English Articles

IBC VIS-À-VIS ARBITRATION: FRESH PERSPECTIVE

an application is filed under S 7 of IBC, 2016 the NCLT should judicially determine IF there is default within the meaning of Section 3(12)

This Article is written by Abhinandan Sharma student of  Symbiosis Law School, Noida.

INTRODUCTION

Recently Supreme Court in Indus Biotech Private Ltd. v. Kotak India Venture Fund adjudicated on a matter related to the scope of an application filed under Section 7 of the Insolvency & Bankruptcy Code, 2016 (hereinafter referred to as IBC, 2016). The Supreme Court discussed whether the mere filing of an application under Section 7 of the IBC, 2016 constitutes in rem proceeding hence ineligible for arbitration or the proceedings became in rem only after admission of application by NCLT. The Supreme Court also clarified whether NCLT has authority to send parties to the arbitration if it is satisfied that there is no default. In this post, the author aims to examine the facts that led to this decision and the rationale that led to it.

 

FACTUAL BACKGROUND

Kotak India Venture Fund (hereinafter referred to as Kotak India) via Share Subscription and Shareholders Agreements subscribed to the equity and Optionally Convertible Redeemable Preference Shares (hereinafter referred to as OCRPS) of Indus Biotech Private Ltd (hereinafter referred to as Indus Private). Later, during the course of business, the Indus Biotech Company decided to launch a Qualified Initial Public Offering. However, QIPO could not be offered as the company had outstanding convertible security. As per Section 5(2) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements), Regulations 2018 any right that would give anyone the option to receive the issuer’s equity shares is ineligible to make a QIPO. To issue QIPO, it became necessary for Kotak India to convert their preference shares into equity shares. To convert Kotak India preference shares under Indus Private into equity shares, Indus Private proposed a conversion mechanism in which Kotak enterprises would receive 10% of total equity shares. On the other hand, Kotak Ventures argued that they were entitled to 30% of the total paid-up share capital.

Subsequently, Kotak India claimed that payment of INR 367.08 crores was due and payable upon OCRPS redemption. After Indus Private failed to pay the required amount, Kotak filed a petition under Section 7 of the Code to initiate the Corporate Insolvency Resolution Process (CIRP). On the other hand, Indus Private filed a miscellaneous application seeking direction from NCLT to refer the matter to arbitration under Section 8 of the Act. NCLT  dismissed the application under Section 7 IBC & approved the Indus application made under Section 8 of the Act of 1996. Later, Kotak India filled a Special Leave Petition against the order of NCLT and Indus Private also filed a petition under Section 11(3), 11(4)(a) & 11(12)a of the Arbitration & Conciliation Act, 1996 for the appointment of arbitration on the behalf of Kotak India to set up an arbitration panel.

 

ANALYSIS

The Supreme Court held that whether a default has occurred as per Section 7 of the IBC, 2016 or not is to be asserted by the documents produced by the financial creditor under Section 7(3) of the IBC, 2016. Supreme Court relying on the decision of  Innoventive  Industries Limited v. ICICI Bank and Another (2018) 1 SCC 407 which held that

It is at the stage of Section 7(5), where the NCLT is to be satisfied that default has occurred, that the corporate debtor is entitled to point out that a default has not occurred in the sense that the ‘debt’, which may also include a disputed claim, is not due. A debt may not be due if it is not payable in law or in fact”.

The Supreme Court inclined towards the view that the NCLT must make an ‘objective assessment’ while determining whether or not a default has occurred. Along with documents filed by financial creditors the NCLT can also look into the material placed by the corporate debtors. As a result, the Supreme Court determined that Indus Private non-payment of INR 367.08 crores to Kotak India on OCRPS redemption will not be considered a default because the parties disagreed on the conversion formula and attended many meetings without reaching an agreement.

Previously, Both the NCLAT and the Supreme Court have held that because IBC procedures are in rem, they are not eligible to be settled by arbitration. In this Judgment Supreme Court further clarifies that if an application under Section 7 of IBC, 2016 is made before NCLT then the proceeding becomes in rem only after NCLT admits the application. As a result, ‘Triggering Point’ is not a pendency of a case but an admission of the same by the Adjudicating Authority. The Supreme Court emphasizes that once an application is accepted by the NCLT that the proceedings would be turned into a ‘in rem proceeding having ergaomnes effect’ hence ineligible for arbitration before that scope of arbitration can be considered. Furthermore, all other legislation will be superseded by Section 238 of the IBC, 2016.

CONCLUDING REMARKS

The Supreme Court held that “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”.

Therefore, once an application is filed under Section 7 of the IBC, 2016 the NCLT should judicially determine whether there is default within the meaning of Section 3(12). It should not be a mechanical process, rather the NCLT shall make a resonated decision. While doing so, the NCLT can take notice of the corporate debtor contentions to establish whether the defense has merit and whether there is a default. In the case at hand, the Supreme Court determined that there was no default and that the case was arbitrable. However, the Supreme Court stated that the case should not be postponed solely because of an arbitration clause in the agreement. Once the NCLT is satisfied that the default has occurred after that application for arbitration would not arise. Many experts feel that the Supreme Court decision contradicts the well-established jurisprudence of the IBC, 2016, which states that the Adjudicating Authority’s power to determine the default is confined to only material submitted by financial creditors under Section 7(3) of the IBC, 2016. However, the author believes that the Supreme Court was correct in noting that the NCLT can also listen to the corporate debtor’s side when evaluating whether or not there has been a default.

In its judgment, the Supreme Court instead of recording its observation on the issue of the NCLT power to decide on Section 8 Application directly, took a different view and observed that the NCLT need not independently consider the Section 8 Application. The Supreme Court made it clear that the first NCLT is duty-bound for deciding whether or not there is a default by examining the evidence presented to it. If the NCLT determines that there has been a default and approves the application, Section 238 of the IBC, 2016 will take precedence over any other law, and the issue of arbitration will not arise. If the Adjudicating Authority, on the other hand, determines there is no default and rejects the application, the parties are free to establish an arbitration panel as provided by law. In this instance, the NCLT would not be required to set up an arbitration panel. As a result, the NCLT should first assess whether there is a default based on insolvency application.

 

REFERENCES

  1. Indus Biotech Private Limited vs Kotak India Venture ARBITRATION PETITION (CIVIL) NO. 48/2019
  2. Innoventive Industries Limited v.  ICICI Bank and Another (2018) 1 SCC 407
  3. A. Singhal & V. Khatri, Indus Biotech v Kotak: A Step in the Right Direction?, India Corp Law (Apr. 04 202) https://indiacorplaw.in/2021/04/indus-biotech-v-kotak-a-step-in-the-right-direction.html
  4. P.Nayak & V. Mahendra Vidya Drolia, A dollop of nectar and a few poison darts, Bar & Bench (Dec. 18,2020) https://www.barandbench.com/columns/vidya-drolia-dollop-of-nectar-few-poison-darts
  5. Niloufer Lam, Determination Of Default Under IBC – Supreme Court’s Confused Message In Indus Biotech, MONDOQ (Jun. 02,2021) https://www.mondaq.com/india/insolvencybankruptcy/1075346/determination-of-default-under-ibc–supreme-court39s-confused-message-in-indus-biotech-
  6. B. Dubai & P. Goyal, Does NCLT has power to refer parties to Arbitration in an in rem insolvency proceeding?, Lexology (Apr. 06,2021); https://www.lexology.com/library/detail.aspx?g=43cd0147-93b0-44bf-9572-d8bc24dc271f