The Intersection between Arbitration and Insolvency Proceedings: An Indian Perspective

Introduction

This article examines various scenarios that may arise in an ongoing arbitration proceeding when a moratorium order is passed by the appropriate National Company Law Tribunal (adjudicating authority) against a corporate debtor (CD) under the Insolvency and Bankruptcy Code, 2016¹ (IBC or Code). The authors have decoded the existing legal framework and jurisprudence of the Indian courts with the aim of identifying issues and suggesting solutions in light of the conflicting nature of insolvency and arbitration laws. While the fate of arbitration proceedings appears to be sealed in the face of Section 14(1) IBC² (moratorium), this article also examines cases wherein proceedings against the CD have been allowed to continue. The judicial gap filling has clarified various aspects of this conflict, however, the position is still evolving on a case-to-case basis. This article, therefore, concludes by arguing that the legislature ought to clarify the legal position to ensure consistency and predictability in the law.

Existing legal framework in India

The tensions of the strained relationship between parallel insolvency and arbitration proceedings have been the subject of much scholarship.³ While arbitration law prioritises party autonomy, insolvency law is a self-contained beneficial legislation enacted with the intention to reduce distressed assets in a time-bound manner and provide for maximisation of the value of the assets of the CD. Before analysing other aspects relating to the scope of moratorium on ongoing arbitration proceedings, it is relevant to examine certain key concepts under IBC. A financial⁴ or operational⁵ creditor or a CD who has defaulted on payment of debts to its creditors can seek initiation of the Corporate Insolvency resolution Process (CIRP) by filing an insolvency application before the adjudicating authority. The distinction between the filing of a petition seeking initiation of CIRP and its admission has been addressed by the Indian courts on several occasions.⁶ Under Indian law, the mere filing of an application seeking initiation of CIRP against the CD, while it is pending admission, does not constitute a bar on an Arbitral Tribunal from proceeding with ongoing arbitration proceedings. The Indian judiciary has unequivocally held that rights and remedies would be available to a party until CIRP proceedings are admitted.

Meaning of “moratorium” and objective behind “moratorium period”

Under Black's Law Dictionary⁷ “moratorium” is defined as “delay in performing an obligation or taking an action legally authorised or simply agreed to be temporary”. The origin of the moratorium under IBC can be traced to Section 446(1) of the Companies Act, 1956⁸, wherein it was stated that once a winding-up order has been made or the Official Liquidator has been appointed, no legal proceeding shall be commenced against the company.

Under IBC, upon admission by the National Company Law Tribunal (NCLT) of an application under Sections 7⁹, 9¹⁰ or 10¹¹ of the Code, a moratorium under Section 14 IBC is declared by the adjudicating authority. A moratorium as envisaged under Section 14¹² specifically, bars:

(a) the institution of suits or continuation of pending suits or proceedings against the CD including execution of a judgment, decree, or order in any court of law, tribunal, arbitration panel or other authority;

(b) transferring, encumbering, alienating, or disposing of by the CD of any its assets or any legal right or beneficial interest therein; and

(c) any action to foreclose, recover or enforce any security created by the CD.

The Report of the Bankruptcy Law Reforms Committee¹³ states that the intent behind the moratorium is to create a “calm period” so that it is value maximising for the CD to continue operations even as viability is being assessed during the insolvency resolution process. The Supreme Court of India elaborated upon this, holding that the purpose of the moratorium was to provide debtors a “breathing spell” during which they can seek to reorganise the business.¹⁴ The question that arises is whether the “calm period” should provide complete immunity to the CDs. While Indian courts have applied the literal rule of interpretation to Section 14 IBC, the following section of this article discusses the interplay between insolvency and arbitration at various stages of the proceedings.

Meaning of “proceedings”

The term “proceedings” is mentioned in Section 14 but is not defined under IBC. A literal reading of Section 14 suggests that all proceedings are barred from the time of imposition of moratorium. The High Court of Delhi in Power Grid Corpn. of India Ltd. v. Jyoti Structures Ltd.¹⁵ (Power Grid Corporation), however, clarified that the term ”proceedings” as mentioned in Section 14(1)(a) is not preceded by the word ”all”, indicating that the moratorium proceedings would not apply to all the proceedings against the CD. In particular, Section 14 would not apply to proceedings which are for the benefit of the CD.

Effect of moratorium during various stages in arbitration proceedings

Effect on fresh and ongoing arbitration proceedings

A bare reading of Section 14 makes clear that the arbitration proceedings must be stayed by an order of moratorium. Commenting on the impact of moratorium on arbitration proceedings, the Supreme Court of India in Alchemist Asset Reconstruction Co. Ltd. v. Hotel Gaudavan (P) Ltd.,¹⁶ (Alchemist) held that,

“4. The mandate of the new Insolvency Code is that the moment an insolvency petition is admitted, the moratorium that comes into effect under Section 14(1)(a) expressly interdicts institution or continuation of pending suits or proceedings against corporate debtors.”

Accordingly, the Court expressed its surprise that arbitration proceedings began after the imposition of a moratorium and further held that, “the arbitration that has been instituted after the moratorium is non est”¹⁷. The ratio of Alchemist¹⁸ was applied by Nclat in K.S. Oils Ltd. v. State Trade Corpn. of India Ltd.¹⁹,wherein Nclat observed that arbitral proceedings pending on the date of commencement of CIRP cannot proceed during the moratorium.

Thus, where arbitration proceedings are initiated after the imposition of moratorium, such proceedings are non est in law. Where arbitration proceedings have been initiated after the declaration of moratorium, the continuation of the arbitration proceedings could depend on whether the claims are (a) for value maximisation of the assets of the CD; or (b) in the nature of a debt recovery action against the CD.

Arbitration invoked for “value maximisation of assets” versus “debt recovery action”

It is important to understand whether the ratio in Alchemist²⁰ can be applied in a case where arbitration proceedings have been invoked for the purpose of maximising the value of the assets of the CD rather than for recovery of debts. This issue arose in Power Grid Corpn.²¹, wherein the High Court of Delhi, while construing the scope of Section 14(1)(a) IBC, took a purposive approach to interpreting Section 14. The High Court of Delhi analysed the object and purpose of Section 14 and held that Section 14 would not apply to proceedings which are for the benefit of the CD, insofar as these proceedings are not a “debt recovery action” and will not endanger, diminish, dissipate, or impact the assets of the corporate debtor.²² The Court did not grant a stay against the award in favour of the CD, as that would stall the recovery of monies. It is clear, therefore, that the embargo under Section 14(1)(a) does not apply to all proceedings.

The above sections considered scenarios in which an arbitration proceeding may or may not proceed post insolvency declaration. However, another scenario has been considered by courts, wherein the arbitration was initiated before the moratorium, however, the award is pending.

Effect of moratorium on “pre-award stage” and “post award stage”

Pre-award stage

Another scenario may arise in which arbitration proceedings are ongoing, however, the issuance of an award may be pending during the moratorium period. In this scenario, there may exist claims and counterclaims by and against the CD. In Jharkhand Bijli Vitran Nigam Ltd. v. IVRCL Ltd.,²³ Nclat was tasked with determining whether a counterclaim in an arbitration could proceed during the moratorium period. Nclat held that the counterclaim filed by the creditor would be a proceeding against the CD and hence fall within the ambit of the embargo under Section 14. However, the counterclaim filed by the CD could proceed before the Arbitral Tribunal even during the moratorium period. Nclat went further, stating that both the claim and counterclaim ought to be heard and decided despite the moratorium. However, Section 14 would apply if the CDs were directed to pay damages or any other amounts as no recovery can take while the moratorium is in place.

The High Court of Delhi took a similar position in SSMP Industries Ltd. v. Perkan Food Processors (P) Ltd.²⁴ While discussing a claim filed by a CD and a counterclaim, the High Court of Delhi held that:

“8…. Section 14 has created a piquant situation i.e. the corporate debtor undergoing insolvency proceedings can continue to pursue its claims, but the counterclaim would be barred under Section 14(1)(a). When such situations arise, the Court has to see whether the purpose and intent behind the imposition of moratorium is being satisfied or defeated. A blinkered approach cannot be followed, and the Court cannot blindly stay the counterclaim and refer the defendant to the NCLT/resolution professional for filing its claims.”

The High Court of Delhi clarified that even though a counterclaim is a proceeding against the CD, its continuation per se is not a threat to the assets of the CD. Section 14 is triggered only when the amount to be paid or recovered is determined.

Thus, arbitrations involving claims and counterclaims by and against a CD may not be hit by Section 14(1) during the pre-award stage. The moratorium may come into effect depending on the award passed in the proceeding. If the award is not in favour of the CD, the moratorium will apply to bar any recoveries.

Post-award stage

Following the issuance of an award by an Arbitral Tribunal, the award may be challenged under Sections 34²⁵ or 36 of the Arbitration Act²⁶. The principle under Section 14 IBC relating to maximisation of the value of the assets of the CD apply to such proceedings. That is, if the monetary award is against the CD, the moratorium will be triggered to bar such recovery. Challenges to an arbitral award may, therefore, only be permitted to continue if the award is in favour of the CD or if continuation of such proceedings does not harm the CD in any manner.

Another issue which the courts have considered is whether a final arbitral award can be considered as evidence of debt. In Annapurna Infrastructure (P) Ltd. v. SORIL Infra Resources Ltd.²⁷, Nclat held that an arbitral award against a CD constitutes a default under IBC. The Supreme Court of India in K. Kishan v. Vijay Nirman Co. (P) Ltd.²⁸, held that even though arbitral awards are valid proof of debt, they will have to be undisputed in order to enable initiation of CIRP by operational creditors. The foregoing analysis reveals that Indian courts are inclined to limit further obligations and liabilities of the CD.

Judicial exceptions to the moratorium regime

Applicability of moratorium to proceedings under “Articles 226 & 32” and Article 136 of the Constitution of India

The prohibition under Section 14 IBC cannot be extended to Articles 32²⁹, 136³⁰ and 226 of the Constitution of India³¹. In Canara Bank v. Deccan Chronicle Holdings Ltd.³², Nclat stated that:

“7. … [t]he Supreme Court has power under Article 32 of the Constitution of India and High Court under Article 226 of the Constitution of India which power cannot be curtailed by any provision of an Act or a court. In view of the aforesaid provision of law, we make it clear that “moratorium” will not affect any suit or case pending before the Supreme Court under Article 32 of the Constitution of India or where an order is passed under Article 136 of the Constitution of India. “Moratorium” will also not affect the power of the High Court under Article 226 of the Constitution of India.”

The judgment passed by Nclat was a significant step in upholding the basic structure of the Constitution of India.

Applicability of moratorium to “criminal proceedings”

One issue that required close examination by the Supreme Court of India pertained to the applicability of Section 14 IBC to proceedings of dishonour of cheques under Section 138 of the Negotiable Instruments Act, 1881³³ (“the NI Act”). The Supreme Court considered this issue in P. Mohanraj v. Shah Bros. Ispat (P) Ltd.³⁴ The Supreme Court examined the legislature's intent to allow value maximising of assets and concluded that Section 14 IBC would cover proceedings under Section 138 of the NI Act. The Supreme Court held that rules of interpretation pertaining to ejusdem generis and noscitur a sociis were incorrectly applied in two earlier High Court decisions to hold that the word “proceedings” does not include “criminal proceedings”. The Supreme Court held that the word “proceedings” cannot be limited only to “civil proceedings”, and that any matter that can create a debt or encumbrance on the assets of a CD, including criminal proceedings, were to be prohibited by an order of moratorium.

The High Court of Delhi, however, has taken a different view on the effect of moratorium on proceedings against a CD under the Prevention of Money-Laundering Act³⁵ (PMLA). In Directorate of Enforcement v. Axis Bank³⁶ the High Court of Delhi held that since the objective of the PMLA is distinct from the purpose of IBC, the latter legislation does not prevail over the former. Thus, criminal proceedings which seek to enforce a civil remedy and are in the nature of quasi-criminal proceedings will be hit by Section 14 IBC.

Applicability of moratorium to “management” of the CD

The initiation of CIRP against a CD does not provide immunity to directors, promoters and management from any legal proceedings connected to their acts in their official capacity. This position has been analysed by the Supreme Court in Anjali Rathi v. Today Homes & Infrastructure (P) Ltd.³⁷, wherein it was clarified by the Supreme Court that the moratorium is intended to preserve the assets of the CD and not in respect of directors/management of the CD against whom proceedings could continue.

Applicability of moratorium to “personal guarantors”

The Supreme Court has considered the issue of applicability of moratorium on personal guarantors in SBI v. V. Ramakrishnan³⁸, holding that since Section 14 does not make any reference to personal guarantors, the moratorium would have not applied to the personal guarantors of the CD. This position has been endorsed in the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018³⁹ which inserted Section 14(3)(b) IBC, clarifying that the order of moratorium shall not apply to a surety to the CD.

Conclusion and recommendations

While Indian courts have filled the gaps in the law and have sought to balance, as far as possible, the competing objectives of insolvency and arbitration law, several legal and policy issues are left to be addressed by the Indian legislature. The judicial precedent set out in the analysis above make it clear that with the exception of proceedings which are for the benefit of the CD, arbitration proceedings cannot continue against a CD once a moratorium has been imposed against them. This leaves much to be desired from the perspective of a claimant in an arbitration proceeding, who may be left without any remedy when an insolvency proceeding is commenced against a respondent in an arbitration proceeding. This conflicting outcome is unsurprising given the considerable differences in arbitration and insolvency law. It is, therefore, necessary for the legislature to address the practical and legal concerns in relation to the effects of insolvency on arbitration proceedings, such as the validity of arbitration agreements, the difference (if any) in how arbitration proceedings which are pending are to be treated versus those which are initiated post the initiation of insolvency, and the conduct of arbitration proceedings, among others. Express legislative provisions addressing the foregoing issues and governing the relationship between arbitration and insolvency will not only provide investors with greater clarity but will also significantly improve the predictability of the arbitral process.