Arbitrability of Pre-Existing Disputes Under IBC and the Curious Case of Indus Biotech

*Sambhawi Sanghmitra and Ankit Yadav

INTRODUCTION

The Insolvency and Bankruptcy Code, 2016 (“IBC”) and the Arbitration and Conciliation Act, 1996 (“Arbitration Act”) have been game-changers in the economic sphere and have changed the landscape of insolvency and arbitration regime respectively. However, more often than not, courts have to deal with issues that emanate from the interplay of these two legislations. One such issue arose in the case of Indus Biotech Private Limited v. Kotak India Venture Fund-I wherein an interlocutory application filed under Section 8 of Arbitration Act seeking reference to arbitration was allowed and the petition filed under Section 7 of IBC was dismissed. Here, the National Company Law Tribunal’s (“NCLT”) decision to refer the parties to arbitration to resolve their pre-existing disputes underlying the insolvency petition stirred a debate with respect to well-settled principles that have been evolved under the IBC. In this article, an attempt has been made to conduct an analysis of the judgment given by NCLT to assert that the arbitrability of pre-existing disputes between the parties cannot assume significance under Section 7 of IBC. Further, other aspects apropos to the same have also been discussed.

FACTS

Kotak Venture Fund-I (“Financial Creditor”) and Indus Biotech Pvt. Ltd. ( “Corporate Debtor”) entered into a Share Subscription & Shareholders’ Agreement (“SSSA”) dated 20 July, 2007 and the Financial Creditor subscribed to Optionally Convertible Redeemable Preference Shares (“OCRPS”) issued by the corporate debtor. Article 20.4 of the SSSA contained an arbitration clause for disputes arising under SSSA.

In accordance with Regulation 5(2) of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“SEBI ICDR”) it became imperative for the financial creditor to convert the OCRPS into equity shares. However, during the Qualified Initial Public Offering (“QIPO”) process, disputes regarding the valuation of OCRPS, conversion formula and fixing of the QIPO date arose between the parties.

Non-resolution of these disputes prompted the financial creditor to invoke the early redemption clause in the SSSA to redeem the OCRPS at an Internal Rate of Return (“IRR”) of 30% if the QIPO did not take place by the QIPO date provided in the SSSA and called upon the debtor to pay a sum of approx. INR 367.09 crore within 15 days. On non-redemption of the OCRPS, the financial creditor filed an application under Section 7 of IBC on 16 August, 2019, but the debtor filed an interlocutory application on 20 August, 2019, under Section 8 of Arbitration Act to refer the parties to arbitration.

THE NCLT’s DECISION

The NCLT allowed the Interlocutory Application filed by the Corporate Debtor whereas, the application filed under Section 7 of IBC was dismissed.

Relying on Booz Allen Hamilton Inc. v. SBI Home Finance Limited & Ors., NCLT observed that disputes relating to rights in personam which have arisen from rights in rem are arbitrable. It also relied on Hindustan Petroleum Corporation Limited v. Pinkcity Midway Petroleums and P Anand Gajapathi Raju & Ors. v. PVG Raju (dead) & Ors., wherein the Apex Court had held that courts are under a mandatory duty and obligation to refer the parties to arbitration and that the language of Section 8 of the Arbitration Act is peremptory. 

The NCLT noted that the dispute between the parties centred around three issues:

1. Valuation of Financial Creditor’s OCRPS.

2. Financial Creditor’s right to redeem such OCRPS when it had participated in the process to convert the OCRPS into equity shares.

3. Fixing of the QIPO date.

Since these issues were instrumental determinants in ascertaining whether a default had occurred or not, the NCLT held that invocation of the arbitration clause, in this case, was reasonable and it was not satisfied that a default had occurred (para 5.14). Further, in consideration of the fact that the debtor was a solvent, debt-free and profitable company, the Tribunal opined that it would not be prudent to initiate corporate insolvency resolution process (“CIRP”) against the debtor at this stage. Therefore, the Tribunal asked the parties to resolve their differences through arbitration because the disputes which formed the main issue in the insolvency petition, i.e., valuation of shares, calculation and conversion formula and fixing of QIPO date, were all arbitrable.

ARBITRABILITY OF PRE-EXISTING DISPUTES

In the present case, the NCLT did not refer the matter of insolvency for arbitration but the peculiarity of this judgment is that the Tribunal referred the parties to arbitration to resolve their pre-existing disputes that had arisen during the QIPO process, i.e., disputes regarding valuation of shares, conversion formula and fixing of QIPO date. As held in Booz Allen & Hamilton Inc. v. SBI Home Finance Limited & Ors., ‘insolvency’ disputes are incapable of being referred to arbitration.

The disputes between the parties that had arisen during the QIPO process were pre-existing disputes and valuation of OCRPS and fixing of the QIPO date had no bearing whatsoever in determining whether a default had occurred or not. It is also pertinent to note that no attempts were made by either parties to resolve these disputes through arbitration and it was only after moving under the Code that the debtor made a reference to arbitration. However, as held by NCLAT in the cases of Vinayaka Exports v. M/s. Colorhome Developers Pvt. Ltd., and Karan Goel v. M/s Pashupati Jewellers & Anr., unlike Section 9 of IBC, pre-existing disputes between the parties cannot be a subject matter of Section 7 of IBC. In the present case, the NCLT broadened its scope of enquiry by going into the question of arbitrability of pre-existing disputes between the parties. In Dinesh Chand Jain v. Fantastic Buildcon (P) Ltd. & Ors., it was held that the presence of an arbitration clause in the share purchase agreement would not cause any impediment in initiating CIRP under Section 7. Similarly, in Mrs. Nandhitha Vedam v. M/s. Udhyaman Investments Pvt. Ltd. & Anr, the NCLAT held that since there was a debt and default in the payment of the debt, the application filed under Section 7 of IBC was rightly admitted and reference of dispute existing between the parties to arbitration cannot be a ground for rejection of the application. In the case of Shalby v. Dr. Pranav Shah, the NCLT Ahmedabad Bench held that irrespective of an arbitration clause in the agreement between the parties, insolvency resolution process is a right in rem and insolvency matters cannot be subjected to arbitration proceedings. Moreover, in Innoventive Industries Ltd. v. ICICI Bank, it was held that by virtue of the non-obstante clause contained in Section 238 of IBC, right of the corporate debtor under any other act cannot interdict the scheme of IBC. The Supreme Court in Innoventive Industries case also laid down the parameters for rejection/admission of an application under Section 7. The Court held that in order to establish the occurrence of a default, the NCLT has to simply see the records of the information utility or other evidence which is produced by the financial creditor. It is immaterial if the debt is disputed as long as it is due, i.e. the debt is payable unless interdicted by some law or is payable at some future date. It is only when this interdiction is proved to the satisfaction of the adjudicating authority that it may reject an application filed under Section 7 of the Code and not otherwise. In the present case, NCLT deviated from this mandate as it did not peruse the records of the information utility or other evidence to establish the occurrence of default. It came to the judicial conclusion that a default had not occurred because the determinants that were important in ascertaining the occurrence of default were themselves disputed and also because the pre-existing disputes underlying the insolvency petition were all arbitrable. However, the NCLT did not consider that the right of early redemption of OCRPS under the SSSA was available to the creditor despite the fact that it had not invoked the arbitration clause to resolve the pre-existing disputes. Also, in the opinion of the authors, the NCLT should not have rejected the application filed under Section 7 of IBC at an interlocutory stage.

Since the pre-existing disputes were all arbitrable, NCLT noted that it would be undesirable to initiate CIRP against the Corporate Debtor which was “a solvent, profitable and debt-free company”. However, in the case of Monotrone Leasing Pvt. Ltd v. Pm Cold Storage Pvt. Ltd, the NCLAT held that the NCLT is required to determine ‘default’ and not the debtor’s ‘inability to pay debt’ under Section 7. A presumption cannot be drawn merely on the basis that a company, being solvent, cannot commit any default.

Therefore, the NCLT referred the parties to arbitration to resolve their pre-existing disputes which were coverable under the arbitration clause because the alternative remedy had not been exhausted before seeking recourse under IBC. However, this clearly goes against the well-settled principle that IBC proceedings are summary in nature and arbitrability of pre-existing disputes between the parties cannot be a ground for rejection of a Section 7 application under IBC.

CONCLUDING REMARKS

In the present case, the NCLT should have confined itself to the ascertainment of default and should not have rejected the petition filed under Section 7 of IBC on the ground that the pre-existing disputes between the parties were coverable under the arbitration clause in the SSSA. The stance taken by the NCLT in the present case opens up a Pandora’s box as it not only deems arbitrability of pre-existing disputes to be a ground for rejection of an application filed under Section 7 of IBC, but also goes against the mandate of summary nature of IBC proceedings by referring the parties to arbitration to resolve their pre-existing disputes. Insolvency proceedings are a right in rem and The Arbitration and Conciliation Act cannot interdict the scheme of the Code merely because the disputes between the parties are arbitrable. The interplay between the two legislations cannot be construed to enable the defaulter to get out of the clutches of the Code only on the ground that the pre-existing disputes between the parties are arbitrable as it would defeat the purpose of both these legislations.

*The authors are students at Chanakya National Law University, Patna.