Introduction
In a recent judgment1, upholding the order passed by the NCLT and settling previous uncertainties, the Supreme Court of India (“Supreme Court”), held that an arbitration petition is not maintainable after a petition under Section 7 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) is admitted. However, during the pendency of a Section 7 petition, parties could be referred to arbitration.
Facts
Optionally Convertible Redeemable Preference Shares (“OCRPS”) issued by Indus Biotech Private Limited (“Indus”) were subscribed by Kotak India Venture (Offshore) Fund (“Kotak”) under a share subscription agreements and shareholders' agreement (“Agreements”). Indus then decided to make a Qualified Initial Public Offering (“QIPO”) and Kotak decided to convert its preference shares into equity shares. A dispute arose between the parties in relation to the calculation and conversion formula to be applied in converting the OCRPS into equity shares. Kotak claimed 30% paid up share capital of the equity shares on conversion whereas Indus claimed the percentage to be 10%.
Kotak contended that on exercising the option of redemption earlier, the amounts became payable by Indus and failure to pay amounted to a ‘default' under the IBC, making them to eligible to trigger resolution of Indus under a Section 7 petition filed by Kotak (a financial creditor). According to Indus, after subsequently entering into discussions regarding conversion of the shares instead of redemption, until a decision was taken on the ongoing dispute regarding the percentage of equity shares to be allotted, there was no liability to repay and therefore there was no ‘debt' or ‘default' under the IBC. Thus, Indus filed a miscellaneous application ("Arbitration Application") under Section 8 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”) seeking a direction to refer parties to arbitration in the Section 7 petition filed by Kotak under IBC, before the NCLT.
The NCLT allowed the Arbitration Application filed by Indus and referred the parties to arbitration and as a consequence, the Section 7 petition stood dismissed. Kotak being aggrieved by the order of the NCLT approached the Supreme Court.
Judgment
Kotak's main contention was that the NCLT committed a grave error in entertaining the Section 8 Arbitration Application, in the backdrop of the legal duty cast on the NCLT to proceed strictly in accordance with the procedure contemplated under Section 7 of the IBC.
The Supreme Court observed that under Section 7 of IBC, a duty is cast on the NCLT to ascertain the existence of a default if shown from the records/evidence as contemplated under Section 7(4) of the IBC. Relying heavily on the judgment in Innoventive2, the Supreme Court elaborated that it is whilst deciding the petition under Section 7, the NCLT has to satisfy itself whether a ‘default' has occurred; failing which, the application is liable to be rejected. The Supreme Court noted that mere existence of a ‘debt' cannot lead to the assumption that there is a ‘default'. Since the NCLT had concluded that there is no default in view of the dispute on the percentage of equity shares to be allotted on conversion, the NCLT was right in referring the parties to arbitration.
The question of whether redemption amounts becoming due, alone would lead to the conclusion that there was a default, was to be considered. The Supreme Court observed that as rightly held by the NCLT, on seeking conversion subsequently, the allotment of equity shares against the OCRPS in view of the QIPO and the applicable formula for the conversion of the OCRPS, was still a matter of discussion between the parties and no conclusion had been arrived at, so as to term it a default. Therefore, it would be premature to hold that there was a default until the issue was resolved and the amount payable to Kotak was determined. The Supreme Court therefore considered it appropriate to constitute the arbitral tribunal.
Kotak further contended that a Section 7 proceeding under the IBC is an action in rem3 and therefore insolvency and winding up matters are non-arbitrable. The Supreme Court held that it is only when the adjudicating authority proceeds to admit the Section 7 application, and once the corporate insolvency process commences, does the proceeding become a proceeding ‘in rem', i.e., on the date of admission and from that point onwards the matter would not be arbitrable. Relying upon the judgment in Vidya Drolia4, the Supreme Court held that actions in rem are not arbitrable. However, the trigger point is not the filing of the application under Section 7, but admission of the same. As the petition was yet to be admitted, therefore it had not assumed the status of a proceedings in rem.
The Supreme Court observed that if in every case where there is a debt, if default is assumed and the process becomes automatic, “a company which is ably running its administration and discharging its debts in planned manner may also be pushed to the corporate insolvency resolution process and get entangled in a proceeding with no point of return.” Therefore, an objective assessment of the whole situation is required to be made.
Conclusion
Though the judgement has drawn a myriad of conflicting views, it needs to be borne in mind that the facts in the present case are unique which certainly required the NCLT to take a subjective view as the NCLT concluded that there is no default.
Footnotes
1 Arbitration petition (Civil) No. 48/2019, Indus Biotech Private Limited v. Kotak India Venture (Offshore) Fund (earlier known as Kotak India Venture Limited) and Ors.
2 Innoventive Industries Limited v. ICICI Bank and Another (2018) 1 SCC 507
3 (2019) 4 SCC 17, (2011) 5 SCC 532
4 Vidya Drolia and Others v. Durga Trading Corporation (2021) 2 SCC 1 and Olympus Superstructures (P) Ltd. v. Meena Vijay Khetan (1999) 5 SCC 651
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