2013 (the “2013 Act”). However, such winding-up procedure is limited to the grounds enlisted u/s.271 of the 2013 Act, which does not include “inability to pay debts” anymore (after its amendment in 2016), as that is governed by the provisions of IBC.

The report of the Bankruptcy Law Reforms Committee noted that one of the purposes of insolvency law is to ensure that the debt collection actions by the creditors are adjourned, so that the debtors and creditors can re-negotiate their contract.[3] This also gives the corporate debtor some breathing space to continue as a going concern in order to ultimately rehabilitate itself.[4] Thus, section 14 of IBC expressly prohibits:

• the institution or continuation of suits/proceedings against the corporate debtor, including the execution of any judgement, decree, or order in any court of law, tribunal, arbitration panel or other authority
• transfer, alienation, etc. of corporate debtor’s assets
• any foreclosure or recovery of securitisation action under the SARFAESI Act 2002.

As emphasised, all proceedings before an arbitration panel are also stayed till the insolvency proceedings are ongoing. This is where the conflict arises between the two laws. The term “proceedings” u/s.14 IBC is not a defined term, and its judicial interpretation is crucial, otherwise all proceedings may be deemed to be excluded.

Analysis: Arbitration Proceedings during Moratorium Period under IBC

1. Fresh/Pending Arbitration Proceedings:

In the landmark Alchemist case,[5] arbitration clause was invoked after the imposition of moratorium period, and SC held that the moment an insolvency petition is admitted, the moratorium that comes into effect u/s.14(1)(a) of IBC expressly interdicts institution or continuation of pending suits or proceedings against corporate debtors, and thus the arbitration that has been instituted after the moratorium is non est.[6] This ratio was applied by NCLAT in K.S. Oils Ltd. v. State Trade Corpn. of India Ltd.,[7] wherein NCLAT observed that arbitral proceedings pending on the date of commencement of CIRP cannot proceed during the moratorium. Therefore, both fresh as well as pending arbitration matters are not allowed during the moratorium period.

            In fact, NCLT Tribunals across the country have initiated CIRP amidst ongoing arbitration proceedings, or despite the existence of an arbitration agreement, as ongoing arbitration cannot bar the commencement of insolvency proceedings.[8]

• “Benefit of Corporate Debtor” – Challenge to Arbitral Award u/s.34 ACA

In the case of Power Grid Corporation,[9] the question before the Delhi High Court was whether the proceedings u/s.34 of ACA needed to be stayed due to the moratorium u/s.14 of IBC. The issue was peculiar because if the stay was implemented, the respondent corporate debtor would be unable to execute the award given in its favor. The court analysed that the term “proceedings” u/s.14 IBC is not preceded by the term “all”,[10] and thus by purposive interpretation, it was held that not all proceedings are barred by the moratorium, particularly if they in the benefit of the corporate debtor, as such proceedings would not adversely affect the assets of the corporate debtor.[11]

            However, this holding was partly overruled by a 3-judge bench of Supreme Court in the P. Mohanraj case,[12] wherein the court observed that the proceedings u/s.34 ACA is certainly a “proceeding against the corporate debtor which may result in an arbitral award against the corporate debtor being upheld, as a result of which, monies would then be payable by the corporate debtor”.[13] It is pertinent to note that the courts did not expressly overrule that proceedings which are for the benefit of the corporate debtor will not be barred u/s.14 IBC, as the purpose of moratorium is such that it is beneficial for the debtor. Nonetheless, it is clear that proceedings u/s.34 ACA (for challenge of arbitral award) are barred u/s.14 IBC, as these may not be ruled in favour of the corporate debtor.

• Counterclaims

In the case of Jharkhand Bijli Vitran Nigam Ltd. v. IVRCL (Corporate Debtor) & Anr.,[14] the issue was whether a counterclaim can proceed during the continuance of moratorium, especially when the adjudicating authority under the Code allowed the corporate debtor to pursue the claim. The appellate tribunal held that such counterclaims can proceed, but if on determination it is found that the Corporate Debtor is liable to pay a certain amount, then no such recovery can be made during the period of moratorium. This issue was also dealt with by the Delhi HC in SSMP Industries case,[15] wherein it was held that arbitration proceedings can continue viz. the counterclaims, and once they are adjudicated upon and the amount to be paid/recovered is determined, then a moratorium u/s.14 could be triggered depending upon the situation.[16] This is because, even though a counterclaim is a proceeding against the corporate debtor, its continuation per se is not a threat to the assets of such debtor.

• Appointment of Arbitrators

The High Courts have held in various cases that appointment of an arbitrator u/s.11(6) ACA is not barred by initiation of insolvency proceedings.[17] However, in those cases, the court was dealing with insolvency petitions which were yet to be accepted, and thus the courts also held that the mere filing of an insolvency application (u/ss.7,9,10) does not automatically invoke the moratorium, and an application u/s.11(6) of ACA remains maintainable until the NCLT decides on the occurrence of default u/ss.7(4) and 7(5) of IBC.

            The issue was finally resolved by the Supreme Court in the matter of New Delhi Municipal Council vs. Minosha India Limited,[18] wherein the apex court held that “proceedings” u/s.14 would be tabooed, but this does not include an application u/s.11(6) of ACA by the corporate debtor, or for that matter, any other proceeding by the corporate debtor against another party.[19]

Conclusion

The Courts have conclusively held that:

1. Institution of fresh arbitration proceedings is barred.
2. Arbitration proceedings pending since before the moratorium are also barred
3. Proceedings u/s.34 ACA are also barred, as the appeal may or may not be in favour of the corporate debtor
4. Proceedings for the benefit of the corporate debtor are not barred.
5. Counterclaims may be proceeded with, but if corporate debtor is liable to make payments by way of such proceedings, then such recovery cannot be made during the moratorium period. The moratorium would be imposed only selectively on such counter claims at the stage of execution or enforcement of the award.
6. A corporate debtor may initiate arbitration proceedings u/s.11(6) ACA to appoint an arbitrator.
7. Mere filing of an insolvency petition does not automatically bar arbitration proceedings; they are valid till the NCLT invokes a moratorium u/s.14 IBC.

Therefore, it is clear that there is ambiguity in the court’s stance, and thus there is a need for legislative intervention to clarify the position of arbitration proceedings which are to be allowed during a moratorium period under IBC.

-Raghav Gupta
Intern
Jindal Global Law School

[1] Indus Biotech (P) Ltd. v. Kotak India Venture (Offshore) Fund, (2021) 6 SCC 436 at ¶26 (“The underlying principle, therefore, from all the abovenoted decisions is that the reference to the triggering of a petition under Section 7 of the IB Code to consider the same as a proceedings in rem, it is necessary that the adjudicating authority ought to have applied its mind, recorded a finding of default and admitted the petition. On admission, third-party right is created in all the creditors of the corporate debtors and will have erga omnes effect. The mere filing of the petition and its pendency before admission, therefore, cannot be construed as the triggering of a proceeding in rem. Hence, the admission of the petition for consideration of the corporate insolvency resolution process is the relevant stage which would decide the status and the nature of the pendency of the proceedings and the mere filing cannot be taken as the triggering of the insolvency process.”).

[2] Bryan A. Garner, Black’s Law Dictionary (2014).

[3] Report of the Bankruptcy Law Reforms Committee of November 2015, para 6.4.1.

[4] Report of the Insolvency Law Committee of February 2020, ¶8.2 & ¶8.11.

[5] Alchemist Asset Reconstruction Co. Ltd. v. Hotel Gaudavan (P) Ltd., (2018) 16 SCC 94.

[6] Id at ¶5.

[7] 2018 SCC OnLine NCLAT 352, at ¶14.

[8] Reliance Commercial Credit Limited v. Ved Cellulose Ltd., 2017 SCC Online NCLT 185; Dinesh Chand Jain and Others v. Fabulous Buildcon (P) Ltd. and Others, Company Petition (IB)-37/2018; M/s.Educomp Infrastructure & School Management Ltd. v. M/s. Millennium Education Foundation, Company Petition IB-245/ND/2022.

[9] Power Grid Corporation of India Ltd vs. Jyoti Structures Ltd, 2017 SCC OnLine Del 12189, ¶5 & ¶10.

[10] Id at ¶6.

[11] Id at ¶10.

[12] P. Mohanraj v. Shah Bros. Ispat (P) Ltd., (2021) 6 SCC 258.

[13] Id at ¶97.

[14] Company Appeal (AT) (Insolvency) No. 285/2018, decided on 3rd August 2018.

[15] SSMP Industries Ltd. vs. Perkan Food Processors Pvt. Ltd., 2019 SCC Online Del 9339.

[16] Id at ¶8, (“…. Section 14 has created a piquant situation i.e. the corporate debtor undergoing insolvency proceedings can continue to pursue its claims, but the counterclaim would be barred under Section 14(1)(a). When such situations arise, the Court has to see whether the purpose and intent behind the imposition of moratorium is being satisfied or defeated. A blinkered approach cannot be followed, and the Court cannot blindly stay the counterclaim and refer the defendant to the NCLT/resolution professional for filing its claims.”).

[17] Millennium Education Foundation v. Educomp Infrastructure and School Management Limited, 2022 LiveLaw (Del) 449 : ARB.P. 326/2022 decided on 13th May, 2022; Sunflag Iron & Steel Co. Ltd. v. M/s Poonamchand & Sons, Misc. Civil Application No. 374/2020.

[18] 2022 LiveLaw (SC) 469.

[19] Id at ¶24.

Disclaimer: The views and opinions expressed in this blog are those of the author and do not necessarily reflect the official policy or position of BIMACC, any of the members of the Board, or the empanelled neutrals.