Navigating the Intersection of Insolvency Petitions and Ongoing Arbitration Proceedings

This article explores the interplay between arbitration and insolvency law, specifically focusing on cases where contract breaches involve debtors and creditors. Arbitration has grown in popularity as a way to resolve disputes outside of court, aiming to settle disagreements efficiently. However, the Insolvency and Bankruptcy Code, 2016 (IBC) is a special framework that addresses insolvency, and its specific procedures can limit the scope of arbitration.

Both arbitration and the IBC aim to resolve disputes in a way that balances the interests of parties involved, such as reviving a financially troubled company instead of leading to its dissolution. Although there are no fundamental contradictions between arbitration and insolvency law, their convergence can create uncertainties due to procedural differences.

The article examines situations where an insolvency petition is filed while arbitration proceedings are ongoing, and vice versa, where arbitration proceedings are initiated during the pendency of an insolvency petition. “Pendency” here refers to the period when an insolvency petition is filed but the adjudicating authority (like the National Company Law Tribunal) has not yet made a decision to admit or reject it. This exploration involves analyzing recent court judgments and orders to understand how these situations are handled and the issues that can arise from them.

Arbitrability of Conflicts After Filing a Petition for Insolvency

When deciding whether a dispute can be resolved through arbitration while an insolvency petition is pending, an important legal question arises: does the National Company Law Tribunal (NCLT) have the authority to refer parties to arbitration? The Supreme Court tackled this issue in the case of Indus Biotech Pvt. Ltd. vs. Kotak India Venture (Offshore) Fund.

The controversy stems from proceedings before the NCLT in Mumbai, where Kotak India Venture filed an insolvency petition against Indus Biotech, claiming default on redeeming preference shares. While this petition was still pending, Indus Biotech submitted an application under Section 8 of the Arbitration and Conciliation Act, requesting arbitration.

The NCLT caused a stir by granting Indus Biotech’s request to refer the case to arbitration, even though the insolvency proceeding was ongoing. This raised questions about the NCLT’s authority to refer parties to arbitration during an in rem insolvency proceeding—where the case has broader implications and affects third-party rights.

The Supreme Court clarified the situation in its ruling. It stated that insolvency proceedings become in rem only after the insolvency petition is admitted by the NCLT, at which point it affects third-party rights and takes on a more general impact. Thus, referring to arbitration before the insolvency petition is admitted is permissible. Additionally, the Supreme Court outlined that the NCLT must first assess the merits of the insolvency application before considering the Section 8 arbitration request. The outcome of the insolvency application determines the course of action. If the insolvency petition is admitted and default is proven, arbitration isn’t applicable. However, if no default is found, the parties can pursue arbitration.

The Status regarding the Appointment of an Arbitrator in the Pending Insolvency Proceedings

In the case of Sunflag Iron & Steel Co. Ltd. v. M/s Poonamchand & Sons, the Bombay High Court clarified whether an arbitrator can be appointed while insolvency proceedings are pending. The court stated that filing an application under Section 7 of the Insolvency and Bankruptcy Code (IBC) does not necessarily block the appointment of an arbitrator under Section 11(6) of the Arbitration and Conciliation Act.

The Applicant argued that there was no dispute about the existence or validity of the arbitration agreement. However, the Respondent countered, saying that since insolvency proceedings had been initiated under Section 7 of the IBC, the appointment of an arbitrator wasn’t valid, citing the IBC’s Section 238, which overrides other laws in cases of conflict.

The Bombay High Court observed that the IBC’s overriding effect under Section 238 only applies if the National Company Law Tribunal (NCLT) admits the insolvency application. This means that just filing a Section 7 application doesn’t automatically invoke Section 238’s restrictions. Thus, appointing an arbitrator under Section 11(6) remains valid until the NCLT admits the insolvency petition and confirms the default.

The court’s decision aligned with the earlier Supreme Court ruling in Indus Biotech Private Limited v. Kotak India Venture (Offshore) Fund & Ors., which emphasized that the NCLT must first confirm the default to make the insolvency proceeding in rem—affecting all parties. Based on this, the Bombay High Court allowed the Section 11(6) application and appointed a sole arbitrator to resolve the disputes.

Another case, Millennium Education Foundation v. Educomp Infrastructure and School Management Limited, further supported this view. It held that the mere filing of an insolvency petition under Section 9 of the IBC does not block the appointment of an arbitrator under Section 8 of the Arbitration Act. The restriction only applies once the insolvency petition is admitted, and a moratorium is declared.

These judgments have provided guidance on appointing arbitrators while insolvency petitions are pending. However, they leave open questions about what happens when arbitration proceedings are initiated after the NCLT has admitted an insolvency petition and declared a moratorium. This area requires further legal clarification.

Commencing CIRP amidst ongoing Arbitration

Courts and tribunals have examined whether the presence of an arbitration agreement or ongoing arbitration proceedings preclude the submission of an insolvency petition under the Insolvency and Bankruptcy Code (IBC). In the case of Reliance Commercial Credit Limited v. Ved Cellulose Ltd., the National Company Law Tribunal (NCLT) in Mumbai ruled that ongoing arbitration proceedings do not prevent the start of the Corporate Insolvency Resolution Process (CIRP) under Section 7 of the IBC. Similarly, in Dinesh Chand Jain and Others v. Fabulous Buildcon (P) Ltd. and Others, the NCLT in Delhi concluded that an arbitration clause in an agreement does not bar insolvency proceedings under Section 7 of the IBC.

In another case, M/s. Educomp Infrastructure & School Management Ltd. v. M/s. Millennium Education Foundation, the NCLT in New Delhi admitted an insolvency petition even though arbitration proceedings were ongoing. The tribunal appointed an Interim Resolution Professional (IRP) and declared a moratorium under Section 14 of the IBC, because the corporate debtor was in default of an operational debt. This example shows that the court can admit insolvency petitions even during ongoing arbitration, and the arbitration proceedings cease as a result of the moratorium imposed by Section 14(1)(a).

Thus, having an arbitration agreement or ongoing arbitration proceedings does not automatically prevent the start of insolvency proceedings under the IBC. Courts have taken a practical approach, emphasizing a balance between the interests of corporate debtors and creditors.

However, there is a restriction on initiating CIRP if there’s a pending challenge to an arbitral award under Section 34 of the Arbitration Act. In the case of Kishan v. M/s Vijay Nirman Company Pvt. Ltd., the broader interpretation of “dispute” included a challenge to an arbitral award. According to the Supreme Court’s decision in the Mobilox Innovation Case, for a challenge to be considered a “dispute,” it must show a plausible contention requiring further investigation. If a challenge to an arbitral award is pending, the operational debt cannot be treated as undisputed, and CIRP cannot be initiated.

The Supreme Court has emphasized that insolvency processes should not be used to circumvent the adjudicatory processes of other statutes. The court reiterated that Section 238 of the IBC, which grants the IBC supremacy in cases of conflict with other laws, doesn’t apply if there’s no inconsistency between the IBC and the Arbitration Act. Therefore, challenging an arbitral award under Section 34 signals an ongoing dispute, which means the insolvency process for operational debt is not warranted while that dispute is unresolved.

Conclusion

In summary, courts have adopted a balanced approach to reconciling arbitration and insolvency proceedings, ensuring that neither undermines the other. It’s permissible to appoint an arbitrator before an insolvency petition is admitted, and insolvency petitions can proceed even if arbitration is ongoing, though the arbitration ends once the petition is admitted and a moratorium is declared. However, if an arbitral award is being challenged, initiating insolvency proceedings is not allowed, as it indicates a pre-existing dispute.

Despite the priority given to the IBC as a specialized law with the primary aim of preventing corporate failure, arbitration still has its place, with minimal restrictions. This approach helps balance the interests of creditors and debtors, providing a fair process that doesn’t excessively favor one over the other. Ultimately, it reflects a system designed to support both the effective resolution of disputes through arbitration and the orderly management of insolvency to avoid corporate collapse.