SECTION 7 OF IBC VIS-À-VIS ARBITRATION CLAUSE: A STEP IN THE WRONG DIRECTION BY NCLT

[Pranay Bhattacharya is a fourth-year student at Maharashtra National Law University, Aurangabad]


A landmark development by National Company Law Tribunal (NCLT), Mumbai in Indus Biotech Private Limited v. Kotak India Venture Fund, whereby a Section 7 application (Initiation of corporate insolvency resolution process by the financial creditor) under Insolvency and Bankruptcy Code, 2016 (IBC) have been referred to Section 8 (Power to refer parties to arbitration where there is an arbitration agreement) of the Arbitration & Conciliation Act, 1996 (Arbitration Act).

The author with the help of this write-up will analyze the incorrect view taken by the NCLT to prioritize Section 8 of Arbitration Act over Section 7 of IBC.


BRIEF BACKGROUND OF THE CASE


In the present case, Kotak India Venture Fund-I (Financial Creditor) filed a company petition under Section 7of IBC to initiate Corporate Insolvency Resolution Process (CIRP) against Indus Biotech Pvt. Ltd. (Corporate Debtor).

In 2007-08, the Financial Creditor subscribed equity and preference shares in the Corporate Debtor’s Company, which included 4 materially identical Share Subscription & Shareholders Agreements (Agreements). Subsequently, the financial creditor opted to convert the subscribed Optionally Convertible Redeemable Preference Shares (OCRPS) into equity shares for Qualifying Initial Public Offering (QIPO) as per SEBI ICDR Regulations.

During the QIPO process, a dispute arose between the parties regarding the conversion process to be followed as per the agreements. The Corporate Debtor invoked the arbitration clause present in the agreement and contended that the arbitral proceedings deemed to have commenced from the date of the dispute under Section 21 (Commencement of Arbitral Proceedings) [i] of the Arbitration Act.


ARBITRABILITY OF THE DISPUTE UNDER ARBITRATION ACT VIS-À-VIS IBC: CONTENTIONS RAISED BY THE PARTIES


Corporate Debtor

The Corporate Debtor contended that the share purchase agreements have an arbitration clause, whereby disputes between the parties shall be resolved under Arbitration Act. Further, stating that Section 8 is mandatory in nature which puts an obligation on the judicial authority to direct the parties for arbitration.

It was also contended that IBC ought not to be used to extort money from profitable companies; rather the first available opportunity to resolve the dispute should be made under the Arbitration Act. Therefore, the presence of a pre-existing arbitration agreement mandate the Financial Creditor to seek remedy under arbitration.


Financial Creditor

The Financial Creditor pointed out that Section 7 of IBC is incapable of being referred to arbitration, being right in rem (right against the world at large) for matters such as probate, criminal matters, matrimonial matters, winding up etc. Also, the existence of an arbitration clause in the agreement should not be a ground to restrict Section 7 petition, which stands in contrast with a Section 8 application (Insolvency resolution by operational creditor) of IBC.

Further, Section 8 of the Arbitration Act relates to only such disputes/matters that the arbitrator is competent to decide [ii]. Therefore, the dispute being inarbitrable, the court can use alternative relief for the parties and admit the CIRP application instead of directing the parties to arbitration.


ISSUE BEFORE THE NCLT

“Will the provisions of the Arbitration & Conciliation Act, 1996 prevail over the provisions of the Insolvency & Bankruptcy Act, 2016? If so, in what circumstances?”

REASONING AND FINDINGS OF THE NCLT

The matter being first of its kind, the NCLT underlined that seeking a reference to arbitration under Section 7 of IBC is res integra (point of law on which neither a decision nor obiter dicta has been pronounced).

NLCT pointed out that arbitration is a general law, whereas IBC is a special law having an overriding effect under Section 238, over a general statute. But the settled principle that generalia specialibus non derogant (special law prevails over general law) is neither rigid nor inflexible, suited for the present case.

The NCLT referred to Consolidated Engineering Enterprises v Principal Secretary, Irrigation Department, (Supreme Court) to point out that where parties intend to refer the matter to arbitration, Arbitration Act shall be applicable as a special law. Therefore, it cannot be said that IBC shall have an overriding effect on Arbitration Act in all such scenarios.

Further, where a pre-existing arbitration clause exists, it is mandatory to refer the dispute to an arbitrator. Relying on Hindustan Petroleum Corporation Limited v Pinkcity Midway Petroleums and P Anand Gajapathi Raju & others v PVG Raju (dead), NCLT held that Section 8 of the Arbitration Act puts an obligation on the court to refer parties to arbitration due to pre-existing agreement.

ORDER

The NCLT held that the present application needs determination of a “default” under Section 3(12) of IBC, which is absent in this case. Therefore, the matter does not fall within the ambit of IBC. Hence, a Financial Creditor cannot use Section 7 application against a solvent, debt-free and profitable Corporate Debtor.

The parties were ordered to reconcile the matter by using arbitration rather than going into CIRP.

ANALYSIS

The judgment of the NCLT is flawed and erroneous based on the following reasons:

Firstly, paragraph 5.15 of the order states,

The disputes that form the subject matter of the underlying Company Petition…..are all arbitrable, since they involve the valuation of the shares and fixing of the QIPO date.

The reference to the above can be analysed from the Supreme Court’s judgment in Macquarie Bank Limited v. Shilpi Cable Technologies Ltd where the Court held that the scheme under Section 7 application stands in contrast with the scheme under Section 8 of IBC. Under Section 7, if the adjudicating authority is satisfied that a debt and default has occurred; it may accept or reject an application. It is of no matter that the debt is disputed or not so long as it is “due”. The same has been reiterated by the Court, in the landmark Innoventive Industries Ltd v. ICICI Bank case. In short, a Section 7 application does not mandates the criteria of pre-existing dispute under the Code, rather the existence of a default by the Debtor.

Hence, rejecting an application on the mere existence of an arbitration clause on the subject matter of QIPO is erroneous on the part of the NCLT. Rather, it would have been prudent to admit the application solely relying on the occurrence of a “debt” and “default” as against contending the subject matter of the debt. Further, the same should have been used to reach the final conclusion rather than disputing the presence of an arbitration clause.

Secondly, paragraph 5.7 relies on Consolidated Engineering Enterprises v Principal Secretary, Irrigation Department & other to highlight that:

….Arbitration & Conciliation Act is a special law, consolidating and amending the law relating to arbitration and matters connected therewith or incidental thereto.”

However, the NCLT’s failed to consider that Section 238 of IBC contains a non obstante clause i.e. provisions of the Code to override other laws, which are general in nature. Therefore, the reasoning of the NCLT can be opposed by precedents like Maharashtra Tubes Ltd. v. State Industrial & Investment Corporation of Maharashtra Ltd., Sarwan Singh v. Kasturi Lal, Allahabad Bank v. Canara Bank etc., where the Supreme Court has underlined that, in case of a conflict between two special legislations, the later enactment would prevail. Further, the Supreme Court has pointed out that: if, both are special statutes dealing with different situations notwithstanding a slight overlap here and there, the latter Act would prevail over the former. [iii]

Hence, the NCLT’s judgment lacks definite reasoning and valid grounds as why Arbitration Act should prevail over IBC; therefore, the same is erroneous in nature. Rather, it would have been prudent to prioritize IBC over Arbitration Act by the NCLT for the said reasons: i) the presence of a non obstante clause in IBC as against Arbitration Act, and ii) the persuasive force of the later enactment shall prevail over the former in case of a conflict between two special legislations or a general legislation.

Thirdly, the NCLT also failed to underline whether insolvency petition is capable of being referred to arbitration or being granted by an arbitral tribunal. Since, the arbitral tribunal/ arbitrator does not have the power to initiate CIRP, the tribunal took an opposite view that the matters underlying the suit with respect to QIPO are arbitrable as the rationale for referring the matter to arbitration, without any substantiate reasoning.

In Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd, the Supreme Court has underlined that insolvency and winding up matters are non-arbitrable. Therefore, the decision of the NCLT to refer the insolvency dispute to arbitration is not appreciable. Also, in Shalby Ltd v. Dr. Pranav Shah, the NCLT underlined that Arbitral Tribunal does not have jurisdiction over the subject matter of CIRP, irrespective of arbitration clause in the agreement.

Lastly, the NLCT failed to appreciate the fact that, in case of a “default”, the application must be admitted unless it is incomplete or defective[ii]. Therefore, analyzing default on the ground that the company is solvent and debt-free company is inconsistent with the principles of IBC.

AUTHOR’S WORD

The view taken by the NCLT is inconsistent as per the judicial precedents as well as the special nature of IBC. The aforementioned analysis makes it clear that the nature of dispute in recovery and winding up petitions do not fall within the purview of arbitration mechanism. Therefore, NCLT should have admitted the application under Section 7 of IBC relying on the default made by the Corporate Debtor.



[i] KSL and Industries Ltd. vs. Arihant Threads Ltd. and Ors. (25.08.2008 - SC), (2008)5CompLJ1(SC), Bhoruka Steel Ltd. v. Fairgrowth Financial Services Ltd. (1997) 89 Comp Cas 547.


[ii] Cases referred in the judgment are Haryana Telecom v. Sterlite Industries (India) Limited, and Booz Allen and Hamilton Inc v. SBI Home Finance Limited & others and, Sukanya Holdings (P) Ltd v. Jayesh H. Pandya.

[iii] 21. Commencement of arbitral proceedings - Unless otherwise agreed by the parties, the arbitral proceedings in respect of a particular dispute commences on the date on which a request for that dispute to be referred to arbitration is received by the respondent.

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