The Viewpoint - Insolvency proceedings barred during the pendency of S.34 petition

Bar & Bench January 25 2019

Meghna Mishra and Ankit Rajgarhia

Introduction

One of the conditions for admission of an application by an operational creditor to initiate insolvency proceedings against a corporate debtor by the Adjudicating Authority (i.e. the National Company Law Tribunal or NCLT) in the Insolvency and Bankruptcy Code (IBC) is that no notice of dispute should be received by the operational creditor or there should be no record of dispute in the information utility. [Section 9(5)(i)(d)]. 

The word “Dispute” is significant for the maintainability of every application filed under Section 9 of the IBC. As per the IBC, dispute includes a suit or arbitration proceedings relating to (a) the existence or the amount of debt; (b) the quality of goods or service; or (c) the breach of a representation or warranty [Section5(6)]. This 

The meaning of the word ‘dispute’ has been the concern of many judicial consideration. In K. Kishan Vs. M/s Vijay Nirman Company Pvt. Ltd. [Civil Appeal Nos. 21824 & 21825-2017], the Hon’ble Supreme court further expanded the scope of this word by including a challenge to an arbitral award under Article 34 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”).

Issue

Whether the Insolvency and Bankruptcy Code, 2016 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 that is the award is pending challenge under section 34 of the Arbitration Act. 

Facts

  1. The Respondent (M/s Vijay Nirman Company Pvt. Ltd) entered into an agreement for construction and widening of the existing two-lane highway on 1st February 2008 with M/s. Ksheerabad Constructions Pvt. Ltd. (“KCPL”).
  2. Certain disputes and differences arose between the parties and the same were referred to an Arbitral Tribunal, which delivered its Award on 21st January 2017. One of the claims that was allowed by the said Award was in favour of the Respondent for a sum of Rs. 1,71,98,302/- which arises out of certain interim payment certificates. Another claim that was allowed related to higher rates of payment in which a sum of Rs. 13,56,98,624/- was awarded. Three cross claims that were made by the Appellant were rejected.
  3. Subsequently, on 6 February 2017, The Respondent issued a demand notice to KCPL under Section 8 of the IBC on KCPL to pay an amount of Rs. 1,79,00,166/-. Within 10 days KCPL disputed the demand notice by a letter dated 16th February 2018 stating that the claimed amount was subject matter of an arbitration proceeding.
  4. After the notice and reply, KCPL filed Section 34 petition under the Arbitration Act challenging the aforesaid Arbitral Award.
  5. Thereafter, on 14th July 2017, the Respondent filed an application under Section 9 of the IBC stating that amount granted in favour of the Respondent by the Arbitral Tribunal was an ‘operational debt’ to initiate the corporate insolvency resolution process. under the IBC.
  6. The National Company Law Tribunal (“NCLT”) admitted the Application vide its order on 29th August 2017 stating that since the claim amount stood admitted in the Arbitral proceeding and there has been no stay of the Award, a pendency of a Section 34 petition is irrelevant.
  7. On appeal, the National Company Law Appellate Tribunal (“NCLAT”) affirmed the ruling of the NCLT on the basis that the non-obstante Clause contained in Section 238 of the IBC overrides the Arbitration Act and the order of the Arbitral Tribunal adjudicating on the default, would be treated as “a record of an operational debt”. 
  8. This decision of the NCLAT was appealed before the Hon’ble Supreme Court.

Judgement

The Hon’ble Supreme Court held that the pendency of a petition under Section 34 of the Arbitration Act constitutes a ‘dispute’ under the IBC. Thereby, the IBC cannot be invoked to initiate the corporate insolvency resolution process (CIRP) in respect of an operational debt where an Arbitral Award has been passed against the operational debtor, though has not yet been finally adjudicated upon due to a challenge under Section 34 of the Arbitration Act.

Reasoning

  1. The Hon’ble Supreme Court held that the prime consideration for the Adjudicating Authority with regards the operational debt is whether the said debt can be said to be disputed. According to the Court, the challenge of the arbitral award under Section 34 of the Arbitration Act proves that there is a “pre-existing ongoing dispute” which exists between the parties and continues till the final conclusion of adjudicatory process under Sections 34 and 37 of the Arbitration Act.
  2. The Hon’ble Supreme Court rejected the contention of the Respondent that the debt set out in the demand notice was admitted by the Appellants during the arbitral proceedings. According to the Court, since the cross claims were subject matter of challenge under Section 34 of the Arbitration Act and there exists a possibility that the Appellant may succeed with respect to the cross claims, the operational debt in the present case cannot be said to be an undisputed debt.
  3. The Hon’ble Supreme Court reiterated from its landmark judgment Mobilox Innovations Private Limited v. Kirusa Software Private Limited [(2018) 1 SCC 353] [Molibox Innovation Case], 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. Meaning thereby, that the operational creditor cannot use the Code either prematurely or for extraneous considerations or as a substitute for debt enforcement procedure.
  4. Section 238 of the IBC applies in cases where there is an inconsistency between the IBC and the Arbitration Act. Since, there is no such inconsistency between the adjudication and enforcement process under the Arbitration Act and Section 8 & 9 of the IBC, section 238 of the IBC is inapplicable. On the contrary, the Arbitral Award passed together with the steps taken for its challenge shows that the operational debt, in the present case, was in dispute.

Analysis

In the Molibox Innovation Case, the Hon’ble Supreme Court held in determination of “existence of a dispute”, NCLT is to satisfy 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.” Moreover, NCLT should reject “a spurious defence which is mere bluster”, in this determining process whether dispute exists or not, the NCLT is not required to satisfy itself that the defence is likely to succeed or to examine the merits of the dispute. Consequently, NCLT should reject the application of an operational creditor if the dispute truly exists in fact and is not spurious, hypothetical or illusory.

In the present case, the dispute was not a patently feeble legal argument or an assertion of fact unsupported by evidence, the cross claim filed by Appellant bore some significance. The Appellant challenged the arbitral award due to the rejection of Appellant’s cross claim. The Appellant’s cross claim was of a much higher value, and if it were to be allowed in the challenge proceedings, the appellant would not owe any debt to the Respondent. 

Consequently, even though as per the Mobilox Innovation Case, NCLT is not required to satisfy itself that the defence is likely to succeed or to examine the merits of the dispute, a baseless challenge of the Arbitral Award under the Section 34 of the Arbitration Act would not constitute under section 9 of the IBC since NCLT is still required to satisfy 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.”

 

About the authors: The authors are lawyers working at the law firm Karanjawala & Co. Meghna Mishra is a Partner at the form. Ankit Rajgarhia is a Senior Associate.

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