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Indus Biotech vs. Kotak: Moulding A Balance Between Insolvency And Arbitration Proceedings

Written by Ishu Gupta [i] and Trisha Singh Naulakha [ii]

Students of Symbiosis Law School, Noida



Disclaimer: Please note that the views expressed below represent the opinions of the article's author. The following does not necessarily represent the views of Law & Order.


 

Introduction:

Arbitration and insolvency laws have been a matter of discussion and debate across different jurisdictions in connection with their intersection, and the issue of the arbitrability of insolvency disputes. In India, the interaction of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) and arbitration laws gained immense consideration and attention of legal and insolvency professionals in 2020 when the National Company Law Tribunal (‘NCLT’), Mumbai Bench allowed an interlocutory application of the corporate debtor under Section 8 of the Arbitration and Conciliation Act, 1996 (the ‘Act’), thereby dismissing the application of the financial creditor under Section 7 of the IBC.


The order of the NCLT was challenged before the Hon’ble Supreme Court of India in a Special Leave Petition (‘SLP’) filed by Kotak India Venture (Offshore) Fund (‘Kotak’) under Article 136 of the Constitution of India, heard together with the Arbitration Petition filed by Indus Biotech (P) Ltd. (‘Indus Biotech’) under Section 11 of the Act, regarding the appointment of an arbitrator on behalf of Kotak and its sister ventures for the constitution of an arbitral tribunal. The Supreme Court pronounced its judgment in Indus Biotech Private Limited v. Kotak India (Offshore) Fund & Ors.[1] (‘Indus v. Kotak’) on 26th March 2021, conclusively discerning the cases in which the disputes between the contracting parties may/may not be referred for arbitration. The judgment involved the questions of default under the IBC, the distinction between arbitrable and non-arbitrable disputes, and the overriding effect of the IBC.


In the course of this paper the authors shall be discussing the judgment of the Supreme Court in Indus v. Kotak while analysing the distinction of proceeding in rem and proceeding in personam for delineating the arbitrarily of insolvency disputes. Further, the standard of review in cases of disputed debt for admitting a corporate insolvency application under the IBC, when there is an agreement to arbitrate between the parties, shall be discussed. Finally, the authors conclude by critically appreciating the reasoning of the Supreme Court for its application of sound principles of arbitration law, and the protection of bonafide parties from insubstantial disputes raised by abusing the process of law.


Factual Background:


The dispute between Kotak and Indus Biotech emanated from the share subscription and shareholders’ agreement (‘agreements’) entered between them. The agreements provided for the subscription of equity shares and Optionally Convertible Redeemable Preference Shares (‘OCRPS’) in Indus Biotech by Kotak and its sister ventures. Subsequently, Indus Biotech decided to make a Qualified Initial Public Offering (‘QIPO’) which could only be done after the conversion of Kotak’s OCRPS into equity shares because of Regulation 5(2) of the SEBI (ICDS) Regulations 2018. Accordingly, discussions took place between Kotak and Indus Biotech for the conversion of Kotak’s OCRPS into equity shares. A dispute pertaining to the calculation and conversion formula to be applied in the said conversion of OCRPS into equity shares arose between the parties.


The agreements between the parties contained clauses for the redemption of the OCRPS and the value of redemption to be paid to Kotak. Notably, the agreements prescribed that the redemption value shall be treated as debt outstanding by Indus Biotech to Kotak. Kotak demanded a sum of INR 367 crores from Indus by resorting to the redemption value clause of the agreements, which was not paid by Indus. Accordingly, Kotak filed an application under Section 7 of the IBC for the initiation of the Corporate Insolvency Resolution Process (‘CIRP’) against Indus Biotech. In the same proceedings, Indus Biotech filed an interlocutory application under Section 8 of the Act seeking reference of the parties for arbitration. The NCLT allowed the application filed by Indus Biotech and dismissed the insolvency petition of Kotak by resorting to Section 7(5)(b) of the IBC which provides for the dismissal of insolvency petition if the Adjudicating Authority is satisfied that default has not occurred.

Thereafter, Kotak filed an SLP before the Supreme Court which was heard along with the arbitration petition of Indus Biotech under Section 11 of the Act.

The decision of the Supreme Court:

The Supreme Court decided that the admission of a petition under Section 7 of the IBC bars the maintainability of application(s) under Section 8 of the Act. However, in circumstances wherein a petition under Section 7 has not yet been admitted by the adjudicating authority under Section 7(5) of the IBC and a simultaneous interlocutory application is made by the corporate debtor under Section 8 of the Act, the adjudicating authority much first decide on the admission or dismissal of the insolvency petition by ascertaining if a default has taken place under Section 3(12) of the IBC. The definition of default under Section 3(12) entails non-payment of debt when the whole or any part of the debt has become due and payable and the debtor has failed to make such payment. The reasoning of the Apex Court was based on the erga omnes effect of the admission of an insolvency petition and Section 238 of the IBC which provides that the IBC shall override all other laws.


Analysis:


Treatment of default under IBC


Kotak argued that the cause of action for invoking the jurisdiction of NCLT to initiate insolvency proceedings against Indus had arisen as the latter failed to pay the amount payable at redemption to Kotak. Such non-payment of debt had constituted a default within the scheme of IBC. On the contrary, the primary bone of contention according to Indus was the determination of an appropriate calculation formula to convert the preference share of Kotak to equity shares and there was no default on its part. To analyse the correctness of contesting claims of parties, it is imperative to take note of the essential factors for triggering an application under Section 7 of the IBC.


The widest construction of the definition of “default” under Section 3(12) implies the non-payment of debt when it becomes due. Likewise, “debt” as per Sections 3(11) and 3(6) can be interpreted as an obligation in respect of payment even if it is disputed. While entertaining an application under Section 7 of the IBC, the adjudicating authority must determine the existence of both debt and default, separately. That is to say, the existence of default cannot be assumed where there is an existence of a debt.[2] If the default were to be assumed wherever there is debt, insolvency proceedings would automatically be forced against all the profit-making and debt-free companies, which in fact would vitiate the purpose of IBC. The authors concur with this stance of NCLT and the Supreme Court while examining the disputed debt, raised as a default because the primary objective of initiating corporate insolvency resolution is to revive the loss-making companies and an assumption in favour of automatic default will render the insolvency proceedings under the IBC as a mere tool for recovery of debt by creditors.


The prima facie view of facts of the instant case indicated that the process of transforming preference shares into equity shares was an issue that had commenced much before the date of redemption of shares as agreed by the parties.

Thus, the Supreme Court highlighted that when there is an ongoing dispute regarding the determination of proper formula concerning the conversion of, it is inappropriate to oversee such dispute which is arbitrable. Accordingly, the creditor cannot be allowed to bypass an arbitration agreement by filing an application of claim under Section 7 of the IBC.

Arbitrability: proceeding in rem v. proceeding in personam


Article II, paragraph 1 of the UNCITRAL Model Law on International Commercial Arbitration provides for the non-arbitrability exception.[3] Similarly, Article II of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958 obliges the contracting states to only recognise arbitration agreements whose subject matter is arbitrable. In India, an arbitration award may be set aside on the ground of non-arbitrability of the subject matter.[4] Hence, the issue of deciding the arbitrability of a cause of action and the subject matter involved holds immense importance.


The question of the arbitrability of disputes has been a matter of consideration in various judgments of the Supreme Court. The trajectory of the legal development on arbitrability debate can be traced from the judgment of Booz Allen and Hamilton v. SBI Home Finance[5] in which the Supreme Court listed six categories of disputes which were per se non-arbitrable. However, things remained unclear as regards the correct standard for determining arbitrability in different peculiar disputes. Most recently, the Supreme Court while determining the arbitrability of tenancy disputes in Vidya Drolia v. Durga Trading Corporation[6] (‘Vidya Drolia’) propounded a four-pronged test for determining the question of arbitrability of a dispute in India. Accordingly, certain disputes are non-arbitrable in which the subject matter of the dispute: (1) relates to actions in rem, that do not pertain to subordinate rights in personam that arise from rights in rem; (2) affects third party rights; have erga omnes effect and mutual adjudication would not be appropriate and enforceable; (3) relates to sovereign and public interest functions of the State; (4) relates to disputes which are expressly or by necessary implication non-arbitrable in India.


The rationale of the Supreme Court in Vidya Drolia was also applied in Indus Biotech v. Kotak for ascertaining the arbitrability of the dispute between the parties. As such, we believe that the stance of the Supreme Court is based on sound principles of law. The question of arbitrability relates to the public policy of a state. Moreover, inherently the powers of an arbitral tribunal are limited in respect of deciding disputes as regards to action in rem proceedings because such statutory / non-statutory claims may only be redressed by an order available to a court.[7] Hence, the proceeding in rem and proceeding in personam dichotomy is a correct view to ascertain the arbitrability of a dispute.


Triggering of proceeding in rem in insolvency matters


It was argued by Kotak that the filling of an application under Section 7 of the IBC had made it an action in rem which rendered the instant dispute as non-arbitrable. However, such a stance is misconceived as the dispute will be non-arbitrable when a proceeding is in rem and the IBC proceeding is to be considered in rem only after it is admitted. The Supreme Court while placing reliance on the cases of Swiss Ribbons Private Limited and Another v. Union of India and Others[8] and Booz Allen and Hamilton v. SBI Home Finance[9], elaborated on the point that the mere filing of an application under Section 7 of IBC and its pendency before admission is not enough to trigger the proceeding in rem because the filling of an application under Section 7 of the IBC merely indicates the intention of the creditor to initiate proceedings under the IBC.


The reasoning adopted by the court is based on the premise that the event of the admission of an application under Section 7 commences the CIRP which creates erga omnus effect, that is, third party rights in favour all the creditors of the corporate debtor, regardless of the applicant/creditor who made the application.[10] As a result, no questions of arbitrability of the inter-party dispute would arise once the NCLT admits an application under Section 7 of the IBC. In light of the aforesaid, the court rightly concluded that since the application was not admitted under Section 7 of the IBC, it had not reached the status of a proceeding in rem which rendered the dispute arbitrable in the instant case.


This judgment has effectively shed light on the conundrum between applications of simultaneous proceedings under the IBC and the Act. We believe that the approach espoused by the court has tried to fill in the vacuum between the two contrasting areas of law without outweighing the effect of either of them and has adopted a mid-way in the instances of any apparent conflict.

The test is to determine whether the stage and nature of the proceedings trigger an action in rem or action in personam. The dispute on default remains arbitrable as long as the proceedings continue to be in personam or inter se.

Concluding remarks:


Indus Biotech v. Kotak is a very significant development on the issue of the arbitrability of insolvency disputes in India. The Supreme Court in this judgment seems to be aligning its reasoning with the developed international arbitration jurisdictions. Most notably, the judgment balances the interests of the investors and its pro-arbitration stance. It ensures that Section 7 petitions under the IBC are not used as a means to avoid arbitration agreements in abuse of the court’s process. This approach corresponds to the view taken by developed arbitration jurisdictions such as Singapore[11] and the United Kingdom[12]. The judgment provides a clear framework for the NCLTs to follow in the matters of insolvency where the subject matter of the dispute is arbitrable and shall go a long way for its nuanced approach for the protection of bonafide enterprises.


 

[1] Indus Biotech Private Limited vs. Kotak India Venture (Offshore) Fund and Ors., (2021) SCC OnLine SC 268 [2] Innoventive Industries Ltd. vs. ICICI Bank and Ors., (2018) 1 SCC 407 [3] Article II, UNCITRAL Model Law on International Commercial Arbitration, 1985. [4] § 34(2)(b)(i), The Arbitration and Conciliation Act, Act 26 of 1996. [5] Booz Allen and Hamilton Inc. vs. SBI Home Finance Ltd. and Ors., (2011) 5 SCC 532. [6] Vidya Drolia and Ors. vs. Durga Trading Corporation and Ors., (2021) 2 SCC 1. [7] A. Ayyasamy vs. A. Paramasivam and Ors., (2016) 10 SCC 386. [8] Swiss Ribbons Pvt. Ltd. and Ors. vs. Union of India and Ors., (2019) 4 SCC 17 [9] Booz Allen and Hamilton Inc. vs. SBI Home Finance Ltd. and Ors., (2011) 5 SCC 532 [10] § 7(6), The Insolvency and Bankruptcy Code, Act 31 of 2016 [11] Anan Group (Singapore) Pte Ltd. vs. VTB Bank (Public Joint Stock Co), [2020] SGCA 33 [12] Riverrock Securities Ltd. vs. International Bank of St Petersburg (Joint Stock Company), [2020] EWHC 2483 (Comm)


BIBLIOGRAPHY


Articles:

  1. Alipak Bannerjee & Payel Chatterjee, The arbitration and insolvency collision: the Indian Perspective, INT. BAR ASSO. (2020), accessed at https://www.ibanet.org/arb-insol-india.

  2. Darius Chan & Sidharrth Rajagopal, To Stay or Not to Stay? A Clash of Arbitration and Insolvency Regimes, 38(2) J. OF INT. ARB. 457, 457-482 (2021).

  3. Michael F. Hoellering, Arbitrability of Disputes, 41(1) THE BUSINESS LAWYER 125, 131-132 (1985).

  4. Shashwat Bhaskar & Winy Diagavane, Arbitrability of Insolvency Disputes: Resolving the Conundrum, 30(2) AMERICAN REV. OF INT. ARB. (2021).

Statutes and Conventions:

  1. The Arbitration and Conciliation Act, 1996.

  2. The Insolvency and Bankruptcy Code, 2016.

  3. The Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958.

  4. The UNCITRAL Model Law on International Commercial Arbitration, 1985.

Case Laws:

  1. Ayyasamy vs. A. Paramasivam and Ors., (2016) 10 SCC 386.

  2. Anan Group (Singapore) Pte Ltd. vs. VTB Bank (Public Joint Stock Co), (2020) SGCA 33.

  3. Booz Allen and Hamilton Inc. vs. SBI Home Finance Ltd. and Ors., (2011) 5 SCC 532.

  4. Committee of Creditors of Essar Steel India Limited vs. Satish Kumar Gupta & Ors., (2019) SCC OnLine SC 1478.

  5. Indus Biotech Private Limited vs. Kotak India Venture (Offshore) Fund and Ors., (2021) SCC OnLine SC 268.

  6. Innoventive Industries Ltd. vs. ICICI Bank and Ors., (2018) 1 SCC 407.

  7. Riverrock Securities Ltd. vs. International Bank of St Petersburg (Joint Stock Company), (2020) EWHC 2483 (Comm).

  8. Swiss Ribbons Pvt. Ltd. and Ors. vs. Union of India (UOI) and Ors., (2019) 4 SCC 17.

  9. Vidya Drolia and Ors. vs. Durga Trading Corporation and Ors., (2021) 2 SCC 1.

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