IBC v. Arbitration: A Case for Prevalence of the IBC over the Arbitration and Conciliation Act

[Mayank Udhwani is a 5th year law student at National Law University, Jodhpur]

The decision of the Mumbai Bench of the National Company Law Tribunal (NCLT) in Indus Biotech Private Limited v. Kotak India Venture Fund-I has recently made the headlines for allowing the Arbitration and Conciliation Act, 1996 [“Arbitration Act”] to prevail over the Insolvency and Bankruptcy Code, 2016 [“IBC”]. The NCLT had refused to admit an application under section 7 of the IBC on grounds that there existed an arbitration agreement between the parties. In this post, the author argues that while the decision of the NCLT was correct for reasons other than the ones given by the NCLT, the Arbitration Act cannot prevail over the IBC.

Background

Kotak India Venture Fund had subscribed to Optionally Convertible Redeemable Preference Shares [“OCRPS”] issued by Indus Biotech Private Limited. Certain disputes arose between the parties regarding the valuation of OCPRS when the same were sought to be converted to equity shares. While this dispute was ongoing, Kotak sought to trigger the early redemption clause provided under the Share Subscription and Shareholders Agreement [“SSSA”] pursuant to which the OCRPS were issued. When Indus failed to redeem the OCRPS, Kotak approached the NCLT under section 7 of the IBC seeking initiation of corporate insolvency resolution process [“CIRP”] against Indus. Before the application under section 7 could be decided by the NCLT, Indus had invoked the arbitration clause under the SSSA. Thereafter, Indus filed an interim application under section 8 of the Arbitration Act, before the NCLT seeking that the application filed under section 7 of the IBC be dismissed because of the existence of an arbitration agreement between the parties. Thus, the issue that fell for consideration before the NCLT was whether the provisions of the Arbitration Act prevail over the provisions of the IBC.

After noting the nature of the dispute, the NCLT directed the parties to resolve their dispute by arbitration, thereby dismissing the application filed by Kotak under section 7 of the IBC. The NCLT held that the dispute primarily revolved around valuation of OCRPS and the rights of Kotak under the SSSA. Thus, the case was better suited for arbitration (Indus Biotech, in paragraph 5.14). Another reason given in support of its decision by the NCLT was that Indus was a solvent, debt-free, and profitable company and that admitting the application would push an otherwise solvent company into insolvency (Indus Biotech, in paragraph 5.15). Therefore, no meaningful purpose would be served by pushing Indus into CIRP.

Analysis of the decision

The author agrees with the decision of the NCLT to reject the application filed by Kotak under section 7 of the IBC. However, the author contends that the approach adopted by the NCLT in doing so was quite erroneous.

In Innoventive Industries Ltd v. ICICI Bank, the Supreme Court held that when an application is filed under section 7 of the IBC, the adjudicating authority is only required to see whether a default has occurred in relation to a financial debt (at paragraph 30). To reject the application in the present case, the NCLT had held that there was no default. This finding was based solely on the nature of dispute between the parties and the NCLT did not provide any reason for holding the same.

The author opines that had the NCLT first inquired whether a financial debt was owed to Kotak, there would not have been any need to inquire into the existence of a default. This is because an owner of a preferential share is not a creditor of the company. In order to understand this point, one must take note of certain provisions under the IBC.

To file an application for initiation of CIRP under section 7 of the IBC, the applicant must be a ‘financial creditor’. The term ‘financial creditor’ is defined in section 5(7) as “any person to whom a financial debt is owed”.[emphasis added] Furthermore, the term ‘financial debt’ is defined in section 5(8) as “a debt along with interest, if any, which is disbursed against the consideration for the time value of money”. The conclusion derived from these two definitions is that a person does not become entitled to make an application under section 7 of the IBC unless a financial debt is owed to him.

In this case, the NCLT did not examine whether Kotak had become a financial creditor to Indus by virtue of subscribing to the OCRPS. Had such an inquiry been undertaken, the NCLT would have come to the conclusion that Kotak was not a financial creditor. This argument is bolstered by the decision of the Bombay High Court in Aditya Prakash Entertainment Pvt. Ltd. v. Magikwand Media Pvt. Ltd. In this case, Aditya Prakash Entertainment was the holder of OCRPS issued by Magikwand Media. Upon the failure of Magikwand Media to redeem the OCRPS, Aditya Prakash Entertainment had sought winding up of the company under sections 433-434 of the Companies Act, 1956. Rejecting the petition, the Bombay High Court had noted as follows (in paragraph 9):

The shareholders of redeemable preference shares of the company do not become creditors of the company in case their shares are not redeemed by the company at the appropriate time. If they do not become the creditors of the company, they cannot apply for winding up of the company under Section 433(e) of the Companies Act, 1956.

Similarly, the Gujarat High Court in Anarkali Sarabhai v. Commissioner of Income Tax, Gujarat also held that the holder of preference shares is not in the same position as that of a creditor. It was further held in the same case (at paragraph 14) that if a company “defaults in redeeming the preference shares by the date fixed for redemption, the holder thereof cannot compel it to do so by suing in debt for the return of his capital or by filing for a mandatory injunction”.

The Calcutta High Court in Hindustan Gas and Industries Ltd. v. Commissioner of Income-Tax had opined that a debenture-holder has a right to sue the company as a creditor.  It further stated (in paragraph 13) that a shareholder “has no such right and preference shareholder is a shareholder of the company”.

In the author’s opinion, these findings squarely apply on the present case. The main ground on which Kotak had supported the application filed under section 7 was the failure of Indus to redeem the OCRPS. Given that failure to redeem preference shares does not make the holder a creditor of the company, the question of Kotak becoming a financial creditor would not have arisen. Consequently, deciding whether a ‘default’ exists or not would have been rendered pointless. Thus, had the NCLT taken this approach, it would not have been required to rule upon the repugnancy between the IBC and the Arbitration Act.

IBC v. Arbitration Act

Although, the NCLT had directed the parties to resolve their disputes through arbitration, it is important to note that the NCLT did not hold that the Arbitration Act would prevail over the IBC. On the contrary, the NCLT had noted that law on this subject is res integra (Indus Biotech, in paragraph 5.2). The author contends that, in case of repugnancy between the provisions of the two Acts, the Arbitration Act could not prevail over the IBC by any stretch of the imagination. This is because of the following reasons:

Insolvency as a subject matter is not arbitrable

In Booz-Allen & Hamilton Inc. v. SBI Home Finance Ltd., the Supreme Court had laid down a list of disputes, which could not be submitted for arbitration. One of the subject matters on the list was “Insolvency and winding up matters”. The reason for holding insolvency, amongst other subject matters, as non-arbitrable was that such cases relate to actions in rem and not in personam. In these cases, the courts are required to determine the rights of the parties not only inter se but also against all persons claiming an interest in the subject matter of the dispute between the parties. Therefore, a private forum could not adjudicate upon such cases (Booz-Allen, at paragraph 23). The Supreme Court has also opined that actions under section 7 of the IBC are actions in rem,[1] thereby rendering them incapable of being referred to arbitration.

Section 238 of the IBC overrides the Arbitration Act

While the IBC was introduced to “consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons”, the Arbitration Act was promulgated to “consolidate and amend the law relating to domestic arbitration”. Thus, both the statutes are special statutes which operate in different fields of law. §238 of the IBC gives an overriding effect to it over all other statues. It reads as follows:  “The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law”.

Thus, in case of conflict, the provisions of the Arbitration Act would have to give way to the provisions of the IBC. This position is supported by the decision of the Ahmedabad Bench of the NCLT in ABG Shipyard Ltd. v. ICICI Bank Ltd.. In that case, the NCLT had to determine whether section 56 of the Electricity Act, 2003 would override section 14 of the IBC. Ruling in the negative, the NCLT held that the IBC would prevail over the Electricity Act, 2003. The reasoning of the NCLT was that given both the statutes are special law, the IBC being later in time would prevail over the Electricity Act. For this finding, the NCLT had relied upon the decision of the Supreme Court in KSL and Industries Ltd. v. Arihant Threads Ltd. In that case, the Supreme Court had held that “it is settled law that when there are two enactments passed by the Parliament, and if there is any provision contained in such Acts which is repugnant to another, the provisions contained in the Act, which is later in point of time, shall prevail” (at paragraph 46).

Conclusion

From the foregoing discussion, it is clear that once the NCLT is satisfied as to the existence of ‘default’ according to section 7 of the IBC, the existence of an arbitration agreement between the parties would not restrict the NCLT from initiating CIRP against the corporate debtor. Therefore, section 8 of the Arbitration Act would not prevail over section 7 of the IBC.

– Mayank Udhwani



[1] Swiss Ribbons Pvt. Ltd. v. Union of India 2019 SCC Online SC 73, at paragraph 79; Pioneer Urban Land and Infrastructure Limited v. Union of India, 2019 SCC OnLine SC 1005, at paragraph 39.

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