Author: Ektha Vivekanand, a student at School of Excellence in Law, The Tamil Nadu Dr Ambedkar Law University
Abstract:
One of the most sought-after questions in the wide landscape of company law, is the relationship between the provisions of arbitration law and insolvency provisions. This question has often troubled the greatest legal minds of the country until it was finally answered by the Hon’ble Supreme Court of India in March 2021 through its pronounced decision in the case of Indus Biotech Pvt Ltd v Kotak India (Offshore) Fund. The aim of this article is to delve into the facts of this case and the issues held, as well as to critically analyse the judgement of the case and its impact on insolvency and alternative dispute resolution procedures in India.
Introduction:
The Indian judiciary has been characterised with a backlog of cases, which necessitated the introduction of alternative dispute resolution methods like arbitration, conciliation, mediation and others. The Arbitration and Conciliation Act 1996 is the statute governing alternative dispute resolution in India, at present.
Laws relating to the declaration of insolvency by corporations as well as the declaration of their non-performing assets were consolidated into the Insolvency and Bankruptcy Code 2016.
The case in hand was decided by a 3-member bench of the Supreme Court upon an appeal from the decision of the National Company Law Tribunal.
Factual Background:
As per Section 11(4) of the Arbitration and Conciliation Act 1996, the Supreme Court has to appoint arbitrators to decide matters of international commercial arbitration. The petitioner, Indus Biotech Pvt Ltd is a Mauritius-based company that filed a petition before the apex court under this section for its dispute with the defendant, Kotak India (Offshore) Fund & Others, which is an Indian entity.
The parties in the given case, entered into a Share Subscription and Shareholder Agreement (also known as a SSSA) in the year 2017. This Agreement had an explicit clause mentioning that any dispute arising out of the agreement would be settled by way of arbitration. Under this Agreement, the defendant, Kotak India opted to subscribe for securities known as the Optionally Convertible Redeemable Preference Shares as well as equity shares that were being issued by the petitioner, Indus Biotech.
After entering into the aforementioned shareholder agreement in 2017, Kotak India wished to convert the shares possessed and owned by them into equity shares in the year 2018. This move was sought to be done by the defendant in order to make a Qualified Initial Public Offer. Regulation 5(2) of the Securities and Exchange Board of India bars companies from making these Qualified Initial Public Offers if they have any outstanding convertible rights that could enable a person to receive equity shares. While this conversion process was occurring, there was some conflict between the two parties pertaining to the calculation and the conversion formula adopted in order to convert the Optionally Convertible Redeemable Preference Shares into Equity Share Capital.
This conflict resulted in a legal dispute since both parties had a conflicting idea on the method to be used for calculation itself. As per the formula followed by the defendant, Kotak India were entitled to receive 30% of the total paid-up share capital held by the petitioner. However, the formula adopted by the petitioner indicated that the defendant, Kotak India, was only entitled to 10% of the total paid-up share capital held by the petitioner. It was established that until an appropriate decision was arrived at pertaining to the method of calculation, no refund amounts could be claimed or transacted between the two parties and no liability could be claimed. Hence, there is no defined ‘debt’ or ‘default’ that the petitioner has made in order to raise a claim that the petitioner company is in a position where it is unable to pay the due amount.
Due to this difference in opinion of calculation, Indus Biotech resorted to a position wherein they refused to pay the redemption amount to Kotak India which resulted in formal legal proceedings. The defendants claimed that the amount due to them by the petitioner was a sum of Rs. 367,08,56,503/- which remained due. This position taken by Indus to not pay the amount, led Kotak to institute proceedings against Indus Biotech before the National Company Law Tribunal (NCLT), Mumbai Bench under Section 7 of the Insolvency and Bankruptcy Code, 2016.
In response to this legal action by Kotak India, Indus filed an interlocutory application before the same Hon’ble bench of the National Company Law Tribunal to request that the matter be transferred to resolution by way of arbitration, as specified in the Share Subscription and Shareholder Agreement entered into initially by both parties in 2017. This power has been granted to courts and tribunals under Section 8 of the Arbitration and Conciliation Act 1996. Hence, the petitioners preferred an application under Section 8.
National Company Law Tribunal’s Decision:
The observation held by the NCLT on the petition of Kotak India, was that in matters pertaining to Section 7, it is up to the discretion of the court and it should be a judicial decision as to whether or not there has been a ‘default’ by the opposing party [Indus Biotech, in the given case] as defined under Section 3 of the Insolvency and Bankruptcy Code 2016.
The Hon’ble Bench held that in the given case, there had not been any default on the part of Indus Biotech. It was also declared by the Tribunal that it was an established fact that Indus Biotech was a solvent, debt-free and profitable company. The Tribunal accepted Indus’ interlocutory application and held that since the dispute concerned was a dispute that was completely of contractual nature, it could be referred and resolved by way of arbitration.
The NCLT consequently rejected the Insolvency Application submitted by Kotak India in accordance with the Insolvency and Bankruptcy Code 2016.
Issues of the Case:
Post the Tribunal’s decision, the matter was referred by Kotak India by way of a special leave petition under Article 136 of the Constitution of India before the Hon’ble Supreme Court of India. Hence, the issues laid for decision before the Supreme Court were as follows:
- Whether the NCLT made an error in dismissing the appeal under Section 8 of the Insolvency and Bankruptcy Code 2016 in a petition that was filed under Section 7 of the same Code, which was being construed as a proceeding in rem?
- Whether the dismissal of a petition under Section 7 is illegal considering arbitration proceedings on the same issue are pending before the appropriate authority?
- Whether the principles held in Vidya Drolia v Drug Trading Corporation apply in the given case and the dispute is non-arbitrable?
Ruling of the Hon’ble Supreme Court of India:
The first and foremost holding of the court was that the question of maintainability of a Section 7 petition can only be decided on one factor – whether a default has occurred.
Section 7 of the Insolvency and Bankruptcy Code 2016 deals with the institution of insolvency processes by financial creditors to a corporation. It endows financial creditors to take steps against the debtors by resorting to legal processes of insolvency before the National Company Law Tribunal. However, it is an established prerequisite condition that any application made by a creditor under this provision, needs to be supported by adequate evidence of the default and the amount defaulted has to be within the threshold specified in the section. This Section serves as a legal remedy to creditors to claim their unpaid dues by way of the insolvency process.
With respect to the first issue, it has been held by the Supreme Court that the initiation of arbitration proceedings is not incorrect if the proceedings before the Tribunal under Section 7 are not in rem. In this particular instance, it was held that these proceedings cannot be considered proceedings in rem because the default required under Section 7 was yet to be admitted and proven.
It has been a standing position taken by the Courts that in case of any dispute under the Insolvency and Bankruptcy Code 2016, a proceeding is considered to be in rem only when it is admitted. Further, it was held that a dispute can be declared as non-arbitrable only when a proceeding is in rem. In order to invoke this precedent, the Supreme Court, in its judgement relied upon the case of Vidya Drolia v Drug Trading Corporation. The Courts usually placed reliance upon the decision in Booz Allen & Hamiton Inc v SBI Home Finance Ltd to determine the arbitrability of disputes. This case provided the difference between disputes in rem and disputes in personam and held that proceedings in rem are non-arbitrable. Insolvency proceedings had been listed as non-arbitrable. This test had been sufficiently criticised by various scholars as it failed to differentiate between rights in rem and their ergo omnes effect. The Vidya Drolia judgement went on to plug in the gaps of the Booz Allen judgement as it reconciled the ‘rights-based approach’ with the ‘effects-based approach’.
The Supreme Court further went on to clarifying the meaning of a “proceeding in rem” for the purpose of this Section. It was established by the Court in this judgement that for a proceeding to be considered in rem, the adjudicating authority should have applied his mind, considered all the facts in hand, recorded any finding of default and admitted the petition. An admission by the court leads to the conception of a third party right to all involved financial creditors of a corporation, thereby creating an ergo omnes effect. The simple filing of the petition before the court before any admission by the adjudicating authority cannot be equivalent to a proceeding in rem.
If the Tribunal concludes that a default has not occurred, the parties are then free to take the dispute forward by way of arbitration proceedings.
The defendants, Kotak India, relied upon the Supreme Court’s decision in Swiss Ribbons Pvt Ltd & Anr v Union of India and Ors to establish non-arbitrability of insolvency proceedings. However, this contention was not considered by the Hon’ble Court as it opined that the reliance upon this judgement was misplaced.
Any subsequent proceeding under Section 8 of the Arbitration and Conciliation Act 1996, if a proceeding under Section 7 of the Insolvency and Bankruptcy Code 2016, has been admitted by the Hon’ble Court, cannot be considered maintainable. On this effect, the Supreme Court reiterated Section 238 of the Insolvency and Bankruptcy Code by stating that the IBC provisions shall override all other laws. Hence, if the application under Section 8 is filed pending admission of the Section 7 petition, a decision must first be made on the Section 7 application even in the situation where the Section 8 petition is heard simultaneously. This order of proceedings is because the decision of the Section 7 petition would affect the decision of the Section 8 application.
Conclusion:
It has been established that if the Tribunal reaches a well-informed decision that a default has not occurred, the dispute can be referred to arbitration at the option of the parties to the dispute. By choosing to rely upon the conditions placed in the Vidya Drolia case, the court has taken a broadminded approach. A blanket approach declaring all insolvency proceedings as non-arbitrable needed to be altered. This judgement is a substantive step for the future to determine the question of arbitrability of insolvency disputes.
FAQs:
Q. Are all insolvency disputes non-arbitrable?
A. The Vidya Drolia v Drug Trading Corporation judgement establishes only specific conditions when an insolvency dispute is non-arbitrable. The Indus Biotech judgement also furthers the progressiveness to answer this question.