Double-Edged Sword of Arbitration and Moratorium

The ‘moratorium’ is arguably the most important feature of the Insolvency and Bankruptcy Code, 2016 ("IBC"). The moratorium, coupled with the IBC's supremacy over other statutes and the sharp rise in corporate insolvency proceedings, has led to a plethora of complex scenarios that are tinged with unsettling concerns. There are several judicial pronouncements arresting the inadequacies of the moratorium, but many questions remain unanswered, or, at least for the time being, there are no definitive answers.

With this caveat in mind, this article is an attempt to analyse the impact of a moratorium on arbitration proceedings and to comprehend the disadvantageous position of creditors’ claims in such proceedings.

Section 14 and Section 33 of the Code are part of distinct chapters, namely Chapter II (Corporate Insolvency Resolution Process) and Chapter III (Liquidation Process), respectively. Chapter II's objective is to revive a corporate debtor ("company"), whereas Chapter III's goal is to maximise the value of the company's assets for the benefit of its stakeholders.

Section 14 of the Code prohibits the institution or continuation of “suits or proceedings initiated against the corporate debtor." Here, the moratorium aims to maintain the current state of affairs, aiding in the resolution process by consolidating the company's assets and preventing their dissipation. Section 33(5) stipulated that subject to Section 52, "no suit or other legal proceeding shall be instituted by or against the corporate debtor," with the exception that a liquidator on behalf of the corporate debtor may institute legal proceedings "with the prior approval of the adjudicating authority." Further, Section 35, underscoring the power and duties of the liquidator, empowers the liquidator “to institute or defend any suit, prosecution, or other legal proceedings, civil or criminal, in the name of or on behalf of the corporate debtor.”.

Thus, there is a striking difference in the language of Section 14 and Section 33(5). Section 14 prohibits the initiation as well as the continuance of proceedings, whereas Section 33(5) only prohibits the institution of legal proceedings. The omitted "continuance of proceedings" in Section 33(5) seems to be a deliberate departure from the earlier law - Section 446 of the Company Act, 1956, and Section 279 of the Companies Act, 2013 - which prohibit the commencement or proceeding of any legal proceedings without leave of the court/ tribunal during the winding-up process.

I. Fresh arbitration proceedings during CIRP/ Liquidation

Sections 14(1)(a) and 33(5) of the Code prohibit the initiation of an arbitration proceeding against the company. In the landmark case of Alchemist Asset Reconstruction Co. Ltd. v. Hotel Gaudavan (P) Ltd., the Supreme Court of India held that such arbitration “that has been instituted after the moratorium is non-est.”

To recover its debts, the company facing CIRP can initiate legal proceedings, including arbitration. During the liquidation phase, the company can initiate arbitration, but it is subject to the NCLT's leave.

In such arbitration, with caution, one can say that counterclaims against a company are maintainable if they are essential to the recovery that the company seeks and are associated with the same transaction. This is supported by decisions in Jharkhand Bijli Virtran Nigam Ltd. v. IVRCL and SSMP Industries v. Perkan Food Processors. In addition, the concept of set-off is recognised, enabling the offsetting of claims, as provided in the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016.

II. Ongoing arbitration proceedings initiated prior to CIRP/ liquidation

The principles applicable to continuing arbitration proceedings initiated by a company prior to CIRP are largely similar to those initiated during CIRP.

CIRP prohibits the continuation of arbitration proceedings against the company. Arbitration initiated by the company generally proceeds without interruption. However, when the company is a counterclaimant, the arbitration continuity generally hinges on whether the proceedings aim to maximise the value of the company’s assets or pursue a debt recovery action against the company. 

During liquidation, Section 33(5) of the IBC allows ongoing proceedings without requiring leave from the adjudicating authority. In Chennai Metro Rail Ltd. versus Lanco Infratech Ltd., the Madras High Court held that pursuant to Section 33(5) of the IBC, no leave from the adjudicating authority is required to continue arbitral proceedings, on the rationale that "a power to grant leave also includes the power to reject the same. A rejection of the leave necessarily entails the authority taking over the case and conducting the same. In its wisdom, the Legislature thought that in cases involving the inability to pay debts and where the resolution plan had failed, there should be no further delay in the procedural aspects while dealing with the pending cases. That is why Section 33(5) omitted to consider the case of pending matters."

Subscribing to this view, the Kerala High Court in the Orieon Kuries and Loans Private Limited case upheld the order passed by the controlling authority under the Minimum Wages Act, 1948, even though the same was passed during the liquidation process.

III. Challenging the Award during CIRP/ Liquidation

Section 34 of the Arbitration and Conciliation Act, 1996 (the “Arbitration Act”) permits the filing of objections to set aside an arbitral award. 

Proceedings under Section 34 of the Arbitration Act may be permitted to continue if the award is in favour of the company. But to understand whether an award obtained against a company undergoing CIRP can be challenged, reference is made to the P Manohar Raj versus M/s Shah Brothers judgment, wherein the Supreme Court ruled that Section 34 proceeding against a company may result in an arbitral award against a company being upheld, as a result of which monies would then be payable by the company. Therefore, an award obtained against the company undergoing CIRP cannot be challenged. Further, in Annapurna Infrastructure Pvt. Ltd. & Anor vs. Soril Infra Resources Ltd., the NCLAT held that an arbitral award against the company would be treated as a default as stipulated under the Code. 

However, the Shah Brothers judgement was rendered when the moratorium under Section 14 was in operation, and thus, this position’s applicability during liquidation remains ambiguous.

IV. Execution of the Award

The execution of awards against the company depends on whether the claims are settled in the company’s favour. If an award does not diminish the company’s assets, it may be executed despite the moratorium.

Otherwise, the moratorium applies, preventing such awards from being executed. Nonetheless, an arbitral award being a valid claim can be filed as a 'claim' with a resolution professional during CIRP.

Typically, the moratorium prevents arbitration against the company, but at the same time, it allows the company to continue or initiate proceedings to recover dues and maximise asset value. This leaves the party defending against the company's claims in a precarious and uncertain position.

Thus, the moratorium serves as a double-edged sword: on one side, it provides necessary respite for the company by preventing a flurry of legal actions against it while allowing it to pursue legal remedies. However, it places significant limitations on its creditors, leaving them to navigate a complex legal landscape, often with diminishing chances of full recovery. Moreover, the creditors, acting as defending parties, bear the burden of arbitration expenses, which often prove to be costly. Thus, creditors equally bear the financial burden of arbitration, from which they stand to gain nothing.

About the author: Tanu Priya Gupta is an Advocate-on-Record at the Supreme Court of India and a Partner at Sarvagya Legal.

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