Supreme Court on the Scope of “Dispute” under the Insolvency and Bankruptcy Code

[Shourya Bari is an associate at a law firm in Mumbai having graduated from Jindal Global Law School, Sonipat (JGLS) in 2018 and Aditi Singh Kashyap is a 4th year B.A., LL.B. (Hons.) student at JGLS]

The Insolvency & Bankruptcy Code (“IBC”) stipulates that the adjudicating authority (i.e. the National Company Law Tribunal or NCLT) would not admit an application by an operational creditor to initiate insolvency proceedings against a corporate debtor if a dispute with respect to the debt exists between them. The scope of such a ‘dispute’ has been the subject of extensive judicial deliberation.

This post will explore the Supreme Court of India’s latest decision on the subject in K. Kishan v. M/S Vijay Nirman Company Pvt. Ltd., (14 August 2018) which held that a dispute under section 9 of the IBC would include within its scope a challenge to an arbitral award under section 34 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”). Before indulging in an analysis, the post will briefly outline the facts.

Facts

It all began when the parties arbitrated their disputes arising out of a construction agreement. In the arbitral award, the claim of the respondent in the present appeal with respect to a certain amount was allowed. The appellant’s cross claim of a much higher amount was not allowed. Now, two events unfolded following this award. First, the respondent sent a demand notice of unpaid operational debt under section 8 of the IBC to the appellant. Second, the appellant responded with a notice of dispute with respect to the debt and challenged the arbitral award under section 34 of the Arbitration Act.

Notwithstanding the receipt of notice of dispute from the appellant, the respondent filed an application for admission of insolvency proceedings against the appellant. Both the NCLT and the National Company Law Appellate Tribunal (“NCLAT”) allowed the admission. The NCLAT reasoned that the non-obstante clause in section 238 of the IBC would override the Arbitration Act, and that a challenge of an award under section 34 of the Arbitration Act would not constitute a dispute under section 9 of the IBC.

Analysis 

To analyze the Court’s decision, we must begin with the Court’s landmark ruling in Mobilox Innovations v. Kirusa Software on the issue of dispute under section 9 of the IBC. The court in K. Kishan relied heavily on Mobilox, where the Court had clarified that the dispute need not be a bona fide one. As long as the dispute is real, and not illusory or hypothetical, it would fall within the scope of dispute under section 9 of the IBC.

The counsel on behalf of the appellant argued that a pending challenge under section 34 of the Arbitration Act is reflective of a real dispute between the parties. The respondent cited insolvency laws of the United Kingdom (“UK”) to argue that an insolvency process should not be stultified just because an application to set aside a judgment or order indicating existence of a debt is pending on appeal or otherwise.

The Court, while ruling in favor of the appellant, made certain critical observations. It reiterated that the dispute between the two parties need not be a bona fide one. In support of his proposition, Justice Nariman observed that although the original Bill contained the expression bona fide, in the ultimate legislation it was dropped. Therefore, a low threshold was set to determine which disputes would fall under section 9 of the IBC. This is in alignment with the broader objective of the Code to prevent the utilization of the IBC as a debt enforcement mechanism. Finally, this observation was crucial to distinguish the standards prescribed in the IBC as opposed to that of the UK or Singapore where, in some situations, the debt need to be disputed bona fide [LKM Investment Holdings v. Cathay Theatres Pvt. Ltd., (2000) SGHC 13]. 

The factual peculiarity with respect to the cross claim filed by respondent bears some significance. The crux of the challenge to the arbitral award was the rejection of appellant’s cross claim. The appellant argued that the cross claim was of a much higher value, and if it was allowed in the challenge proceedings, the appellant would not owe any debt to the respondent. The court examined the nature of the cross claim and found that one of the cross claims was not rejected due to lack of evidence but on merits. This observation nudged the Court to rule that a dispute did exist.

We can conclude from the Court’s observation that although a low threshold has been set to determine whether a dispute would fall under section 9 and the adjudicating authority need not examine the merits of the dispute, the authority would need to find a certain element of authenticity with respect to the dispute.

In this case, if the cross claims were completely without merit, a mere challenge proceeding under section 34 of the Arbitration Act perhaps would not have been enough to constitute a dispute under section 9 of the IBC. We arrive at this submission on two grounds. First, in Mobilox the Court noted that a dispute which is a patently feeble legal argument or an assertion of fact unsupported by evidence would not fall within the scope of section 9 of the IBC. Second, in K. Kishan, the Court did examine the soundness of the cross claim to hold that the challenge under section 34 constituted a valid dispute under section 9 of the IBC.

Combining these two observations, we submit that a baseless challenge under section 34 of the Arbitration Act would not constitute a dispute under section 9 IBC. Insolvency proceedings cannot be evaded under the garb of a challenge under section 34 which is without any foundation. Just like the IBC cannot be utilized as a debt enforcement mechanism, the corporate debtor cannot hide under the shield of an unfounded challenge proceeding under section 34 to insulate itself from insolvency proceedings.

Conclusion

In Mobilox (paragraph 40), the Supreme Court allowed for examination of merits of a dispute to the extent it is necessary to determine whether a dispute is a sham or not. The court in K. Kishan did exactly so by verifying the soundness of the cross claims.

Therefore, in conclusion we submit that a baseless challenge under section 34 would not constitute a dispute under section 9 of the IBC, and a certain element of genuineness needs to be present in the dispute raised to qualify as a dispute under that provision.

Also, the Court pointed out that the non-obstante clause in section 238 applies only in case of an inconsistency between the Code and any other legislation. The court found no inconsistency between the Arbitration Act and the IBC. Therefore, in this case, the challenge proceeding under section 34 was held to be a dispute under section 9 IBC. 

Shourya Bari & Aditi Singh Kashyap

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