Insolvency & Bankruptcy Code: Arbitral Proceedings and Bona Fide Dispute

[Guest post by Puneet
Dinesh
, is a IV year student at the National Law University, Delhi. He can
be reached at puneetdin@gmail.com.]
The Insolvency and
Bankruptcy Code, 2016 (the ‘Code’) has given rise to some interesting legal
questions. As previously discussed on this Blog (here and here), the interpretation of the term
‘dispute’ under section 5(6) of the Code has arisen multiple times before the National
Company Law Tribunal (‘NCLT’). In this post, I intend to cover the aspect
concerning a dispute raised by way of an arbitral proceeding.
The scheme of an
insolvency proceeding under the Code initiated by an operational creditors run as
follows. The operational creditor, upon the occurrence of a default, delivers a
notice to the corporate debtor under section 8 of the Code. A period of ten
days is provided for the debtor to respond to the notice proving the existence
of a ‘dispute’. In this regard, section 5(6) defines the meaning of the term
‘dispute’:
“dispute”
includes a suit or arbitration proceedings relating to—
(a) the
existence of the amount of debt;
(b) the
quality of goods or service; or
(c) the
breach of a representation or warranty;
The existence of an
arbitral proceeding is sufficient to stall the entire proceedings under the
Code. In order to determine whether an arbitral proceeding exists or not, it
would be necessary to refer to the Arbitration and Conciliation Act, 1996 (the
‘Arbitration Act’). Section 21 of Arbitration Act provides that ‘the arbitral proceedings …commence on
the date
on which a request for that dispute to be referred to arbitration
is received by the respondent
’. Further, section 3(2) of the Arbitration Act
provides that ‘the communication is
deemed to have been received on the day it is so delivered
’. Reading sections
21 and 3(2) in conjunction, an arbitral proceeding is commenced the moment the debtor sends a written
communication
requesting the reference to arbitration, which is received by
the creditor. Therefore, all that a corporate debtor needs to do to stall the
proceedings under the Code is to merely send an email requesting for
arbitration, and any efforts of the creditor to resort to protection under the Code
is instantaneously stalled.
The interesting question
that emerges here is to ascertain if the NCLT can scrutinize any abuse of
process by the debtor in seeking to stall insolvency proceedings. Section 9(5)
of the Code confers power on the NCLT to admit or reject the application by the
operational creditor on listed grounds. Section 9(5) as it stands is extremely
formalistic and provides limited flexibility for the NCLT to adjudicate.
In these
circumstances, it would be useful to analyse analogous situations in other
legislation where courts or other adjudicating authorities have had to
ascertain the existence of a dispute, and standards they have employed to
determine whether such dispute was bona
fide
. Indian courts have faced
similar questions under the Arbitration Act. Section 8 of the unamended
Arbitration Act, which provided for reference of disputes to arbitration was
extremely formalistic requiring the courts to refer the matter, except when
formal conditions provided in the Act were not met. The parallel between these
two provisions has not gone unnoticed before the tribunal. The National Company
Law Appellate Tribunal (‘NCLAT’) in Kirusa
Software Pvt. Ltd
. recently observed:
It may be helpful to
interpret Sections 8 and 9 and the jurisdiction of the Adjudicating Authority
being akin to that of a judicial authority under Section 8 of the Arbitration
& Conciliation Act, 1996 amended up to date, which mandates that the
judicial authority must refer the parties to arbitration.
Section 8: Dispute and its bona fide nature
Section 8 of the
Arbitration Act, as interpreted through landmark decisions such as P.
Anand Gajapathi Raju
and Pinkcity
Midway Petroleums
have consistently guarded against judicial
interference at the reference stage. However, in a recent decision the Delhi
High Court in M/S Fenner (India) Ltd.
vs M/S Brahmaputra Valley

ventured into finding whether there was a valid ‘dispute’ in the first place.
While it is arguable whether an adjudication of the existence of the dispute (and the extent thereof) is permitted
under section 8, the decision also makes observations to the effect that a
dispute must be a bona fide dispute
in the first place. In making reference to several provisions of Code of Civil
Procedure, 1908 (‘CPC, 1908’) the court made some important observations with
regard to the dispute being one with bona
fide
motive. While the NCLT is not bound by the procedure laid down by CPC,
1908, section 424 (2) of the Companies Act, 2013 vests the tribunal with the same
powers of a civil court. Although the nature of section 8 of the Arbitration
Act and section 9(5) of the Code are vastly different in their subject-matter,
it is useful to bear in mind that the court under section 8 with similar formalistic
powers as section 9(5) attempts to navigate through the ‘intention’ of the
dispute raised.
Section 9
of Arbitration Act: Commencement of Arbitration
As previously noted, an insolvency proceeding under the Code can be
brought to a complete halt by the debtor by merely sending a notice of
arbitration. In theory, it is possible that the debtor does not intend to
participate in the arbitration proceeding and exercises this option as a
dilatory tactic. Can the tribunal examine whether the debtor truly intends to
commence arbitration?
In this regard, useful parallels can be drawn from the jurisprudence under
section 9 of the Arbitration Act. Section 9 empowers the court to grant interim
relief ‘before or during’ the
arbitral proceedings. The looming concern was that parties may attempt to seek
interim relief even before the commencement of an arbitral proceeding without intending to commence arbitration in
the first place
! Sundaram
Finance
(1999) caught on to this mischief early on and held that
the parties must show a manifest
intention
to arbitrate while seeking a relief through section 9 of the Act.
Later, the Supreme Court in Firm Ashok Traders (2004)
extended Sundaram Finance’s logic to
hold that ‘….the Court may also while
passing an order under Section 9 put the party on terms and may
recall the order if the party commits breach of the terms
’. Even apart
from section 9, nothing in the Arbitration Act confers such a power on the
court. All this was read into section 9, given the ‘… scheme in which Section 9 is placed’. While both these cases serve
as classic examples of judicial legislation, in the current analysis, it serves
as suitable examples regarding the implicit powers the court has exercised to
verify the bona fide conduct of the
parties in the proceeding.
Winding up of Company: IBA Health on Bona Fide Nature of Dispute
The
courts interpretation under winding up cases also provides some guidance in
this regard. While the Companies Act, provided for winding up ‘if the company is unable to pay its debts’,
the court in IBA
Health 
v. Info-Drive Systems
(previously covered here)
held that if there is a bona fide
dispute regarding the debt, the creditor cannot file a winding up petition.
This is one more instance, wherein the court implicitly read in the bona fide
nature of the dispute to check if the parties engage in abuse of process. This
post highlights that through multiple instances, the court implicitly required
the parties to engage in good faith without a specific legislative mandate. In Kirusa
Software
, NCLAT made a passing reference in this regard:
(Dispute) must be raised in a court of law or
authority and proposed to be moved before the court of law or authority and not
any got up or malafide dispute just to stall the insolvency resolution process
.
It is hoped that the scheme of the
Code which seeks to create a time bound insolvency resolution process is
protected by developing internal mechanisms to check such abuse of process by
corporate debtors. In the absence of clarity in the legislation, much will
depend on the jurisprudence developed by the adjudicating authority, and the
analogous circumstances discussed above will likely provide some guidance.

Puneet Dinesh

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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