[Ankur Singhal and Vasavi Khatri are 5th year B.A., LL.B. (Hons.) students at National Law School of India University, Bangalore]
On 26 March 2021, the Supreme Court, in Indus Biotech Private Limited v. Kotak India Venture Fund ruled that an arbitration petition would not be maintainable after the insolvency resolution petition under section 7 of the Insolvency and Bankruptcy Code is admitted. The Court upheld the order passed by the National Company Law Tribunal (“NCLT”) in this matter. This judgment settles a critical issue that had arisen before the tribunals and was marred with contradictory pronouncements. In this post, we analyse the factual background and the reasoning behind this judgment.
Background
Kotak and Indus Biotech had entered into share subscription and shareholders’ agreements. Through the agreements, Kotak had subscribed to equity shares and Optionally Convertible Redeemable Preference Shares (“OCRPS”) in Indus Biotech. Subsequently, Indus Biotech decided that it would make a Qualified Initial Public Offering (“QIPO”). This decision made it necessary for Kotak to convert their OCRPS into equity shares in view of regulation 5(2) of SEBI (ICDR) Regulations, 2018. The agreements also provided for early redemption on the ground of QIPO to convert OCRPS into equity shares of the company.
The main issue that arose in this process was with respect to the calculation and conversion formula that was to be applied by the parties. Kotak claimed that it would be entitled to 30% of the total paid-up share capital in equity shares, whereas Indus Biotech claimed that Kotak would be entitled to 10% of the total paid-up share capital. Because of this, Kotak claimed that a sum of INR 367.08 crores became due and payable on redemption of OCRPS. Since Indus Biotech did not pay the amount demanded by Kotak, a petition under section 7 of the Code was filed by Kotak to initiate the Corporate Insolvency Resolution Process (“CIRP”). In the same matter, a miscellaneous application had been filed by Indus Biotech to refer the matter to arbitration under section 8 of the Arbitration and Conciliation Act, 1996. The NCLT had passed an order allowing the section 8 application, and as a consequence, the petition under section 7 of the Code was dismissed. Being aggrieved by the order passed by the NCLT, Kotak filed a special leave petition before the Supreme Court. This judgment deals with the arbitration petition filed by Indus Biotech seeking the appointment of an arbitrator on behalf of Kotak under section 11, and the special leave petition filed by Kotak against the NCLT Order.
Analysis
It was argued before the Court that section 7 proceedings under the Code had to be “considered in a stringent manner” and that they were ‘in rem’ proceedings and hence, insolvency and winding-up matters could not be arbitrated. To this end, it was contended that the agreement provided for manner, date, and value of redemption and also had a clause which provided that the redemption value ‘shall’ constitute a debt.
The question was whether the agreement, which provided that the redemption value shall constitute a debt, was sufficient to constitute a ‘default’ for the purposes of the Code. The Supreme Court noted that there were meetings in March and April of 2018 wherein certain aspects about conversion and QIPO were discussed. However, the question of 30% or 10% of the equity shares was not concluded, and hence, it would not be correct to term it as ‘default’ in respect of any payment of ‘debt’.
As per the procedure under the Code, the adjudicating authority has to be satisfied (by making an ‘objective assessment’) whether ‘default’ has occurred or not after assessing the material placed by the financial creditor and the points raised by the corporate debtor. If it is satisfied that there is a default, it would admit the application under section 7(5)(a), and if there is no default, then it would reject the application under section 7(5)(b). The admission of the application marks the commencement of the CIRP. The Supreme Court rightly observed that in cases where there is mere possibility of an existence of a debt, default could not be automatically assumed. This is important to safeguard those companies which are discharging their debts and running their administration efficiently. This position is bolstered in view of the objective sought to be achieved by the Code. The Supreme Court in Duncans Industries Ltd. v. AJ Agrochem held that the objective of the Code was to “ensure revival and continuation of the corporate debtor” and not to use it as a “mere recovery legislation for creditors”.
As per the Supreme Court in this case, it was pertinent to note the stage of the proceedings. The nature of proceedings would get transformed into a “proceeding in rem having erga omnes effect” only after the petition under section 7 is admitted and, therefore, would fall outside the scope of arbitrability. Put simply, this means that the procedure under the Code would be strictly followed upon admission. However, until the application under section 7 is admitted, the proceedings would not be termed as ‘in rem’ and, therefore, would fall within the scope of arbitrability. The Supreme Court inSwiss Ribbons (P) Ltd. v. Union of India had held that the proceedings are ‘in rem’ and are in the nature of a collective proceeding after admission.
Regarding the non-arbitrability of actions ‘in rem’, reliance was placed upon the fourfold test laid down in Vidya Drolia v. Durga Trading Corporation. The impact of admitting a section 7 petition is that third party rights are created in the creditors, and these will have an erga omnes effect. Therefore, while the section 7 petition is pending, the proceedings are not ‘in rem’ and hence, arbitrable.
The Supreme Court was cognizant of the fact that arbitration could be used as a way to delay the process. Hence, it noted that even if an application under section 8 of the Arbitration Act was pending before the adjudicating authority, the authority would be duty bound to consider the section 7 application under the Code and determine whether there was a default or not. If there is a default and the debt is due, then arbitration could not be used as a sham to delay the process and defeat the timelines prescribed under the Code. Thus, if the application under section 7 of the Code is admitted, any application made thereafter under section 8 of the Arbitration Act becomes non-maintainable. In a case where the petition under section 7 is yet to be admitted, and an application under section 8 of the Arbitration Act is kept alongside for consideration, the adjudicating authority has to first decide the application under the Code and whether a default existed. In the present case, the adjudicating authority had not done anything with respect to the arbitration application, except holding that the arbitration claim was justified because the ‘default’ had not occurred.
The NCLT had noted that the corporate debtor was a “solvent, debt-free and profitable company”. Furthermore, given the judicial determination that there was no ‘default’ as per section 3(12), it held that disputes in the present case (dealing with the valuation of shares, calculation and conversion formula and fixing of QIPO date) were all arbitrable. The Supreme Court also noted that since there was a dispute and no determination had taken place regarding the 10% and 30% dispute, it would be inappropriate to conclude that ‘default’ in respect of payment of any debt had occurred. Therefore, the Supreme Court held that the petition for constitution of an arbitral tribunal under section 11 of the Arbitration Act was justified.
Concluding Remarks
Kotak argued that it had shown that debt was due, and since it was not paid, the debt should have been recorded as a default. However, there is a material difference that is to be noted between the terms ‘claim’, ‘debt’ and ‘default’ as recognised by the Supreme Court in Swiss Ribbons. As per the Supreme Court, “a claim gives rise to a debt only when it becomes ‘due’, and a default occurs only when a debt becomes ‘due and payable’ and is not paid by the debtor”. The criticism that section 238 of the Code should have been read strictly, and therefore, should have prevailed was untenable in the present set of facts. There was no ‘default’, and hence, it was appropriate to refer the dispute between the parties to arbitration for ascertaining the value and adjudicating the dispute between the parties.
There is no doubt that insolvency as a subject matter is not arbitrable (Vidya Drolia and Booz Allen and Hamilton v SBI Home Finance Ltd.). If the triggering factors under section 7 of the Code are satisfied, then the CIRP can be initiated, regardless of the existence of an arbitration agreement between the parties. However, that was not the situation in the present case. The authors agree with the conclusions reached by the Supreme Court and the NCLT that there was no ‘default’ in the present case and that the proceedings before the admission of section 7 application are not ‘in rem’ and hence, arbitrable. It is a step in the right direction as it would save the unnecessary trouble of facing insolvency proceedings despite being a profit-making entity. It is a case where arbitration was appropriate due to the nature of the dispute and an arbitration clause in the Agreements between the parties that covered that dispute. It had been rightly observed by NCLT that the real dispute was concerning the Agreements and its interpretation and not a case of ‘default’ which would fall within the domain of insolvency law.
– Ankur Singhal & Vasavi Khatri
