Arbitration and Insolvency: Bringing Arbitration into the CIRP

[This article has been authored by Aditya Joby, a final-year law student & Mayannk Sharma, a third-year law student from JGLS, Sonipat]


Keywords: Insolvency, Arbitration, Moratorium, Parallel Proceedings


Introduction

The only effective remedy for an insolvent entity in India is through the process approved by the National Company Law Tribunal (“NCLT”). This would require the creation of a Committee of Creditors (“CoCs”) that currently only consists of ‘financial creditors’, which would ‘safeguard’ the continuation of the company and ensure an equitable distribution of assets among them. However, this process has been condemned for not being effective, as only 14% of the total resolution plans proposed have been approved, while the others have led to the liquidation of the company’s assets. 47% of the Corporate Insolvency Resolution Processes (“CIRPs”) ended in liquidation, with potential buyers waiting for the resolution plan to be rejected so they can buy their asset of choice during liquidation. However, creditors have tried alternative dispute resolution routes like arbitration to enforce their claims.


This article examines the possibility and legitimacy of parallel arbitration proceedings along with the CIRP. Further, the article seeks to explore the possible solutions as an alternative to the blanket moratorium period imposed by the NCLT. Considering the parallel proceedings possible within the Insolvency and Bankruptcy Code, 2016 (“IBC”) allow creditors to apply to be a part of the CoC as a financial or operational creditor based on their type of debt owed, or at the same time enforce the arbitration clause within their contracts with the Corporate Debtor, it becomes difficult for creditors to resolve their disputes, as will be detailed later within the article. We propose to include solutions to resolve this conundrum through methods such as amendments to the CIRP or the creation of a core proceedings list, as in the US Bankruptcy Code. These solutions seek to include disadvantaged creditors, i.e., potential creditors who could not be included within the CoCs due to such an imposition of the moratorium.


How can Parallel Proceedings Happen During the CIRP Despite the Moratorium Period?

The IBC envisions a centralised approach towards the resolution of a company that has been unable to fulfil its debt obligations and has hence undergone insolvency. As soon as an application for the CIRP is admitted against the Corporate Debtor, a moratorium period commences as per Section 14 of the Code, which bars the institution and/or continuation of legal proceedings against the Corporate Debtor. The reason behind the same is to provide breathing room to the Corporate Debtor so that the assets of the Corporate Debtor may be preserved during the resolution process. However, since blanket protection is given to the Corporate Debtor due to the moratorium in place, disputes which have an Arbitration clause or Arbitration proceedings that have commenced against the Debtor before the acceptance of the CIRP request lead to a conflict between the Code and the Arbitration and Conciliation Act, 1996 (“The Act”).


In its early years, Courts were completely against the arbitrability of insolvency and winding-up matters, as held in the Booz Allen case. In the said case, the Supreme Court, in Para 22, recognised insolvency and winding-up matters to be exclusively non-arbitrable. This was further reiterated by the Supreme Court in the Alchemist Asset Reconstruction case, according to which arbitrations that commenced after the imposition of moratorium under Section 14 would be non-est in law. However, through judicial precedents, certain exceptions have been carved out to allow an interplay between the Code and the Act. For instance, arbitration proceedings have been held to be valid after the commencement of the CIRP if they (a.) maximise the value of the Corporate Debtor’s Assets, (b.) benefit the Corporate Debtor and do not adversely impact the assets of the Debtor, and (c.) do not provide for a recovery against the Corporate Debtor during the moratorium.


Barring these exceptions, the moratorium period prohibits the continuation or institution of a suit against the Corporate Debtor irrespective of whether a parallel application to refer the parties to arbitration exists under Section 8 of the Act. To that effect, the Supreme Court in Indus Biotech Pvt. Ltd. v. Kotak India Venture carved out a distinction against such a blanket application. The Court stated that determination of the insolvency application would govern the validity of a Section 8 application under the Act. In case the Adjudicating Authority is satisfied that a default has been committed by the Corporate Debtor, the CIRP would commence, and an application under Section 8 would not be maintainable. However, in case there is no default, arbitration proceedings would be valid. Following this observation, the Apex Court made further inroads for Arbitration proceedings after the CIRP by permitting the Operational Creditor to pursue Arbitration against the Corporate Debtor even after the resolution plan had been approved by the Adjudicating Authority. In Fourth Dimension Solutions Ltd. v. Ricoh India Ltd, the Arbitration proceedings were adjourned sine die, and the Operational Creditor’s dues (worth Rs. 2400 Cr) were admitted as ‘nil’ by the Resolution Professional. The note appended to the claim stated that the liability would be “subject to the outcome of the arbitration proceedings”. In appeal, the Supreme Court allowed the Appellant to proceed against the Corporate Debtor despite the former’s claim being nullified by the Resolution Professional. As such, the decision in the Fourth Dimension is the current status of the interplay between the Code and the Act.


How Can Disadvantaged Creditors be Included within the CIRP?

The inclusion of potential creditors because of the moratorium period on all disputes during the CIRP is problematic since the current insolvency resolution process is disadvantageous against creditors that are not financial creditors, who are a major part of the CoC. This position is seen in Swiss Ribbons v. Union of India, wherein the Supreme Court held that operational creditors are not interested in the finances of the company and, therefore, should not be given voting rights regarding the dissolution of the company and that for a dispute to be arbitrable, it should be a right in personam. The treatment of the operational creditor was worsened in the Insolvency Committee Report, 2018, which states that operational creditors come under the category in Section 53 of the Code, so the problem could be considered trite. However, this proved the unwillingness to allow diverse types of creditors to have a say in the CoCs. The decision in Vidya Drolia made a clear distinction regarding the creation of a debt, stating that third-party rights could be created only when the CIRP application is admitted. Similarly, the exceptions to the moratorium period allow creditors to be included within the CIRP if they maximise the value of the assets of the Corporate Debtor and if the arbitration proceedings cannot pursue recovery during the moratorium period due to the pendency of the arbitration.


This proves that the arbitrability of insolvency claims is possible, and when the arbitration of such disputes leads to resolution post the CIRP itself, it may be impossible to enforce the award since the assets would have already been distributed amongst the creditors. Thus, these disadvantaged creditors would have to be included within the CIRP in some form to prevent the non-enforcement of the arbitral award. This could be done through amendments to the CIRP, which would allow existing disputes to continue and include the parties involved as creditors till the completion of the arbitration, or through alternative methods like the creation of a “core proceedings” list, like in the US’ Bankruptcy Code, which restricts the jurisdictions of certain matters and allows for arbitration to be applied since those topics would be considered as arbitrable. This would also require the Parliament to overrule the precedents stated above to allow the partial arbitrability of insolvency disputes and allow those disadvantaged by being in dispute with the Corporate Debtor to become entitled as creditors.


Conclusion

The implementation of ADR mechanisms such as arbitration requires the reconsideration of the blanket of non-arbitrability of insolvency claims within the Act and the Code, in addition to the rationale laid down in the precedents of Booz Allen, Alchemist Asset Reconstruction. This would allow for the creation of a distinction between the different types of insolvency claims to ensure equitable distribution among the stakeholders of the company while also ensuring that creditors are given their due. In cases such as Fourth Dimension Solution Solutions Ltd. v. Ricoh India Ltd, the uncertainty of a potential creditor’s claim could lead to a dangerous precedent that could prevent other claims that would have occurred before the moratorium period but would have the locus to do so. Thus, to include transborder arbitral claims against insolvent companies and to ensure disadvantaged creditors such as operational creditors are given their due in the CoC, the Judiciary must reconsider their stance on the arbitrability of insolvency disputes and chart a clear distinction between the types of cases that could be arbitrated, as opposed to providing broad exceptions that could only benefit the Corporate Debtor and the CoC.

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