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  • Yasaschandra Devarakonda, Sushmit Mandal

Insolvency Arbitration : Dawn of a New Era in India

[Yasaschandra and Sushmit are students at National Law University, Odisha. The following post is the winning entry in the Second IRCCL Blog Writing Competition (2021-22), organised in association with Khaitan & Co.]

Insolvency and arbitration, seemingly at odds quite vigorously, in certain unique situations possess an overlap that requires legislative intervention or in its absence, judicial introspection. In India, a paradigm shift has been achieved in insolvency regulation post the introduction of the Insolvency and Bankruptcy Code 2016 (Code) which has served as a potent tool to craft such processes into a time-bound and well governed affair, and its provisions have been given an overriding effect over all other legislations, as per Section 238. However, our intent here lies to first, take cognizance of the fact that the corporate insolvency resolution process (CIRP) as envisioned in the Code - much publicised and often cumbersome in its technicalities – may not be the best procedure or provide the most appropriate outcome in all circumstances. Second, the principle of party autonomy may supplement CIRP in the time-tested halls of arbitration. The aim thus is to suggest a synergised framework offering the best of both regimes.

Status Quo: Interaction between Insolvency and Arbitration

What perhaps makes an insolvency process via arbitration the most challenging is the strict dictum of the Supreme Court of India on the matter of arbitrability. There are two aspects to arbitrability - procedural and substantive. Procedural arbitrability refers to whether an arbitration agreement envisages within its scope, an arbitration of the dispute, while substantive arbitrability refers to whether the subject matter of the dispute is capable of arbitration as per the public policy. While engaging with this question, the apex court has drawn out a four-fold test in Vidya Drolia and Others v Durga Trading Corporation where the first limb states that the subject matter is non-arbitrable in a dispute where the “cause of action and subject matter of the dispute relates to actions in rem, that do not pertain to subordinate rights in personam that arise from rights in rem”. This remains a crucial marker in any subsequent analysis of arbitrating insolvency proceedings. However, the court took cognizance of the fact that multiple jurisdictions allow inter partes arbitrations with respect to in rem rights via a statutory framework. It then contemplated upon its feasibility in India, in order to provide impetus to arbitration.

This brings a need to ponder on the many points where arbitration and insolvency proceedings find themselves in each other’s vicinity. The first situation that may arise is where ongoing arbitration proceedings involve the corporate debtor as one of the parties against which an insolvency application is brought under the Code. The fate of such proceedings seems sealed in the face of Section 14(a) where once a moratorium is declared by the National Company Law Tribunal (NCLT), the continuation of any such proceedings in any “arbitration panel” henceforth, becomes prohibited and thus stayed till the completion of the CIRP. Further, the NCLT has clearly held that the pendency of any such arbitral proceedings is not a hindrance to initiate a CIRP under the Code.

The above-mentioned provision also bars the institution of such arbitration proceedings which brings us to a second major overlap where parties may seek arbitration measures post the fact that an application has been made under the Code. While the legislation is clear on the declaration of a moratorium from the insolvency commencement date, several decisions have allowed us to better understand the timeline and point of no return. In Indus Biotech Private Limited v Kotak India Venture (Offshore) Fund (earlier known as Kotak India Venture Limited) and Others (Indus Biotech), a Section 8 application under the Arbitration and Conciliation Act 1996 (Arbitration Act) was made in addition to Section 7 of the Code to refer the parties to arbitration. Looking at the overlap, the Supreme Court has clarified that a mere application under the Code does not render insolvency proceedings to be one in rem and thus, non-arbitrable in nature. This occurs only when the application is admitted, leading to the creation of third-party rights against all creditors, and causes the manifestation of a corresponding erga omnes effect. However, the court also clarified that in the period post the admission of a petition and before the creation of the Committee of Creditors (CoC) – parties are allowed to approach the authority within the inherent powers granted to it under Rule 11 of the NCLT Rules 2016 for matters of withdrawal or settlement. Thus, the true effect of the moratorium, and a bar on arbitration comes into play only post the formation of a CoC, when the in personam proceedings truly become in rem. It must be noted that the court did not delve into the powers of NCLT in an application under Section 8 of the Arbitration Act. Instead, it opined that the disposal of such an application would entirely depend on the outcome of the insolvency application under Section 7 of the Code without any independent appraisal of the former.

There is a need for a system that values party autonomy especially in disputes involving mixed questions of law such as those arising out of contracts and matters of insolvency, where a strict characterisation of the proceedings as those in rem does not remain a viable option. We thus feel the need for a system where, on demand from the parties, the NCLT is empowered to refer them to arbitration with the need for relevant legislative amendments so as to allow the arbitration proceedings to commence and conclude within the aegis of the insolvency regime under the Code. In such a case, a proposed insolvency arbitration structure has been quantified where the arbitral tribunal itself acts as an overseer of the insolvency process.

Arbitration of Corporate Insolvencies

The decision of the Supreme Court in Indus Biotech missed the opportunity to engage with the conjoint working of the Code and Section 8 of the Arbitration Act. Section 8 contemplates referral of the parties to an arbitration by a judicial authority before which an action is brought that is also the subject matter of a preexisting arbitration agreement. With no clear definition of ‘judicial authority’ in the Arbitration Act, it is not unwarranted to interpret NCLT within the ambit of this term. In the absence of a direct engagement via judicial interpretation, it is felt that a legislative amendment would fill the gap allowing for an effective entry point for an insolvency arbitration framework. Insertion of Section 8(4) in the Arbitration Act is thus recommended: “Judicial authority, for the purpose of this section, includes the National Company Law Tribunal constituted under Section 408 of the Companies Act, 2013.

Congruously, amendment must ensue via insertion of proviso to Section 6 of the Code: “Provided that, NCLT is empowered to direct the parties to an arbitration if there exists an agreement to arbitrate and an application is made under Section 8 of the Arbitration and Conciliation Act, 1996.

Under this proposed framework, to initiate CIRP, the applicant must approach the NCLT with an insolvency application under either Section 7 or 8 of the Code along with an application for referral to arbitration under Section 8 of the Arbitration Act and a copy of the agreement to arbitrate. Upon perusal of the agreement to arbitrate, which we propose must mandatorily contain the Code as one of the applicable laws, the NCLT would then direct the parties to arbitration without considering the insolvency application on merits. Absence of applicable law as the Code, or insufficient scope of the agreement to arbitrate would lead to procedural non-arbitrability.

Arbitrability of in rem rights

Before delving into the finer details of CIRP via arbitration, this framework must pass the test of the judicial dicta in India which prevents arbitral tribunals from arbitrating insolvency and winding off proceedings since they pertain to rights in rem. This position has however been changed since the recent judgement of Indus Biotech where the court held that CIRP can be bifurcated into ‘pre’ and ‘post’ the formation of CoC, and that the only question of non-arbitrability owing to the existence of in rem rights exists in the ‘post the formation of CoC’ phase. This significant development in the scrutiny must be met with jubilation while also enquiring on the precise nature and adjudication of the in rem rights in CIRP.

We argue that the in rem adjudication phase of post CoC formation is limited to the adjudication by the CoC. In the CIRP under the Code, subsequent to the presentation of all plans by Resolution Professional to the CoC, the approval of the plan must be done by CoC, the success of which would lead to the submission of the plan to the NCLT, or the failure of which would lead to the liquidation of the insolvent company by NCLT. The CoC’s determination on the success of the plan, which is indeed the only juncture where in rem rights are at stake, has no involvement of the NCLT. Challenge to the plan approved by CoC on procedural grounds must be delineated from substantive rights in rem that CoC decides upon.

Similarly, under the proposed framework, subsequent to the decision of the CoC, the tribunal, on the basis of such decision, would subject to procedural irregularities, pass an award in favor of the plan or order liquidation as the case may be. For the purposes of enforcement of the award, an analogous amendment must be brought into Section 31 of the Code along the lines of: “Provided further that, in relation to arbitral referrals made under Section 6, a copy of the award passed must be submitted to the Adjudicating Authority for an order to approve or reject the repayment plan on the basis of the award.

With the understanding that the determination of CoC is the only in rem right sphere in the CIRP process, the proposed insolvency framework would pass the test of arbitrability of the law of the land.

Kompetenze Kompetenze and moratorium

The next important segment to train our lenses on is the status of the insolvency petition post referral by the NCLT. The arbitral tribunal, once duly constituted, has to decide first on the admissibility of the petition. The important principle of Kompetenze Kompetenze, as enshrined in Section 16 of the Arbitration Act provides for the power of tribunal to rule on its own jurisdiction. Just as the NCLT decides on the same since it is authorized legislatively under Sections 7, 8 and 10 of the Code – similarly, the aforementioned principle will fortify the arbitral tribunal’s jurisdiction to rule on such an insolvency petition brought to it for due assessment of its admissibility. This further also allows it to go into an assessment of the presence of a default as also provided in the Code, which finally again weighs down on the decision to admit such an insolvency petition.

Consequently, the next aspect which becomes crucial is the declaration of a moratorium to preserve the value of the corporate debtor once the petition is admitted. Being of utmost importance, we feel that it is important to comply with this process via the NCLT’s jurisdiction and powers to declare the same under Section 13(1)(a) of the Code so as to utilize its overriding power under Section 238. This will prevent any undue challenges that may arise from an arbitral tribunal induced moratorium that can erode the value of the debtor. Thus, the ideal process would entail, a successful referral to arbitration by the NCLT within the Code – this would lead to constitution of the arbitral tribunal and a ruling by such tribunal on the admissibility of an insolvency petition making use of the principle of Kompetenze Kompetenze. Next, once the tribunal rules that such petition is admissible, the NCLT would then declare a moratorium, and the remaining process would continue within the aegis of the arbitral tribunal. Finally, the NCLT’s role would again become crucial in the post award stage when the award so passed containing the approved resolution plan would be given due enforcement with the NCLT’s approval under Section 31 of the Code.

Insolvency Arbitration - The Way Forward

Arbitration is a highly nuanced and sophisticated manner of resolving disputes. Akin to various forms of arbitration such as commercial, investment, maritime and sports arbitrations, insolvency arbitration too will, with time, evolve into a niche of its own - reaping benefits that the arbitral system has to offer. As a consequence, it would also become a preferred manner of recouping for financially distressed companies, a specific consequence that is exasperated in the aftermath of COVID-19.

Indisputably, the comfort of control over the appointment of the arbitral tribunal via party appointed arbitrators who would in turn appoint a chair arbitrator is lacking in the present CIRP under the Code. Further, arbitration is also convenient in terms of setting up of the hearings, at whichever venue, and date as desired amongst the parties. Other than the time-bound nature of CIRP, arbitration offers a flexible process. Under this framework, the date on which the award is rendered must be considered for the 330-day deadline within which the CIRP must be completed under the Code, which is analogous to the time-bound nature of rendering arbitral award within twelve months under Section 29A of the Arbitration Act. The framework thus does not overtly disturb the insolvency timelines in India.

One crucial aspect that needs a deep understanding is confidentiality of arbitral process. While confidentiality is, undeniably, a major attraction for debt ridden companies to avoid further decline in market value, the mandatory public disclosure requirement for invitation of claims and subsequent invitation of Expression of Interest (EOI) appears to supersede company preference. Reconciliation of these seemingly contradictory interests could follow in two prongs. First, arbitral hearings can be held behind closed doors with a veil of secrecy protecting the insolvent company and its image from media spotlight and scrutiny. Secondly, as for the documents, and crucially the award itself, a familiar concept of redacted arbitral awards and arbitral documents would come to rescue. Importantly, respondents of EOIs must be roped into the arbitration with strict confidentiality clauses regarding the financials of the corporate debtor.

While it appears that confidentiality of arbitration alone would be a deal breaker to attract companies to prefer arbitration led CIRP to the current one under the Code, it must be born in mind that at the crux of the entire framework lies a very liberal interpretation of who decides on the in rem rights involved in the CIRP. Indus Biotech, in many ways rattled the feathers off the primeval understanding of the extent of arbitrability in insolvency. The understanding thus, that in rem rights are solely determined by the CoC, with hardly any intervention by the NCLT save as in extreme cases of irregularities, whilst ambitious and liberal, is quite necessary for arbitration to meet insolvency amidst the rise in corporate insolvencies in the aftermath of COVID-19, thus leading a transnational crusade to a novel approach in business and commerce.

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