Advancing the Objectives of IBC: Why Arbitration Should Persist During Moratorium Periods

[Arunoday Rai is a 3rd-year B.A., LL.B. (Hons.) student at the National Law School of India University, Bangalore]

There has been sufficient literature arguing for reconciliation between insolvency and arbitration proceedings. This post argues for the continuation of arbitration proceedings as it furthers the objectives of insolvency and enhances its efficiency. It critiques the position taken by the Supreme Court in the P. Mohanraj v. Shah Brothers Ispat Pvt. Ltd.judgment where they held that there is an automatic stay on all proceedings filed by or against the corporate debtor once the moratorium under section 14 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) has been imposed. The legal position from this case follows that no proceedings can continue regardless of whether there is a risk of dissipation of the assets of the corporate debtor or not.

Carving out an Exception to Section 14: The No Prejudice Test

The ratio of this judgment overrules a catena of High Court cases where they had allowed the continuation of certain legal proceedings, including arbitration, in situations where the test of ‘no prejudice’ has been met. Several Bankruptcy Law Reform Committee (“BLRC”) reports have highlighted that the purpose of the moratorium under section 14 is to ensure, (i) a calm period for the corporate debtor to manage and negotiate their contracts; (ii) orderly completion of the process, (iii) ensure that the company continues as a going concern, and (iv) maximize value for all stakeholders. In light of the above rationale, a Single Judge bench of Delhi High Court in Power Grid Corporation of India Limited v. Jyoti Structures Limited was dealing with an issue as to whether a section 34 petition under the Arbitration & Conciliation Act, 1996 (“1996 Act”) could be continued if a moratorium is imposed after the acceptance of the section 7 application by the National Company Law Tribunal (“NCLT”) under the IBC. The corporate debtor argued that non-continuance of the pending application would prohibit them from executing the award passed in their favor impeding their financial condition. The High Court ruled in favor of the corporate debtor by holding that the word ‘proceeding’ in section 14 should be read to mean only ‘debt recovery actions’. It also pointed out that the meaning of section 14 should be read in light of the above-mentioned purpose of the Code and it applied the principle of ejusdem generis to show that the legislature has deliberately used a narrower term ‘against the corporate debtor’ in this section. It reasoned that the continuance of such proceedings would enhance and not diminish the assets of the corporate debtor, therefore not causing ‘prejudice’ and being in line with the purpose of ‘asset protection’ and ‘value maximization’ of all the stakeholders.

Similarly, the Delhi HC in SSMP Industries Limited v. Perkan Food Processors Private Limited was dealing with the issue of whether a counter-claim against the corporate debtor is barred in light of the moratorium imposed under IBC. It held that although a ‘counter-claim’ is technically a proceeding ‘against’ the corporate debtor, it has to be adjudicated by the arbitral tribunal as the corporate debtor cannot claim their money until the counter-claim is adjudicated upon. Further, it noted that a moratorium can be imposed in a scenario where the adjudication of such a claim would result in the payment by the corporate debtor. Therefore, it followed the reasoning of Power Grid to allow arbitration proceedings if they don’t cause prejudice to the assets of the corporate debtor.

Issue Created by the Mohanraj Judgment

The Court in Mohanraj was dealing with the issue of continuation of proceedings under section 138 of the Negotiable Instruments Act, 1881(“NI Act”) once a moratorium had been applied. For our purposes, the court held that section 138 proceedings are ‘against’ the corporate debtor and are covered under section 14 (1)(a) of IBC. It cited the above-mentioned rationale behind the section 14 moratorium and held that such proceeding would result in the depletion of assets of the corporate debtor as they may have to pay compensation which can amount to twice the amount of the cheque.

However, the Supreme Court went further to interpret the meaning of section 14(1)(a) of IBC. Rejecting the principle of ejusdem generis and noscitur a sociis in interpreting section 14, it held that the said section is very widely worded and would cover ‘any proceeding’ even indirectly relatable to the recovery of any debt. It explicitly overruled Power Grid by holding that section 34 proceedings under the 1996 Act are proceeding ‘against’ the corporate debtor as they maylead to an arbitral award against the corporate debtor. In the given fact scenario of the case, there was no need for the Supreme Court to put a ‘blanket ban’ on all the proceedings after the moratorium was imposed as section 138 proceeding under the NI Act was anyway held to be ‘against’ the corporate debtor.

This post argues that the Supreme Court erred on two points of law: (i) Incomplete reading of the purpose of the section 14 moratorium, and (ii) an incorrect understanding of arbitration proceedings.

Incomplete Reading of the Purpose of the Section 14 Moratorium

The Supreme Court failed to understand the true scope of the moratorium provided by the legislature under the IBC. It has been time and again highlighted that the purpose of a moratorium is to protect the assets of the corporate debtor and maximize their available assets. Hence, such an understanding of section 14 harms the financial condition of the corporate debtor by impeding its ability to continue a proceeding in its favor. Therefore, Supreme Court should have adopted an interpretation that advanced the said purpose of the Code instead of mere adherence to the literal meaning of the law as it has led to deleterious results.

It is for this reason, that this said decision of the Supreme Court has rarely been cited by the courts in dealing with similar matters. Further, after the Mohanraj judgment, a three-judge bench of Supreme Court in Minosha explicitly held that a moratorium under section 14 does not prohibit proceedings by the Corporate debtor against another party. The Supreme Court in Mohanraj also seems to ignore the fact that certain proceedings under Article 32 and 226 of the Constitution were allowed to continue despite the imposition of a moratorium. Similarly, Allahabad HC in Trading Engineers has underscored that the ratio of Mohanraj should be seen in the context of the case and should not be considered as a blanket ban on all proceedings.

Incorrect Understanding of Arbitration Proceedings

The Supreme Court in Mohanraj failed to understand the distinction between section 34 and 36 of the 1996 Act while holding a section 34 proceeding as ‘against’ the corporate debtor. As highlighted by Delhi HC in Power Grid, section 34 deals with the objections to the award whereas section 36 deals with the execution of an award. Hence, section 34 is a step before the execution of an award; i.e., the determination of section 34 proceeding would not result in an award against the corporate debtor. It is only under section 36, that the award may be enforced against the corporate debtor and Power Grid had already held that such situations would be covered by moratorium under section 14(1)(a). The BLRC report in 2018 stated that “a proceeding to assess or determine liability, and a proceeding to recover the assessed or determined liability stand at a different footing.” It stated that a purposive interpretation of section 14 would suggest the moratorium would not hit proceedings where liability is merely assessed or determined.

Continuation of Arbitration Proceedings Enhances the Efficiency of the Insolvency Process

It should be noted that allowing arbitration proceedings to continue would increase efficiency as ‘speed is of the essence’ in an insolvency proceeding. If the court prohibits the continuation of the arbitration proceeding, such disputes would have to be dealt with either by the Resolution Professional (“RP”) or NCLT. The court in SSMP noted that the proceedings before NCLT are summary in nature and the RP does not conduct a trial. Therefore, they cannot be burdened with the task of adjudicating such claims where proper evidence is required, issues need to be framed, witnesses need to be examined, and the claims are complex in nature. In these scenarios, it would save both time and cost to allow arbitration proceedings to continue to decide the dispute. In a situation where the award is passed against the corporate debtor, such an award would be hit by a moratorium under section 14 of IBC. The Supreme Court in Essar Steel, while holding the timelines of the Corporate Insolvency Resolution Process (“CIRP”) as a directory, indicated that there will be scenarios where the overburdened Tribunal would not be able to adjudicate the litigant’s dispute within a requisite period. The concern highlighted by the court further supports the argument that it would be efficient for the NCLT to allow the continuation of arbitration proceedings in scenarios where it would increase procedural efficiency.

Moreover, it should be noted that several disputes might arise once the CIRP  has been initiated. Section 25 of the Code obligates the RP to continue, amend, or modify several contracts, and make the required arrangements to keep the corporate debtor as a going concern. In performing such duties and contractual obligations, several disputes can arise which might have an arbitration clause in the contract. In these circumstances, it would be both time and cost-efficient to let these disputes be decided by the arbitral tribunal rather than NCLT which might not be competent enough to deal with such disputes.

The Way Forward

The position of the Indian judiciary about the scope of the section 14 moratorium under IBC is yet to be clear. Such contradictory judgments by similar benches of Supreme Court increases uncertainty; thereby raising transaction costsfor the parties. It makes it difficult for the parties, arbitral tribunals, and adjudicating authorities such as NCLT to understand the scope of section 14 and make decisions consistently and predictably. Further, the judgment of Supreme Court in Mohanraj misallocates the resources by allowing certain parties to escape their obligations as it bars proceedings even in favor of the corporate debtor. The judgment therefore creates an inefficient situation where the objectives of IBC are defeated harming the corporate debtor and the creditors.

It is high time that the status of arbitration proceedings upon commencement of insolvency is clarified in India. One way to resolve such uncertainty by the legislature is to bring a notification under section 14(3) of IBC expressly exempting such arbitration proceedings from the moratorium that does not diminish the assets of the corporate debtor.

– Arunoday Rai

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