The Dilemma of Jurisdiction under Arbitration and Insolvency: Another Trolley Problem? – Part I

[Kartikey Sanjeev Bhalotia and Arshit Kapoor are 2nd year students at National Law University Odisha]

Though the Arbitration and Conciliation Act, 1996 (‘Arbitration Act’) and the Insolvency and Bankruptcy Code, 2016 (‘IBC’) pertain to different subject areas, various adjudicating authorities in India have started facing a very important question arising out of the interplay between these laws. The question pertains to the choice of jurisdiction for adjudication of disputes arising out of a contract that has an arbitration clause. The authors try to deal with the question by classifying the types of disputes on the basis of their arbitrability, as ‘inarbitrable disputes’ (that do not fall within the ambit of the arbitration clause) and ‘arbitrable disputes’.

In Booz Allen and Hamilton Inc. v. SBI Home Finance Ltd., the Supreme Court held that a dispute cannot be referred to arbitration despite such agreement between the parties if the National Company Law Tribunal (‘NCLT’), while acting as a ‘judicial authority’, finds the dispute between the parties to be inarbitrable in nature [at paragraph 22]. It is apparent that the dilemma with respect to the choice of jurisdiction withers away in case of an inarbitrable dispute between the parties. In this post, the authors shall first explain the concept of ‘dispute’ under the IBC and then analyse the jurisdictional conflict between the Arbitration Act and the IBC in an arbitrable dispute.

Test of Existence of a Dispute under Section 9 of the IBC

Section 9 of the IBC provides for an insolvency application by operational creditors and imposes a complete bar against the admission of an application on mere existence of a dispute between the parties prior to its filing. Section 5(6) of the IBC defines ‘dispute’ to include any suit or arbitration proceeding in relation 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 Supreme Court in interpreting the above definition in Mobilox Innovation Pvt. Ltd. v. Kirusa Software Pvt. Ltd. held:

“…First and foremost, the definition is an inclusive one, and we have seen that the word “includes” substituted the word “means” which occurred in the first Insolvency and Bankruptcy Bill … Section 5(6) only deals with suits or arbitration proceedings which must “relate to” one of the three subclauses, either directly or indirectly. We have seen that a “dispute” is said to exist, so long as there is a real dispute as to payment between the parties that would fall within the inclusive definition contained in Section 5(6)…” [at paragraph 43]

Therefore, as far as section 9 is concerned, the legislature and the judiciary have made it very clear that whenever there exists a dispute between the parties that comes within the scope of section 5(6), an application under the former provision would be rejected. Such explicit restraint on the power of the adjudicating authority under section 9 leaves almost no room for any uncertainty in dealing with pre-existing arbitration disputes. However, this is not the case when it comes to section 7 of the IBC.

Test of Existence of a Dispute under Section 7 of the IBC

Section 7 of the IBC that provides for the CIRP process to be initiated by an application of a financial creditor. It is important to note that section 7 does not provide for a bar against the admission of an application on the grounds of existence of a ‘dispute’ between the parties. The Supreme Court, in the case of Innoventive Industries Ltd. v. ICICI Bank, has held that when dealing with a section 7 application, an adjudicating authority needs to satisfy itself with only one brief question, i.e., whether there exists a ‘debt’ and whether there has occasioned a ‘default’ on the repayment of such a debt. Therefore, the mere existence of a dispute is not a test to be applied to a section 7 application.

Nevertheless, the question of the existence of a ‘dispute’ becomes relevant for the adjudicating authority even in a section 7 application where the determination of the ‘debt’ and the ‘default’ itself is contingent on the settlement of the dispute in question. In other words, such determination would not amount to including a test of ‘dispute’ when it has been excluded from the text of section 7. It would merely amount to giving effect to the test of the existence of a ‘debt’ and a ‘default’ (per Innoventive Industries) by not admitting applications under section 7 where such test is not satisfied due to the existence of a dispute. This follows from the operation of the legal maxim expressio unius est exclusio alterius. The fact that the test of ‘existence of disputes’ as a ground for non-acceptance of application has been explicitly included under section 9 but not under section 7, indicates that the legislature never intended to include such a test to deal with section 7 applications.

Indus Biotech Pvt. Ltd. v. Kotak India Venture Fund-I

The above problem was faced by the NCLT, Mumbai Bench in Indus Biotech Pvt. Ltd. v. Kotak India Venture Fund-I. Kotak India had moved an application under section 7 of the IBC against Indus Biotech. The insolvency plea was filed on the ground that Indus Biotech had failed to redeem optionally convertible redeemable preference shares before the redemption date as per the terms of their agreement. In response to the same, Indus Biotech moved an application under section 8 of the Arbitration Act for seeking reference of the dispute to arbitration as per the arbitration clause agreed upon by the parties to the contract.

The NCLT, before coming to its decision, clarified that the adjudicating authority, while hearing an application under the IBC, can act as a judicial authority to hear an application under section 8 of the Arbitration Act filed in reply. The NCLT, in coming to its decision of rejecting the application filed by Kotak India, concurred with Indus Biotech and found that there existed certain pre-existing disputes between the parties. The NCLT found the arbitrable dispute to have a direct bearing on the determination of the ‘default’, and therefore, was not ‘satisfied that a default has occurred’ which is a necessary condition for admission of applications under section 7 of the IBC.

A perusal of the above decision of the NCLT clarifies the confusion on the question of choice of jurisdiction in favour of arbitration, where a respondent to a section 7 application proves the existence of arbitrable dispute having a direct bearing on the determination of ‘debt’ and/or ‘default’. In other words, the NCLT has laid down the law that if an adjudicating authority, while hearing a section 7 application, finds a pre-existing dispute between the parties and such dispute restricts the said authority in being satisfied with the existence of a ‘debt’ and/or ‘default’, the authority shall be obligated under section 8 of the Arbitration Act to refer the dispute to arbitration.

Existence of a Dispute Independent of Determination of Debt and Default

Even after the decision in Indus Biotech, one question related to this dilemma between the choice of jurisdiction under the Arbitration Act and the IBC remains unsettled. Which jurisdiction would be preferred in cases where the respondent to a section 7 application has established the existence of an arbitrable dispute when such dispute does not have a bearing on the determination of the essentials under section 7? In other words, will the adjudicating authority be under an obligation to refer an arbitrable dispute to arbitration while dealing with a section 7 application, even when it is satisfied with the existence of a ‘debt’ and ‘default’ by the respondent?

The above uncertainty arises because section 8 of the Arbitration Act mandates the ‘judicial authority’ to refer the dispute to arbitration if it is of the prima facie opinion that an arbitrable dispute has occured between the parties. An adjudicating authority under the IBC acts a judicial authority when it has to deal with a section 8 application under the Arbitration Act filed by the respondent in reply to a section 7 application under the IBC.

Moreover, section 7 of the IBC has not provided for a bar against the admission of applications filed under the provision merely on the ground that a pre-existing arbitrable dispute exists between the parties. The only requisite is that the adjudicating authority is satisfied with the existence of a debt and its consequential default thereof.

Therefore, in a case where an arbitrable dispute is proved it leads to the creation of an obligation on the authority to refer the dispute to arbitration under section 8 of the Arbitration Act. Further, when the authority acting under section 7 of the IBC is satisfied with the existence of a debt and default, irrespective of the existence of such an arbitrable dispute, it would not be going beyond its statutory powers in accepting the section 7 application.

Hypothetically, it is probable that the decision would go in favour of the IBC in such situations. This is due to section 238 which provides that the IBC being a special legislation would have an overriding effect on every other law that is inconsistent with it. Therefore, in the above scenario where there does not exist any bar against the acceptance of an application under section 7 (irrespective of such acceptance contradicting the reference to arbitration due to the arbitrability of the dispute), the NCLT would probably adopt the view that the insolvency application be admitted on account of section 238. This would grant the IBC primacy over the Arbitration Act.

However, the authors opine that such a view would be inconsistent with the legislative intent of section 7 of the IBC. The authors elaborate their stance and offer policy reasons to justify their view in the next post.

[to be continued]

– Kartikey Sanjeev Bhalotia & Arshit Kapoor



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