Maintainability of Application Under Section 8 of Arbitration & Conciliation Act, 1996 In An Insolvency Proceeding
The Supreme Court in a recent judgment of Indus Biotech Pvt. Ltd. vs. Kotak India Venture (Offshore) Fund [AIR 2021 SC 1638] has settled an important question of law: ‘whether an application filed under Section 8 of Arbitration & Conciliation Act, 1996 (‘A&C Act’) can be said to be maintainable in a proceeding initiated under Insolvency and Bankruptcy Code, 2016 (‘IBC’)’.
The Supreme Court of India was seized of two connected matters. The first matter was filed by the Petitioner, Indus Biotech Pvt. Ltd. (‘Indus’), under Section 11 of A&C Act seeking appointment of nominee arbitrator of Respondent Nos. 1 to 4, who were 4 different Kotak Group Companies (‘Kotak Group’). While one of the entities was a Mauritius based company, the other entities, though Indian entities, were its sister ventures. The second matter was an appeal arising out of the judgment dated 09.06.2020 passed by NCLT, Mumbai. NCLT Mumbai had allowed an application filed by Indus under section 8 of A&C Act, in an insolvency proceeding initiated under section 7 of IBC by one of the Kotak Group Companies against Indus.
Indus and Kotak Group entered into various Share Subscription Agreements and Share Purchase Agreements, for subscription of Optionally Convertible Redeemable Preference Shares in Indus. Due to the decision of Indus of making Qualified Initial Public Offering (QIPO), Kotak Group was required to convert its preference shares into equity shares in compliance of SEBI Regulations, 2018.
In this process, dispute arose between the parties regarding calculation and application of conversion formula to be applied for the conversion of preference shares into equity shares as well as payment to be made by Indus pursuant to such conversion. Indus relied on its auditors’ report and contended that Kotak Group was entitled to approx. 10% of total paid up share capital only. Whereas, Kotak Group contended that they were entitled to 30% of the total paid up share capital in equity shares, and claimed an amount of Rs. 367,08,56,503/- from Indus.
Indus invoked arbitration clause contained in the agreements vide its letter dated 15.10.2019 and nominated Justice V.N. Khare (Former Chief Justice of India) as its nominee arbitrator. However, due to the dispute between the parties, the arbitral tribunal could not be constituted, therefore, Indus approached Supreme Court of India under section 11 of A&C Act seeking appointment of nominee arbitrator on behalf of Kotak Group. In the meantime, one of the Kotak Group entities filed an application under section 7 of IBC (‘Section 7 application) before NCLT Mumbai seeking to initiate insolvency proceeding against Indus on the ground that Indus had defaulted on payment of its debt of Rs. 367,08,56,503/-. Indus, however, filed an application under section 8 of A&C Act (‘Section 8 application’) praying NCLT, Mumbai to refer the parties to arbitration, as all the agreements contained arbitration clause.
Kotak Group contended before NCLT, Mumbai that since Indus defaulted on payment of its debt, therefore, insolvency proceeding was maintainable against such default. Accordingly, they claimed that the dispute was non-arbitrable and section 8 application was liable to be rejected.
NCLT, Mumbai while allowing section 8 application of Indus, referred the matter to arbitration and dismissed section 7 application. NCLT Mumbai also held that since the conversion process was not complete, therefore, there was no debt and no default on the part of Indus. The aforesaid judgment was challenged in an appeal before Supreme Court directly, instead of preferring an appeal before National Company Law Appellate Tribunal. It was contended by the Kotak Group that the impugned judgment dated 09.06.2020, was an order on section 8 application and since IBC does prescribe for any appeal against such an order, therefore, the appeal was filed directly before Supreme Court. The said appeal by Kotak Group was clubbed with section 11 petition filed by Indus.
FINDINGS OF THE SUPREME COURT:
The issue whether a direct appeal before Supreme Court was the only remedy available with Kotak Group was decided against Kotak. The Supreme Court held that the judgment dated 09.06.2020 did not only allow section 8 application but also rejected section 7 application of Kotak Group and therefore, the remedy of appeal before National Company Law Appellate Tribunal was available under Section 61 of IBC.
Supreme Court, thereafter, proceeded to discuss the scope of ‘debt’ and ‘default’ under various provisions of IBC and held that for maintaining an application under section 7 of IBC, the following four factors are essential:
- there should be a ‘debt’;
- ‘default’ should have occurred;
- debt should be due to ‘financial creditor’; and
- such default which has occurred should be by a ‘corporate debtor’.
The court further held that since the process of calculation and share conversion was not complete and parties were still deliberating on the same, therefore, there was no ‘debt’ due and payable by Indus, and hence, there was no ‘default’ as defined under IBC. The court, thereafter, proceeded to deal with the issue of arbitrability of a dispute under the provisions of A&C, Act. In this regard, the Court reiterated the legal position settled in its earlier judgment of Vidya Drolia vs Durga Trading Corporation [(2021) 2 SCC 1], whereby, Supreme Court had propounded a four-fold test to determine the arbitrability of a subject matter and had held the following disputes to be non-arbitrable:
- Disputes which relate to actions in rem, and do not pertain to subordinate rights in personam that arise from rights in rem;
- Disputes which affect third party rights; have erga omnes (towards all) effect; require centralised adjudication, and mutual adjudication would not be appropriate and enforceable;
- Disputes relating to inalienable sovereign and public interest functions of the State; and
- Disputes which are expressly or by necessary implication non-arbitrable as per mandatory statute(s).
The above test was propounded on the basis of Supreme Court’s earlier decisions in Booz Allen and Hamilton vs. SBI Home Finance Ltd. [(2011) 5 SCC 532] and A. Ayyasamy vs. A. Paramasivam [(2016) 10 SCC 386]. The court further explained that insolvency matters, intra-company matters, grant of patent and trademark, criminal matters, matrimonial disputes, probate and testamentary matters, etc. are non-arbitrable disputes.
On the basis of above position of law, the court proceeded to hold that for admitting a section 7 application, NCLT has to apply its mind and record a finding that a default has occurred. On admission of the application, third party rights become alive for all the creditors of the corporate debtor having an erga omnes effect, thereby making insolvency proceeding a proceeding in rem. However, the court clarified that mere filing of an application under section 7 of IBC does not amount to a proceeding in rem. NCLT is also duty bound to adhere to the timelines provided in IBC, so that the purpose of IBC is not defeated when a corporate debtor files a section 8 application with the intent of delaying the proceedings.
The court while relying upon section 238 of IBC, further held that if a corporate debtor files an application under section 8 of A&C, Act in a proceeding initiated under section 7 of IBC, it is bounden duty of NCLT to decide section 7 application first. Section 238 provides that provisions of IBC will have overriding effect on other statutes. It was further observed that if NCLT admits section 7 application and insolvency of a corporate debtor is initiated, the proceeding becomes proceeding in rem, and hence, non-arbitrable. However, if while deciding section 7 application, NCLT concludes that no default has occurred and consequently dismisses section 7 application, then NCLT is not required to decide section 8 application because parties are free to avail alternate remedies available to them in law.
In light of the above, the Supreme Court while dismissing the appeal filed by the Kotak Group, upheld the rejection of insolvency application by NCLT, Mumbai, however, concluded that NCLT, Mumbai ought not have allowed section 8 application filed by Indus. The court thereafter, proceeded to allow section 11 petition filed by Indus and appointed Justice R.M. Lodha (Former Chief Justice of India) as the nominee arbitrator on behalf of Kotak Group. The two arbitrators then were left to decide the name of the third arbitrator. The court thereafter while relying on its earlier judgment of Duro Felguera vs Gangavaram Port Ltd. [(2017)9SCC 729], directed that since there were more than one contract, separate arbitral tribunals should be constituted for each contract, though members of the tribunal can remain same.
The above judgment has settled an important question of law and it is clear from the judgment that an application filed under Section 8 of the A&C, Act is not at all maintainable in an insolvency proceeding initiated either under Section 7 or Section 9 of IBC. Though in the judgment the court has only dealt with a proceeding initiated under section 7 of IBC, however, from the discussion and conclusion made in the judgment, it can be safely concluded that the position of law will remain same even in a proceeding initiated under section 9 of IBC. Therefore, the above judgment is a welcome step for the law of insolvency, which would discourage the frivolous attempts by a corporate debtor to delay the IBC proceedings by resorting to arbitration clause despite there being no dispute on the debt payable by it and is a defaulter in terms of IBC.