All that is not right with Indus Biotech v. Kotak | Indus Biotech (P) Ltd. v. Kotak India Venture (Offshore) Fund : A case comment

Introduction

1. This article analyses the following issues arising from the Supreme Court (SC) decision in Indus Biotech Pvt. Ltd. v. Kotak India Venture (Offshore) Fund[1]:

(i) Should the adjudicating authority first decide the application under Section 8 of the Arbitration and Conciliation Act, 1996[2] (the A&C Act), before deciding the application under Section 7 of the Insolvency and Bankruptcy Code, 2016[3] (IBC)?

(ii) What should be the inquiry of National Company Law Tribunal (NCLT) under Section 7 IBC?

(iii) Was the procedure for appointment of Arbitral Tribunal followed?

Relevant facts 

2. 4 entities of Kotak Fund (Kotak) entered into 4 separate share subscription agreement (SSSA) with Indus Biotech Private Limited (Indus).
3. Kotak subscribed to certain equity shares and optionally convertible redeemable preference shares (OCRPS) of Indus. According to Kotak, (i) Schedule J of SSSA specified that OCRPS were issued for a term of 20 years unless previously redeemed and cancelled or converted; (ii) Kotak also had an option to convert or seek redemption of OCRPS; and (iii) SSSA specified that at the end of the period specified, investment of Kotak is redeemable at internal rate of return (IRR) of 30% and if not redeemed, it will be treated as debt. Indus of course advance a different interpretation of these terms.
4. According to Kotak, Indus failed to provide Kotak an exit by an agreed date by qualified initial public offering (QIPO). Therefore, Kotak exercised its right of redemption and asked Indus to make payment of Rs 367 crores as the redemption value of OCRPS.
5. Indus did not make the payment. According to Kotak, as per the calculation and conversion formula to be followed while converting OCRPS into equity shares, Kotak should get 30% of the total paid-up share capital of Indus; while as per Indus, it should only be 10%.
6. On 16-8-2019, one of the four entities of Kotak filed a petition before NCLT Mumbai, under Section 7[4] IBC, as a financial creditor claiming a default in payment of debt by Indus, a financial debtor, to initiate corporate insolvency resolution process (CIRP) against Indus.
7. On 20-9-2019, Indus sent an arbitration notice to Kotak seeking to invoke arbitration under all the 4 SSSA. Kotak set up a defence that the notice was defective because (i) under the arbitration clause, Indus had no right to appoint an arbitrator; and (ii) there were 4 separate agreements providing for constitution of separate Arbitral Tribunal.
8. On 6-11-2019, Indus filed an application, in the pending Section 7 IBC proceedings, under Section 8 of the A&C Act, to refer to dispute to arbitration. Indus had also filed an application seeking dismissal of Section 7 IBC proceedings as not maintainable.

Proceedings before NCLT

9. The impugned order[5] of NCLT allowed Indus’ application under Section 8 of the A&C Act and dismissed Kotak’s Section 7 IBC application as a corollary.
10. From the orders of NCLT, it is apparent that NCLT heard and decided the Section 8 application first and did not meaningfully engage or decide the Section 7 IBC application on merits. This article discusses why this approach is problematic.
11. Kotak’s case before NCLT was:

(i) Existence of arbitration clause is not relevant, not a factor and cannot affect proceedings under Section 7 IBC;

ii) Section 7 IBC deals with subject-matter of insolvency which is non-arbitrable and in rem; and

(iii) Non-payment of redemption value of OCRPS is a default in payment of debt by Indus and, therefore, NCLT should admit the application under Section 7 IBC.

12. Indus’ response was:

(i) Dispute pertains to valuation of Kotak’s OCRPS, which is arbitrable;

(ii) Indus is a debt-free, profitable company and is not in need of resolution; and

(iii) Investment of Kotak was in the share capital of Indus, by preference shares and Kotak is not a financial creditor.

13. Without addressing the issue of maintainability i.e. whether Kotak is a financial creditor or whether there is a debt, NCLT Mumbai allowed[6] the application under Section 8 of the A&C Act. While allowing the application, NCLT made observations that:

(i) Indus is a solvent, debt-free and profitable company and pushing a solvent company into insolvency is neither meaningful nor desirable at that stage;

(ii) Dispute between the parties is regarding the valuation of OCRPS and parties must make an attempt to reconcile the differences and invocation of arbitration is justified; and

(iii) Petition for appointment of arbitrator filed by Indus is pending before the SC.

Proceedings before the Supreme Court

14. There were 2 proceedings before the SC: (i) petition by Indus, common for the 4 SSSA, under Section 11[7] of the A&C Act for appointment of an Arbitral Tribunal; and (ii) special leave petition (and not appeal) by Kotak against the NCLT order. The SC appointed an Arbitral Tribunal and held:

(i) Mere filing of an application under Section 7 IBC does not make the proceeding in rem. It becomes in rem only on the date of admission; and

(ii) IBC overrides all other laws.

15. Therefore, if there is an application under Section 8 of the A&C Act pending in a Section 7 IBC application which has not been admitted, the adjudicating authority will first decide Section 7 IBC application and ascertain if there is any default by the financial debtor. This will ensure that mere filing of an application under Section 8 of the A&C Act will now allow corporate debtor to delay the process. There will be no independent consideration of Section 8, A&C Act application dehors the Section 7 IBC application.
16. The SC justified the NCLT’s approach where it allowed Section 8, A&C Act application and as a corollary rejected Section 7 IBC application, in the facts and circumstances of the case and “construed in the reverse”[8].

Should adjudicating authority first decide the application under Section 8 of the A&C Act, before deciding Section 7 IBC application?

17. The SC held that if there is an application under Section 8 of the A&C Act pending in a Section 7 IBC application which has not been admitted, the adjudicating authority will first decide the Section 7 IBC application and ascertain if there is any default by the financial debtor. However, in the facts of Indus Biotech[9], the SC does not meaningfully engage with this issue.
18. There was an application filed by Indus challenging the maintainability of Section 7 IBC proceeding. However, NCLT considered the Section 8, A&C Act application. This is evident from the order of NCLT.
19. NCLT ought to have first decided whether it would admit Section 7 IBC proceeding. If it chose to admit it, the proceeding would become in rem and there would be no occasion for a pending Section 8, A&C Act application to survive or a future application to be maintainable. However, if it found that there is no default and hence no trigger for Section 7 IBC, there would have been no occasion to decide Section 8, A&C Act application as the main proceeding had terminated. Therefore, it is not easy to reconcile the conclusion of SC to uphold NCLT order of allowing Section 8, A&C Act application even after dismissing Section 7 IBC proceedings.
20. The scope and inquiry of a Section 7 IBC application is different from the scope and inquiry of a Section 8, A&C Act application. The presence of an arbitration clause and existence of a dispute is relevant for the purpose of Section 9[10] IBC where an operational creditor approaches the court. It will be a bar to initiation of corporate insolvency resolution process. However, not in the case of Section 7 IBC. This is the main difference between Section 7 and Section 9 IBC.
21. By deciding Section 8, A&C Act application first, NCLT did not actually conduct a proper inquiry under Section 7 IBC. Its inquiry was primarily directed to Section 8 application with a perfunctory mention of the default. This is evident from:

(a) NCLT recorded submissions of Indus in the Section 8 application first, followed by submissions of Kotak’s counsel.

(b) In para 3.1 of NCLT order[11], Kotak submitted that if Section 8 application is dismissed, Section 7 IBC matter should be heard on merits.

(c) In para 3.8[12], the order states “the principal argument in the present IA….”

(d) In para 5.2[13] where NCLT records its findings, “[a]t the outset, we must say that the subject-matter of this IA – seeking a reference to arbitration in a petition filed under Section 7 of the IBC – is something that is res integra”.

(e) In para 5.5.[14], the question framed was “[W]ill the provisions of the Arbitration and Conciliation Act, 1996 prevail over the provisions of Insolvency and Bankruptcy Code, 2016?”.

22. The NCLT order extracts Section 238[15]IBC and wrongly concludes in paras 5.10 and 5.11 that the A&C Act will prevail over IBC. Apparently, the NCLT decided the Section 8, A&C Act application on this premise. This is contrary to law.
23. Even Kotak in its written submissions before the SC argued that it was not heard on merits of Section 7 IBC by NCLT. This should have weighed with the SC. If NCLT did not hear the parties on merits of Section 7 IBC proceedings, the SC could have considered remanding the matter back to NCLT.

What should be the inquiry of NCLT under Section 7 IBC?

24. The inquiry of NCLT ought to have been:

(i) Is Kotak a financial creditor?

(ii) Whether OCRPS constitute financial debt?

(a) Whether OCPRS issued with IRR of 30% constitute disbursal against consideration for time value of money as per Section 5(8)[16]IBC?

(b) Whether OCPRS constitute “any amount…having commercial effect of a borrowing” under Section 5(8)(f) IBC?

(c) Whether a shareholder can be a debtor and what is the nature of OCRPS?

       (iii) Whether there is a default?

      (iv) If Section 7 IBC application is allowed or rejected, what should be the fate of Section 8, A&C Act application? – not the reverse.

25. Both NCLT and the SC proceeded on the understanding/assumption that Kotak is a financial creditor, to whom financial debt is due, but go on to find that there is no default yet. Both NCLT and SC did not engage in a meaningful analysis of default. There is also no analysis or finding of debt.
26. This issue was raised in written submissions before the SC, but the SC in para 36[17] observed that:

36…“[t]he contention as to whether payment of investment in preferential shares can be construed as financial debt was raised in the written submissions. However, we have not adverted to that aspect since the same was not the basis of the impugned order passed by the adjudicating authority.”

27. This issue should have formed the basis of the proceedings before NCLT. However, in para 5.5, the question framed by NCLT was “[W]ill the provisions of the Arbitration and Conciliation Act, 1996 prevail over the provisions of Insolvency and Bankruptcy Code, 2016?”.
28. If there is no financial debt, Kotak could not have maintained Section 7 IBC proceedings. The application should have been rejected and there should have been no occasion to even examine Section 8 application. According to Kotak, non-payment is a default which should trigger Section 7 IBC, while according to Indus payment cannot be made till the conversion formula calculation is finalised, hence, no default. Kotak relied on Clauses 5.1 and 5.2 of Schedule J to SSSA to argue that parties had agreed that redemption value shall constitute a debt outstanding by Indus to Kotak.
29. NCLT in allowing the Section 8, A&C Act application was influenced by the following factors:

(i) Indus is a solvent, debt-free and profitable company and pushing a solvent company into insolvency is neither meaningful nor desirable at that stage;

(ii) Dispute between the parties is regarding the valuation of OCRPS and parties must make an attempt to reconcile the differences and invocation of arbitration is justified; and

(iii) Petition for appointment of arbitrator is pending before the SC.

30. In paras 20 and 21[18], the SC agreed that NCLT’s exercise of finding no default is correct. It observed that:

(i) Yes, there is a debt including a clause in the agreement providing that redemption value shall constitute a debt;

(ii) There is a redemption date;

(iii) There were inconclusive discussions between the parties on the redemption value;

(iv)It was premature to arrive at a conclusion of default in payment of debt until the amount payable is determined; and

(v) It is not appropriate to find a default merely because Kotak made a claim as per the agreed date of redemption and filed a petition under Section 7 IBC.

Why is it not appropriate? Would a dispute between parties on the redemption value, postpone the trigger of default? The SC should have given reasons for its findings or the relevance of these questions.

31. Let us test these factors – in the author’s opinion, none of these are relevant for an inquiry default under Section 7 IBC proceeding:

 (i) In para 27[19] of Monotrone Leasing (P) Ltd.v. PM Cold Storage (P) Ltd.[20], the National Company Law Appellate Tribunal (NCLAT) held that inability to pay debts and committing default are two different aspects which are required to be adjudged on equally different parameters. Inability to pay debt has no relevance for admitting or rejecting an application for initiation of CIRP under the IBC.

(ii) Similarly, the SC in para 64 of Swiss Ribbons (P) Ltd. v. Union of India[21], observed that the legislative policy is to move away from the concept of “inability to pay debts” to “determination of default”. The said shift enables the financial creditor to prove, based upon solid documentary evidence, that there was an obligation to pay the debt and that the debtor has failed in such obligation.

(iii) There is no connection between the value of redemption and a finding of default. If the debt is unpaid on the due date, it is default. If the Court’s reasoning is correct, a debtor has to simply create a dispute about the sum/amount to be paid and will escape Section 7 IBC.

(iv)The finding of default under Section 7 IBC is independent from the inquiry whether the subject-matter of the underlying dispute of valuation is capable of being resolved by arbitration.

32. This decision is a missed opportunity for the SC to develop jurisprudence for issues like – can an agreement change the nature of a security – in this case the agreement specified that OCRPS will constitute debt upon redemption; and whether preference shares/OCRPS constitute financial debt under Section 7 IBC.

Was the procedure for appointment of Arbitral Tribunal followed?

33. There are 2 issues here. First, Section 11 petition was filed by Indus but as per SSSA, Indus did not have a right to nominate an arbitrator. The agreed procedure had not failed, and Section 11 petition was premature. On this issue, the SC treated the affidavit by promoters (only promoters and Kotak had a right to nominate arbitrator), who had the right to nominate arbitrator, as sufficient to constitute an Arbitral Tribunal. The problem with this is that Indus had no locus standi to file Section 11 petition. Kotak argued that the arbitration notice is defective, and the petition is not in accordance with the arbitration agreement. This was an opportunity for the Court to decide whether Section 11 can be invoked by a party which does not have a right to nominate an arbitrator under the agreement. The author has not come across any decision on this issue. Additionally, such appointment of Arbitral Tribunal is contrary to settled position of law that procedure for appointment has to be followed strictly and appointment which is not in accordance with the procedure is void.
34. Second, the SC thought it was fit to consider the nature of Arbitral Tribunal, because one agreement will give rise to ICA and other three to domestic arbitration. However, after flagging this issue, the SC does not meaningfully address it. In para 39[22], the SC appointed a single Arbitral Tribunal with same members but separately constituted for each agreement and left it open to the Tribunal to work out the modalities of conducting ICA separately and clubbing the remaining domestic arbitrations.
35. In the author’s view, the SC could have considered clarifying whether this will be a composite arbitration which will result in 1 award or 4 arbitrations under 4 agreements with 4 separate awards. In absence of this, Kotak is likely to seek 4 separate awards from the Tribunal and Indus will seek a composite common award.

Conclusion

In the author’s view, the order of NCLT is not an order on merits of the Section 7 IBC application. If existence of dispute is not an inquiry for a Section 7 IBC proceeding and Section 7 IBC application has to be considered first, the SC should have considered setting aside the impugned order and remanded the matter to NCLT for deciding the Section 7 IBC proceedings on merits. The Court should, if an opportunity arises, consider clarifying that NCLT cannot decide Section 8, A&C Act application first and dismiss Section 7 IBC proceeding as a corollary or consequence.

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*Advocate. Author can be reached at renu@renugupta.co.in

[1] 2021 SCC OnLine SC 268.

[2]  The Arbitration and Conciliation Act, 1996.

[3] The Insolvency and Bankruptcy Code, 2016.

[4] 7. Initiation of corporate insolvency resolution process by financial creditor.— (1) A financial creditor either by itself or jointly with other financial creditors, or any other person on behalf of the financial creditor, as may be notified by the Central Government, may file an application for initiating corporate insolvency resolution process against a corporate debtor before the adjudicating authority when a default has occurred:

*                               *                                     *

Explanation.— For the purposes of this sub-section, a default includes a default in respect of a financial debt owed not only to the applicant financial creditor but to any other financial creditor of the corporate debtor.

(emphasis supplied)

[5] Indus BioTech (P) Ltd. v. Kotak Venture Fund, 2020 SCC OnLine NCLT 1430 [NCLT Mumbai].

[6] Ibid.

[7]<http://www.scconline.com/DocumentLink/02bfnuC4>.

[8]Indus case, supra Note 1.

“36. In that circumstance though in the operative portion of the order dated 9-6-2020 the application filed under Section 8 of the Act,1996 is allowed and as a corollary the petition under Section 7 of the IB Code is dismissed; in the facts and circumstances of the present case it can be construed in the reverse. Hence, since the conclusion by the adjudicating authority is that there is no default, the dismissal of the petition under Section 7 of IB Code at this stage is justified. Though the application under Section 8 of the Act, 1996 is allowed, the same in any event will be subject to the consideration of the petition filed under Section 11 of the Act, 1996 before this Court. The contention as to whether payment of investment in preferential shares can be construed as financial debt was raised in the written submissions. However, we have not adverted to that aspect since the same was not the basis of the impugned order passed by the adjudicating authority.

                                                                                                                                                                (emphasis supplied)

[9] Supra Note 1.

[10]<http://www.scconline.com/DocumentLink/09ftZIDF>.

[11] “3.1. Mr Fredun E DeVitre, learned Senior Counsel for the respondent-financial creditor, submitted that the only issue to be decided in the present is this:

“Are the reliefs claimed in the petition capable of being referred to arbitration or being granted by an Arbitral Tribunal?”

If the answer is no, then the present IA should be dismissed, and the underlying company petition should be heard on merits.”

[12] “3.8. The third aspect of Mr Fredun E DeVitre’s argument centred on the QIPO date. He submitted that in terms of the SSPA, the date was to be December 2011 or a date which is approved by three investors. The principal argument in the present  IA is that the respondent-financial creditor has not redeemed the OCRPS by 2011. In this regard, there was an amendment made to the SSPA in 2017, in terms of which the life of the agreement was extended by another ten years. The amendment retains the QIPO definition from the original document, since all other terms and conditions were retained. Therefore, Mr Fredun DeVitre argues, a fresh right of redemption by agreement was conferred on the respondent.”

(emphasis supplied)

[13] “5.2. At the outset, we must say that the subject-matter of this IA – seeking a reference to arbitration in a petition filed under Section 7 IBC – is something that is res integra. The facts of the case are, however, undisputed, and therefore, we seek to address the points of law that need to be addressed. In our endeavour to arrive at a decision, we have tried to be guided by the decisions of the constitutional courts under other laws, and the underlying reasons in arriving at those decisions. The case law cited by both senior counsel is a good starting point in this quest.”

(emphasis supplied)

[14] Be that as it may, the question that really needs to be answered is this: Will the provisions of the Arbitration andConciliation Act, 1996 prevail over the provisions of the Insolvency and Bankruptcy Code, 2016? If so, in what circumstances?

[15]Section 238 IBC.

[16] Section 5(8) IBC.

[17]Indus case, supra Note 1. “36. In that circumstance though in the operative portion of the order dated 9-6-2020 the application filed under Section 8 of the Act, 1996 is allowed and as a corollary the petition under Section 7 of the IB Code is dismissed; in the facts and circumstances of the present case it can be construed in the reverse. Hence, since the conclusion by the adjudicating authority is that there is no default, the dismissal of the petition under Section 7 of IB Code at this stage is justified. Though the application under Section 8 of the Act, 1996 is allowed, the same in any event will be subject to the consideration of the petition filed under Section 11 of the Act, 1996 before this Court. The contention as to whether payment of investment in preferential shares can be construed as financial debt was raised in the written submissions. However, we have not adverted to that aspect since the same was not the basis of the impugned order passed by the adjudicating authority.”

(emphasis supplied)

[18]Indus case, supra note 1, paras 20 and 21.

“20. Therefore, in a fact situation of the present nature when the process of conversion had commenced and certain steps were taken in that direction, even if the redemption date is kept in view and the clause in Schedule J indicating that redemption value shall constitute a debt outstanding is taken note ; when certain transactions were discussed between the parties and had not concluded since the point as to whether it was 30 per cent of the equity shares in the company or 10 per cent by applying proper formula had not reached a conclusion and thereafter agreed or disagreed, it would not have been appropriate to hold that there is default and admit the petition merely because a claim was made by Kotak Venture as per the originally agreed date and a petition was filed. In the process of consideration to be made by the adjudicating authority the facts in the particular case are to be taken into consideration before arriving at a conclusion as to whether a default has occurred even if there is a debt in strict sense of the term, which exercise in the present case has been done by the adjudicating authority.

21.  In such circumstance if the adjudicating authority finds from the material available on record that the situation is not yet ripe to call it a default, that too if it is satisfied that it is profit-making company and certain other factors which need consideration, appropriate orders in that regard would be made; the consequence of which could be the dismissal of the petition under Section 7 of IB Code on taking note of the stance of the corporate debtor. As otherwise if in every case where there is debt, if default is also 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, the adjudicating authority certainly would make an objective assessment of the whole situation before coming to a conclusion as to whether the petition under Section 7 of IB Code is to be admitted in the factual background. Dr Singhvi, however contended, that when it is shown the debt is due and the same has not been paid the adjudicating authority should record default and admit the petition. He contends that even in such situation the interest of the corporate debtor is not jeopardised inasmuch as the admission orders made by the adjudicating authority is appealable to the NCLAT and thereafter to the Supreme Court where the correctness of the order in any case would be tested. We note, it cannot be in dispute that so would be the case even if the adjudicating authority takes a view that the petition is not ripe to be entertained or does not constitute all the ingredients, more particularly default, to admit the petition, since even such order would remain appealable to the NCLAT and the Supreme Court where the correctness in that regard also will be examined.”

                                                                                                                                                                                                          (emphasis supplied)

[19] 2020 SCC OnLine NCLAT 581.   “27. We are bound to emphasise that a presumption cannot be drawn merely on the basis that a company, being solvent, cannot commit any default. As observed in financial and economic parlance, the inability to payoff debts and committing default are two different aspects which are required to be adjudged on equally different parameters. Inability to pay debt has no relevance for admitting or rejecting an application for initiation of CIRP under the IBC.”

                                                                                                                                                                                (emphasis supplied) 

[20]2020 SCC OnLine NCLAT 581. Civil appeal and a review both were dismissed by the Supreme Court.

[21] (2019) 4 SCC 17

“64. The trigger for a financial creditor’s application is non-payment of dues when they arise under loan agreements. It is for this reason that Section 433(e) of the Companies Act, 1956 has been repealed by the Code and a change in approach has been brought about. Legislative policy now is to move away from the concept of “inability to pay debts” to “determination of default”. The said shift enables the financial creditor to prove, based upon solid documentary evidence, that there was an obligation to pay the debt and that the debtor has failed in such obligation. Four policy reasons have been stated by the learned Solicitor General for this shift in legislative policy.”

                                                                                                                                                                                  (emphasis supplied)

[22]Indus case, supra Note 1. “39. A perusal of the arbitration agreement indicates that the arbitration shall be held at Mumbai and be conducted by three arbitrators. For the purpose of appointment KIVF I, KEIT and KIVL are to jointly appoint one arbitrator and the promoters of Indus Biotech Private Limited, to appoint their arbitrator. In the second agreement dated 20-7-2007, “KMIL” as the investor is on the other side. In the third agreement dated 20-7-2007, “KIVFI” as the investor is on the other side and in the fourth agreement dated 9-1-2008 it has the same clause as in the first agreement. The two arbitrators who are thus appointed shall appoint the third arbitrator who shall be the Chairperson. Recital (c) in the different agreements though refers to each of the entity in  Kotak Investment Venture and amount invested in shares is referred to, it is provided therein that the equity shares and preference shares subscribed by KMIL, KIVF I, KEIT and KIVL are hereafter collectively referred to as the “financial investors shares”. If the said aspect is taken into consideration keeping in view the nature of the issues involved being mainly with regard to the conversion of preference shares into equity shares and the formula to be worked thereunder, such consideration in the present facts can be resolved by the Arbitral Tribunal consisting of same members but separately constituted in respect of each agreement. It will be open for the Arbitral Tribunal to work out the modalities to conduct the proceedings by holding separate proceedings in the agreement providing for international arbitration and by clubbing the domestic disputes. All other issues which have been raised on merits are to be considered by the Arbitral Tribunal and therefore they have not been referred to in this proceedings.”

                                                                                                                                                               (emphasis supplied)