Legislations and Policies

A Tale of Two Proceedings: Revisiting the Intersection of Insolvency and Arbitration

Sanskar Modi, Vijpreet Pal

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This piece explores the interface between arbitration and insolvency proceedings, in light of arbitrability being limited to rights in personam and the rights in rem created by insolvency proceedings – by focusing on the case of Indus Biotech Pvt. Ltd. v Kotak India Venture Fund.

 

Introduction

The recent pronouncement of the Supreme Court in the case of Indus Biotech Private Limited v. Kotak India Venture Fund (“Indus Biotech Case”), wherein the Supreme Court has discussed the extent of arbitrability of insolvency disputes, has garnered the attention from academicians and arbitration practitioners in expounding the intersection between Insolvency & Arbitration Proceedings under Indian legislative framework. Discourse on the intersection of arbitration and Insolvency is of immense significance with the advancement of a new insolvency regime in India.

The relationship between Insolvency and Arbitration is quite contrasting as insolvency aims to centralize all the proceedings against a debtor to one jurisdiction hence giving proceedings in rem effect and thereby creating third party rights, arbitration on the other hand prescribes a decentralized approach and promotes party autonomy resulting in in personam proceeding. Resultantly, due to the limited availability of legislative framework on this interplay, many arbitral proceedings have been hindered due to the commencement of Insolvency proceedings. The aim of this article is to firstly discuss the Indian approach with respect to the existing conundrum of the arbitrability of Insolvency disputes in light of the Indus Biotech case and then analyze the international jurisprudence guiding the scope of settling insolvency disputes via arbitration. The article finally argues for a uniform approach across all the jurisdictions in dealing with this intersection.


The Curious Case of Indus Biotech

The Indian law is settled on the position that if the subject matter of the dispute gives the proceedings in rem effect, then the same is not arbitrable. As the insolvency proceedings create third party rights, thereby, once the insolvency proceedings commence, the subject matter becomes non-arbitrable. However, the issue which often perturbs the Court is the determination of a point that triggers any “in personam” proceeding into an “in rem proceeding”, thereby making it non-arbitrable under the Arbitration Act.

The Hon’ble Supreme Court in the Indus Biotech Case was seized with this issue in which Kotak India has filed an application before the NCLT Mumbai under Section 7 of the Code seeking commencement of Corporate Insolvency Resolution Process (“CIRP”) against Indus Biotech for its alleged default in redeeming the Preference Shares subscribed by Kotak India under the Agreement. However, during the pendency of the said CIRP application, Indus Biotech filed a miscellaneous application before the NCLT under Section 8 of the ArbitrationAct praying to refer the matter to arbitration for settling their disputes.

NCLT rejected Section 7 application on the ground of non-existence of ‘default’ and further allowed the Section 8 Arbitration Application and referred the matter to Arbitration. The said decision was challenged before the Apex Court on the ground that the NCLT usurped its jurisdiction while allowing a Section 8 Arbitration Application in an in-rem insolvency proceedings amidst the absence of any specific power conferred under the Code to refer parties to Arbitration.


Reasoning of the Court guiding India’s status quo

Under the Indian Insolvency Regime, once a CIRP application is admitted, a public announcement is made and a moratorium is declared prohibiting the institution or continuation of suits or other proceedings against the corporate debtor. It is under this moratorium that arbitration or other related proceedings commenced after the initiation of CIRP are considered non-est in law.

However, the judicial precedents have created certain exception against this rule and the Court on certain occasions have allowed continuation of the arbitration proceedings if (a) it maximizes the value of the asset of corporate debtor, (b) the proceedings are beneficial to corporate debtor and do not adversely affects the assets of the debtor and (c) even if proceedings are allowed to be continued no recovery can be pursued against the debtor during the operation of moratorium period, etc.

In the instant case, the Court while taking reference from Vidya Drolia case noted that only upon the admission of CIRP application, third parties rights are created in favour of creditors, alternatively, proceedings have erga omnes effect and not before that stage. During pre-admission stage, the NCLT is only required to establish the existence of default and it is after that the third-party rights are generated in the CIRP. The Court ruled that as in the instant case, the dispute is with respect to the interpretation of clause used to calculate the redemption value, the observation of the NCLT that the said dispute does not constitute a valid debt under the Code holds substance under the law and hence could be settled through Arbitration.

Although this judgment clears the mist to an extent regarding when insolvency proceedings create third party right and truly becomes in rem in nature. However, it brings us to seek more clarity on the issue as to which insolvency matters can be settled through arbitration and which cannot and what are the certain occasions where the Court can allow continuation of the arbitral proceedings. Therefore, at this juncture it would be imperative to appreciate the international jurisprudence revolving around the interplay of these laws.


International Perspective

Even transnational Insolvency laws grant stay order on the Arbitral Proceedings upon commencement of the Insolvency proceedings and justification behind such a stay is to ensure that all the creditors are treated in just and equitable manner and the relevant court/tribunal is allowed to exercise its exclusive jurisdiction. Under the jurisprudence of Insolvency, there are certain matters which are invariably considered as non-arbitrable (see here), commonly called as ‘Core’ matters of Insolvency laws like the initiation of insolvency proceedings, verification of the claims of creditors, winding up of company etc. and arbitrators are not possessed with competency to settle such Core matters. In a sense, it is possible to settle certain, albeit constrained, Insolvency issues through Arbitration. However, major issue is delimitation between core and non-core insolvency matters and due to the myriad of divergent insolvency regimes across the countries there is no consistency in the answers regarding which matters can be adjudicated through Arbitration.

For instance, in Australia, there is no defined bifurcation. Australian Laws stick to the international substantive law in considering insolvency matters as non-arbitrable on the basis of sufficient public policy considerations, for example, the winding up of a company. Australian adjudicating authorities deny stay if the rights of the parties stem from the contract rather than statute. Parties cannot settle the matter stemming from the statute as it hampers the rights of the third parties.

On the contrary, the public policy considerations hardly affect the arbitrability of the dispute under the Swiss Law. By and large insolvency issues are arbitrable, like repayment of amount involved in preferential/fraudulent transactions, identification or repudiation of the existence of debt, decisions regarding inclusion or exclusion of assets, determination of the committee of creditors etc. However, commencement of Insolvency proceedings, verification of the claims of creditors, liquidation etc. are core matters and only courts are the competent adjudicating authority in such matters.

Moving to the approach adopted by the UK, it is evident from the obiter dicta of several judgments that the English courts construe the public policy doctrine narrowly like the Swiss Law. As a matter of law, parties involved in insolvency disputes cannot be restrained from settling through Arbitration, however, it is imperative to consider if the matter infringes the third-party rights or is against the public policy. ‘The liquidators’ power to intervene and set aside the preferential transactions stems from the statute which is beneficial for all the creditors and this power cannot be over-ridden by the arbitration clause mentioned into the contract entered into by the parties.’ Further, it might appear that when the creditors are dissatisfied with the liquidator’s resolution of debts, they are supposed to approach the court, however, this is not panoramic rule and all the creditors can mutually agree to arbitrate. 

Heading towards the United States’ approach on this aspect, the jurisprudence of US regarding this conundrum is more definite than other nations. US Court in Mitsubishi Motors Corp. vs. Soler Chrysler-Plymouth Inc significantly expanded the scope of arbitrability of insolvency matters. Furthermore, the Bankruptcy Code of US contains a non-exhaustive list of “core” proceedings at 28 U.S.C. Sect. 157(b)(2). US Bankruptcy Courts have no jurisdiction in non-core matters and arbitration must be compelled in such cases. Although, the core insolvency issues ought to be adjudicated by the courts, however, not compulsorily all core matters would inherently conflict or jeopardize the underlying objectives of the Bankruptcy Code and could be settled through Arbitration.

This comparative study of various nations provides us the broader idea regarding the parameters which must be considered while deciding the issue of arbitrability of insolvency issues; like: matters of public interest, matters affecting third party rights, matters stemming from the statute etc. are universally non-arbitrable. However, it could be witnessed that some nations have embraced strict approach while some are very lenient. Some nations have progressed legislative framework having definite structure to an extent while others decide on a case-to-case basis.


The Way Forward

The absence of regulations leads to variability and unpredictability, therefore, there is a need for consistent framework or a Legislative Guide like model to examine the arbitrability of insolvency disputes. For instance, there can be a list for core and non-core matters like the Bankruptcy Code of US has, however, such a list would be difficult to be incorporated under the Swiss substantive Law.

Nevertheless, it is believed that such challenges are not unconquerable and it is argued that a Handbook would help national courts as well as International Arbitral tribunals by fostering a more certain trans-boundary approach to the arbitrability of Insolvency procedures. This will benefit the international business community by extending more certainty and predictability, lessening arbitration/litigation and transaction costs, increasing lucidity, and bestowing appreciable belief in the International Legal regime.


Sanskar Modi and Vijpreet Pal are third-year students at the National Law Institute University (NLIU), Bhopal.