Challenge to an arbitral award makes the operational debt owed ‘disputed’: The Insolvency & Bankruptcy Code, 2016

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Preface:

In the matter of: K. Kishan V/s M/s Vijay Nirman Co. Pvt. Ltd. (Supreme Court of India, Civil Appeal No. 21824/2017, Date of Decision: 14.08.2018, Coram: R.F. Nariman & Indu Malhotra, JJ.) the question of law that came up for adjudication before the Hon’ble Supreme Court of India was, “…whether the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “the Code”) can be invoked in respect of an operational debt where an Arbitral Award has been passed against the operational debtor, which has not yet been finally adjudicated upon?…

Ratio in the matter of: Mobilox Innovations (P) Ltd. V/s Kirusa Software (P) Ltd., (2018) 1 SCC 353:

In the matter of Mobilox (Supra) the Hon’ble Supreme Court of India held that:

a.   Improper use of the insolvency process would occur in cases where a creditor uses insolvency as an inappropriate substitute for debt enforcement procedures, even though they may not be well developed.

b.   A reading of Section 9(5)(ii)(d) of the Insolvency & Bankruptcy Code, 2016 (hereinafter referred to as ‘the Code’) would show that an application under Section 8 of the Code must be rejected if notice of a dispute has been received by the operational creditor.

c.   A combined reading of Section 8 and Section 9 of the Code would show that, what is important is that the existence of the dispute and/or a suit or arbitration proceeding must be pre-existing, that is, it must exist before the receipt of the demand notice or invoice, as the case may be.

d.   The Code in letter and in spirit aims to ensure that operational creditors, whose debt claims are usually smaller, are not able to put the corporate debtor into the insolvency resolution process prematurely or initiate the process for extraneous considerations.

e.   In Para 51 of the judgment the Hon’ble Supreme Court summarized the law as regards Section 8 and Section 9 of the Code as follows:

…51. It is clear, therefore, that once the operational creditor has filed an application, which is otherwise complete, the adjudicating authority must reject the application under Section 9 (5) (ii) (d) if notice of dispute has been received by the operational creditor or there is a record of dispute in the information utility. It is clear that such notice must bring to the notice of the operational creditor the “existence” of a dispute or the fact that a suit or arbitration proceeding relating to a dispute is pending between the parties. Therefore, all that the adjudicating authority is to see at this stage is whether there is a plausible contention which requires further investigation and that the “dispute” is not a patently feeble legal argument or an assertion of fact unsupported by evidence. It is important to separate the grain from the chaff and to reject a spurious defence which is mere bluster. However, in doing so, the Court does not need to be satisfied that the defence is likely to succeed. The Court does not at this stage examine the merits of the dispute except to the extent indicated above. So long as a dispute truly exists in fact and is not spurious, hypothetical or illusory, the adjudicating authority has to reject the application…”.

Non-Applicability of the Ramsay Judgment:

In the matter of: Ramsay Health Care Australia Pty Ltd. V/s Adrian John Compton, [2017] HCA 28, the Australian High Court held that where a judgment debt has been obtained after testing of the merits in adversarial litigation, then in the absence of some evidence of fraud, collusion, or miscarriage of justice, a court exercising bankruptcy jurisdiction will rarely have substantial reasons to investigate whether the debt which emerged in the judgment was truly owed. The Hon’ble Supreme Court of India in the matter of K. Kishan (Supra) declined to follow the law laid down by the Australian High Court in the matter of Ramsay (Supra) by highlighting the ratio contained in the matter of Mobilox Innovations (Supra) to the effect that the insolvency process, particularly in relation to operational creditors, cannot be used to bypass the adjudicatory and enforcement process of a debt contained in other statutes.

Section 34 and Section 37 of the Arbitration & Conciliation Act, 1996 and the Insolvency & Bankruptcy Code, 2016:

i.          Under the Code, in so far as an operational debt is concerned, all that has to be seen is whether the said debt can be said to be disputed, and there is no doubt in stating that the filing of a Section 34 petition against an arbitral award shows that a pre-existing dispute which culminates at the first stage of the proceedings in an award, continues even after the award, at least till the final adjudicatory process under Section 34 and Section 37 of the Arbitration & Conciliation Act, 1996 has taken place.

ii.         There may be cases where a Section 34 petition challenging an arbitral award may be clearly and unequivocally be barred by limitation, in that case it can be demonstrated to the Court that the period of 90 days plus the discretionary period of 30 days has clearly expired, after which either no petition under Section 34 has been filed or a belated petition under Section 34 has been filed. It is only in such clear cases that the insolvency process may then be put into operation.

(According to the mandate contained in Section 34 (3) of the Arbitration & Conciliation Act, 1996 an application for setting aside of an arbitral award may not be made after three months have elapsed from the date on which the party making that application had received the arbitral award. As per the proviso to Section 34 (3) of the Arbitration & Conciliation Act, 1996, if the court is satisfied that the applicant was prevented by sufficient cause from making the application within the said period of three months it may entertain the application within a further period of thirty days, but not thereafter.)

iii.        Where a Section 34 petition has been instituted in the wrong court, as a result of which the petitioner may claim the application of Section 14 of the Limitation Act, 1963 to get over the bar of limitation laid down in Section 34 (3) of the Arbitration & Conciliation Act, 1996. In such cases also, it is obvious that the insolvency process cannot be put into operation without an adjudication on the applicability of Section 14 of the Limitation Act, 1963.

Takeaways:

1.   It is wrong to suggest that an insolvency process does not get stultified because an application to set aside the judgment, order or decision is pending in an appeal or otherwise.

2.   The Adjudicating Authority (National Company Law Tribunal) when examining an application under Section 9 of the Code, will have to determine the following:

(a)  Whether the operational debt legally due and payable is exceeding Rs. 1,00,000/-?

(b) Whether the documentary evidence furnished with the application shows that the aforesaid debt is due and payable and has not yet been paid?

(c)  Whether there is existence of a dispute between the parties or there is a suit or an arbitration proceeding pending adjudication since before the receipt of the demand notice of the unpaid operational debt in relation to such dispute?

3.   Operational creditorscannot use the Code either prematurely or for extraneous considerations or as a substitute for debt enforcement procedures.

4.   The object of the Code, at least in so far as operational creditors are concerned, is to put the insolvency process against a corporate debtor only in clear cases where a real dispute between the parties as to the debt owed does not exist.

5.   It is incorrect to suggest that a pending proceeding challenging an award or decree of an arbitral tribunal or court would not make the debt contained therein a debt that is disputed.

6.   An operational debt contained in an arbitral award for a small amount (say, Rs. 2,00,000/-)cannot possibly jeopardize an otherwise solvent company worth several crore of rupees. Such a company would be well within its rights to state that it is challenging the arbitral award passed against it, and the mere factum of challenge would be sufficient to state that it disputes the award.

7.   Form V of the Code deals with ‘Application by Operational Creditor to initiate Corporate Insolvency Resolution Process under the Code’ and Part 5 of Form V of the Code deals with ‘Particulars of Operational Debt (Documents, Records and Evidence of Default)’. Serial No. 3of Part 5 of Form V of the Code states, ‘Particulars of an Order of a Court, Tribunal or Arbitral Panel adjudicating on the Default, if any (Attach a Copy of the Order)’. Even though an arbitral award may fall in the category of evidence of operational debt due, but the moment objections are preferred against the arbitral award under Section 34 of the Arbitration & Conciliation Act, 1996 or an appeal is preferred under Section 37 of the Arbitration & Conciliation Act, 1996 against an order passed under Section 34 of the Arbitration & Conciliation Act, 1996, the award passed by the arbitral tribunal ceases to be an operational debt due and in fact steps into the category of ‘disputed debt’ against which insolvency resolution process under the Code cannot be initiated.

About Shivam Goel

Shivam GoelShivam Goel; B.Com (H), LL.B. (Delhi University), LL.M. (NUJS, Kolkata); Author of: Corporate Manslaughter and Corporate Homicide: Scope for a New Legislation in India, Partridge India, 2015; Associate, S.G. & Co. (New Delhi); advocate.shivamgoel@gmail.com

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