Insolvency and Bankruptcy: Is a Challenge to an Arbitral Award an “Existing Litigation” Within the Meaning of the Code?

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The Supreme Court held that:

  • the request for the opening of a procedure for the resolution of the insolvency of the company by the operational creditor is likely to be rejected in the presence of a “pre-existing dispute” as to the debt;
  • the pending challenge of an arbitral award qualifies as a “pre-existing dispute” for the purpose of initiating a corporate insolvency resolution process by the operating creditor;
  • the Code should not be used inappropriately as a substitute for debt adjudication and enforcement proceedings under other laws.

INTRODUCTION

Recently, the Supreme Court of India (“Supreme Court“) in K. Kishan v M/s Vijay Nirman Company P. Ltd.1, considered whether the Insolvency and Bankruptcy Code, 2016 (“the Coded”) may be invoked in respect of an operational debt where the arbitration award made against the operational debtor creating that debt is pending challenge under section 34 of the Arbitration and Conciliation Act 1996 (“Law”).

QUICK FACTS

M/s Vijay Nirman Company Pvt. Ltd (“Respondent”) and M/s Ksheerabad Constructions Pvt. ltd. (“KCPL”) entered into an agreement on February 1, 2008 for the construction and widening of the existing two-lane highway. Subsequently, disputes and disputes arose between the parties and these were referred to arbitration proceedings which ultimately resulted in an award dated January 21, 2017 (“Award”). In the award, among other relief, a sum of INR 1,71,98,302 was awarded in favor of the Respondent in relation to certain certificates of interim payment. Some counterclaims were dismissed in the award.

Subsequently, on February 6, 2017, the defendant issued a formal notice (under section 82 of the Code) on KCPL. KCPL challenged the formal notice within 10 days on the grounds that the amount claimed was subject to arbitration proceedings.

Subsequently, on April 20, 2017, KCPL challenged the award under Section 34 of the Act. On July 14, 2017, a section 9 request3 of the Code was filed by the Defendant indicating that the amount granted in favor of the Defendant was an “operational debt” and that the non-payment of the said debt was grounds for initiating the process of resolution of the company’s insolvency (“CIRP”) under the Code (“Section 9 Request”).

On August 29, 2017, the National Court of Company Law (“NCLT”) admitted the application under article 9 and observed that the expectation of a challenge under article 34 was irrelevant because there had been no suspension of the sentence and , moreover, the amount of the claim was admitted during the arbitration proceedings. On appeal, the National Company Law Appeal Tribunal (“NCLAT”) upheld the NCLT’s decision basing the reasoning that the Arbitral Tribunal’s order adjudicating on default, would be treated as “a recording of an operational liability”. The NCLAT’s decision was later challenged in the Supreme Court.

RESTRAINTS:

Appellant:

Based on the Supreme Court’s decision in Mobilox Innovations Private Limited v Kirusa Software Private Limited4 (2018) 1 SCC 353 (“Mobilox”), it has been argued that the purpose of the code is not to replace debt settlement and enforcement under other laws (including the law), and as soon as there is a genuine dispute between the parties which does not necessarily have to be a “good faith dispute”, which is likely to end in court, the CIRP procedure cannot be initiated against the operational debtor. It was argued that the very fact that a section 34 challenge is pending reflects a genuine dispute that was pre-existing and that resulted in the award and was challenged.

There have been counterclaims rejected by the Arbitral Tribunal, which exceed the amount awarded to the Respondent.

Contrary to the conclusion of the NCLAT, there is nothing inconsistent between the arbitration and enforcement process under the Act and the application of sections 8 and 9 of the Code, and so long as the existence of a dispute is established, the Act will apply.

Respondent:

It has been relied on insolvency laws in the UK and Singapore to argue that once there is a primary judgment that indicates the existence of a debt, any further litigation that may be in proceeding on appeal or otherwise regarding the debt cannot be considered to be in good faith. dispute by the debtor.

The NCLAT correctly applied section 238 of the Code because there would be an inconsistency between the applicability of the Code and the proceedings under section 34.

JUDGEMENT

The Supreme Court relied on Section 9(5)(ii)(d) of the Code and observed that an application under Section 8 of the Code must be dismissed where a Notice of Dispute has been received by the operational creditor. The Supreme Court noted the following facts: (a) the basis of the claim under Article 8 stems from the award granted in favor of the respondent, but the formal notice setting out the particulars of the debt was challenged in the response; (b) a counterclaim in excess of the granted claim was dismissed by the arbitral tribunal (and while two counterclaims were dismissed for lack of evidence, the third counterclaim in the amount of INR 19,88,20,475 was dismissed on the basis of a price adjustment request on the merits). Subsequently, the Supreme Court observed that the subject matter was pending dispute under Section 34 of the Act and it could not be said that no dispute existed between the parties. In this light, the award challenge has been considered a “pre-existing dispute” that culminates at the first stage of the proceedings in an award, continues even after award, at least until the final adjudicative process under the section 34 and section 37 of the Act is complete.

The Supreme Court did not accept the Respondent’s argument that the claim stated in the formal notice was admitted by the Appellant during the arbitration proceedings. It was observed that the counterclaims, which were rejected by the Arbitral Tribunal, were the subject of a dispute under Article 34 of the Law, and that the mere possibility that the Appellant might succeed in the counterclaims was sufficient to assert that the operating debt in this case could be considered an uncontested debt.

The Supreme Court relied on Mobiloxwho had settled the ‘disputed debt‘ conundrum under the Code. He reaffirmed that if there is ‘existence of a disputebetween the parties or legal or arbitration proceedings pending before the formal notice was sent to the operational debtor, the CIRP cannot be initiated by the operational creditor and the request under article 8 of the Code should then be rejected . The Supreme Court later ruled that the operational creditor cannot use the Code either prematurely or for extraneous considerations or as a substitute for lawsuit proceedings.

The Supreme Court also observed that: (a) in cases where a petition to contest under Section 34 of the Act may be clearly and unequivocally barred by limitation, in such cases the CIRP may be enforced work ; (b) CIRP cannot be initiated by an operational creditor pending a claim for time exclusion under Section 14 of the Limitation Act, 19635.

The Supreme Court further observed that there was no inconsistency between the adjudication and enforcement process under the Act and sections 8 and 9 of the Code and therefore section 238 of the Code would not apply in this case.

Furthermore, the Supreme Court affirmed that even if the arbitral awards are valid recordings of an operational debt, the same should be uncontested within the parameters discussed in this judgment and Mobiloxto allow the initiation of CIRP by operational creditors.6

ANALYSIS

The Supreme Court judgment is commendable and clarifies what constitutes a dispute under the Code. Basically, he pointed out that a debt is not crystallized until the arbitral award containing such debt has reached its definitive character. This judgment amplified the scope of previous judgments by Mobilox and Annapurna include challenges to arbitral awards within the meaning of “the existence of a dispute” under section 9 of the Code.

However, it remains to be seen how courts will consider similar situations involving financial creditors. The report of Mobilox can not in itself apply to financial creditors because the contracting authority, at the stage of the admission of a request for the opening of the CIRP, is only required to ensure the occurrence of a default and to ensure that the request is complete and that no disciplinary proceedings are pending against the resolution professional and is not required to pursue the aspect of “the existence of a dispute”.

Further, in this case, the challenged award was a national award challenged under Section 34 of the Act. It will be interesting to see the treatment of a foreign award being resisted, which in itself does not constitute a challenge to an arbitral award. Perhaps it would still be brought as part of an “existing dispute” until the award is finally enforced in India.

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