Harmonization of Arbitration and Insolvency Laws in India: Legislative Gaps and Judicial Impediments: Part 1
- Anish Mishra
- Jan 25
- 9 min read
- by Anish Mishra, student at Tamil Nadu National Law University
Insolvency laws and Arbitration have been contested areas of commercial law in India. Due to this inherent clash, there has been a certain level of judicial intervention. In this article, I argue about the absence of clear doctrinal or legislative guidance. I have suggested that there is a need for a harmonized construction between both the laws, which is the need of the hour for increasing the strength of India’s commercial dispute resolution landscape. This will only be able to solve the pressing concerns of misuse and unpredictability. The article is divided into two parts.
This part of the article examines how Indian courts handle the conflict between arbitration and insolvency law, focusing on two areas: first, how the Hon’ble Supreme Court permitted arbitration to proceed in lieu of insolvency when default was contested in relation to Optionally Convertible Redeemable Preference Shares (hereinafter referred as OCRPS), a decision that was criticized for diluting creditor rights and the definition of "default"; and second, the interpretation of the Moratorium under Section 14 of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred as the Code), where various judgments have either stayed, nullified, or rejected reliance on challenged arbitral awards as legitimate evidence of debt.
In the second part of the article, I analyzed Moratorium’s impact on criminal/quasi-criminal proceedings like cheque dishonor cases. I also analyzed exclusions for promoters, directors, and personal guarantors during the Moratorium period. I have suggested that inspiration can be taken from the United States of America and United Kingdom’s approach, where they distinguish core and non-core proceedings in Bankruptcy matters. The definition of “dispute” under Section 5(6) of the Code is also examined. The conclusion urges harmonization between both the laws through uniformity in judicial decisions and legislative amendments.
1. Introduction
Over a considerable duration, Arbitration and Insolvency law have been characterised as a clash between fundamentally different principles. Insolvency law aims to protect and balance the interests of all the stakeholders. Whereas, arbitration promotes party autonomy and is decentralised. In India, both laws have gained significant importance. Modelled on the UNCITRAL Model Law on International Commercial Arbitration, and the Arbitration and Conciliation Act , 1996, (hereinafter referred as Arbitration Act) creates a framework for both international and domestic arbitration. The Insolvency laws, which were previously fragmented, were consolidated into a single code to provide time-bound resolution and ensure maximisation of asset value.
Insolvency proceedings operate in Rem, while Arbitration operates in Personam. Courts in India have taken a contradictory approach, sometimes the Code overrides Arbitration Act, and sometimes harmonising both the laws. The nuances of the same have been explored through this article to understand how these unresolved issues can be addressed to provide better legislative clarity and ensure predictability in the evolving area of law.
2. Insolvency-Arbitration Dilemma: Convertible Preference Shares
While conducting risk analysis, investors may consider Convertible Preference Shares. These are a special class of preference shares that can be converted into equity shares of the company, either on a future date or upon the occurrence of a particular event. These are categorised as hybrid financial instruments, as shareholders have the opportunity to become equity shareholders at their discretion. These are also categorised into two types of shares: Optionally Convertible Preference Shares (hereinafter referred as OCPS), either by the holder of the shares (investor) or by the company (issuer). The other type is Mandatory Convertible Preference Shares, which are converted either after a fixed maturity period or if a specific event occurs, like Initial Public Offering or the takeover of the company.
Though investors usually prefer to go with OCPS, it can sometimes lead to issues like uncertainty in the capital structure, sometimes there can be issues with respect to the conversion formula, which can lead to disputes, and Regulatory restrictions under Foreign Exchange Management Act, 1999 make it more rigid and less lucrative. Such issues occurred, and were addressed by the Hon’ble Supreme Court in the case of Indus Biotech Private Limited v. Kotak India Venture (Offshore) Fund, 2021.
The dispute arose due to a financial arrangement between Kotak India Venture (Offshore) Fund (Kotak) and Indus Biotech Private Limited (Indus). By acquiring OCRPS, Kotak invested in Indus. OCRPS provides holders an option to either have the company redeem them for a cash payment or convert them into equity shares.
Kotak chose to convert its OCRPS into equity shares when Indus decided to go for a Qualified Initial Public Offering. Due to disagreement on deciding the conversion formula, a dispute arose. Thereby, Kotak decided to exercise its other right and demanded that they go for the redemption of the OCRPS. Later on, due to non-payment of the cash by Indus, Kotak filed a petition under Section 7 of the Code for initiating the Corporate Insolvency Resolution Process (hereinafter referred as CIRP). The ground was that Indus' failure to pay constituted a default on a debt.
In the meantime, Indus applied Section 8 of the Arbitration Act, where they requested the National Company Law Tribunal (hereinafter referred as NCLT) to refer the dispute to arbitration, in accordance with the agreement between both parties. Hereby, NCLT dismissed the CIRP petition and referred the matter to arbitration. This led to the filing of an appeal to the Hon’ble Supreme Court of India by Kotak.
The Hon’ble Supreme Court upheld the NCLT’s ruling. The ratio decidendi was that if the dispute is subjected to arbitration, then CIRP under the Code couldn’t be initiated. This conclusion was based on several factors:
Just because there is the existence of a debt, it does not suffice to trigger the proceedings under the Code. The requirement is a case-by-case examination of evidentiary records.
The core issue was with respect to the disagreement regarding the conversion formula for the OCRPS. It would be premature to conclude that a “default” had occurred just based on board meetings and ongoing discussions. The court viewed the claim for redemption as part of the negotiation, and not as an established failure to pay the conversion amount.
The clarification was provided that the insolvency proceeding becomes a proceeding in rem once there is acceptance of the application by the Adjudicating Authority (hereinafter referred as AA) and not before. Thereby, before the admission, the AA can consider an application which is made under Section 8 of the Arbitration Act. Thus, in the case of a dispute regarding the debt or default, the Adjudicating Authority is within its powers to refer the dispute to arbitration.
The Court also showed concern regarding the potential misuse of the Code’s proceedings. A financially sound company can become prey to the CIRP application based on the claim of debt (where the evidence of default is not substantial).
2.1. Critical perspective on the treatment of OCRPS under Insolvency Law
From a prima facie perspective, the Hon’ble Supreme Court’s decision looked to protect the companies from potentially malicious or premature insolvency filings. But the judgment fails to overlook the fundamental rights of the OCRPS holder. There was a clear contractual right provided to Kotak to either convert the shares or demand redemption. They exercised the right to redemption once the conversion method failed. Terming the matter as “premature” invalidates OCRPS holders’ right to choose for the redemption, mainly compelling them to continue negotiation regarding a conversion formula which they decided against.
Also, just the mere participation of the Nominee Director of Kotak in the Board meeting where the conversion formula was discussed does not negate Kotak’s right to seek redemption. The right to redemption and conversion into equity shares are not mutually exclusive. The Definition of the Default under the Code clearly states that a failure to pay a due debt is sufficient to be considered a default. Putting emphasis that the satisfaction of the AA creates issues for the financial creditors seeking relief under the Code. This can even lead to a Corporate Debtor (hereinafter referred as CD) using different methods to delay insolvency proceedings by raising a dispute.
The core conundrum that the court should have focused upon should have been whether the redemption amount was a “debt due”. Here, the Respondent did not raise any objections on the Appellant not having the right to redeem, or that they were unable to make the payments. Thereby, due to the absence of such contentions, failure in paying the legally demanded amount should have been considered as a default. Here, the priority was given to the spirit of negotiation rather than the contract.
3. Literalism, Purposive Interpretation, and Destiny of Pre and Post-Moratorium Arbitrations: Judicial Approach to Section 14 of the IBC, 2016
Under the Code, there are two types of creditors: financial creditors, which are financial institutions and banks, and operational creditors, such as goods and services suppliers. In case there is a default in repayment of the debt, any or both of the creditors can initiate CIRP proceedings against the CD.
For resolving the corporate insolvency in a time-bound and structured way, the Code provides a foundation for the same. One of the key features is the process of the moratorium period under Section 14 of the Code. In this period, legal actions against the corporate debtor are frozen for a temporary period. Under the Black’s Law Dictionary, it is defined as: “Delay in performing an obligation or taking an action legally authorised or agreed to be temporary.”This concept of Moratorium was borrowed from Section 446(1) of the Companies Act of 1956. I will be further discussing that how during the moratorium period, the arbitration proceeding can be initiated or continued, and how arbitral awards are treated during this period.
In the Code, the term “proceedings” is not defined. Due to this, there have been a lot of challenges in interpreting it. If literal interpretation is applied here, then during the moratorium period, every kind of proceedings (even arbitration) will be halted. Though the Hon’ble Delhi High Court in the case of Power Grid Corporation of India Limited v. Jyoti Structure Limited, 2017, “proceedings” given under Section 14(1)(a) of the Code was interpreted, and it was observed that as before “proceedings”, the word “all” is not mentioned then that indicates that legislation intended to limit the scope of the section. It was also observed that if the debtor’s estate is increasing by the proceedings where the CD is initiating the recovery action, then that should not be barred by the law, as the estate is not diminishing. The objective of the section is the maximisation of the value of the assets. Here, the court followed the purposive interpretation and not the rigid literalism.
3.1. Arbitrations Post-Moratorium
In Alchemist Asset Reconstruction Company v. Hotel Gaudavan (P) Ltd., 2018, the Hon’ble Supreme Court observed that Section 14(1)(a) of the Code clearly states that during the Moratorium period, the institution or continuation of suits or proceedings against the CD is prohibited. Regarding the Arbitration Proceeding, which began after the moratorium period was declared as “non est in law”.
In Canara Bank v. Deccan Chronicle Holdings, 2017, the National Company Law Appellate Tribunal (hereinafter referred as NCLAT) observed that with respect to the extraordinary writ jurisdiction of the Hon’ble High Courts and the Hon’ble Supreme Court, the Moratorium does not affect these proceedings. But this period does apply to the cases of money suits filed under the Original Jurisdiction of the High Court. If the claim is of debt, this observation ensured that the creditor does not bypass the moratorium by filing a regular lawsuit in a High Court.
3.2. Pending Arbitrations during Moratorium
In the Power Grid Corporation of India Limited v. Jyoti Structure Limited, 2017 the Hon’ble Delhi High Court observed that in case during the recovery of the debt from the CD, if the proceeding is not “endangering, diminishing, or having an impact on the assets” of the CD, then these proceedings should not be barred by the process of Moratorium. Even this observation was affirmed in Jharkhand Bijli Vitran Nigam v. IVRCL Ltd. (Corporate Debtor) & Anr., 2018 by the NCLAT. Even in SSMP Industries Ltd. v. Perkan Food Processors Pvt. Ltd, 2017, the Hon’ble Delhi High Court observed that the fairness would be undermined by the blanket ban on the counterclaims. Assessment should be done of such counterclaims where the assets of the CD are in danger.
A Conundrum arises when there is a claim and counterclaims against the CD in arbitration. It was observed that with respect to adjudication, arbitration can continue, but it cannot be enforced during the moratorium period. This ensures that the CD is protected during this period.
As can be observed, Hon’ble High Courts and AA have taken a balanced approach whenever there has been a clash between the Arbitration Act and the Code. But the Hon’ble Supreme Court’s observation of declaring the arbitration proceeding as “non est in law” is too harsh. Rather than declaring it as void ab initio, it could be stayed until the moratorium ends. The judgment of Alchemist Asset Reconstruction Company undermines the jurisdiction of the arbitration tribunal.
The judgment is also against the international arbitration norms, where the insolvency laws allow the tribunals to go forward with the proceedings (with certain restrictions regarding enforcement). Here, the Hon’ble Supreme Court missed the opportunity to do the Constrictive Harmonization between the Arbitration Act and the Code. It is to be understood that both the laws should complement each other and steps should be taken to reduce the conflict.
The hard approach created a hierarchy where the Code trumps the Arbitration Act, and the middle ground was not thoroughly observed. The judgment also had an impact on the foreign investors, whose reliance is on the arbitration clauses. Due to the current stance, nullify the dispute resolution forum. The need of the hour is focusing on the purposive interpretation and not the strict interpretation. The law remains unsettled, a nuanced approach is needed to permit that the arbitral proceedings should continue, but the enforcement mechanism can be stayed.
The conundrum arises on the evidentiary value of the arbitral awards in the debt for insolvency initiation. For the same two landmark judgements are important: the first is given by the NCLAT in Annapurna Infrastructure Private Limited v. SORIL Infra Resources Limited, 2017, it was held that an Arbitral award which is given against the CD constitutes a default. Even the Hon’ble Supreme Court in the case of K. Kishan v. Vijay Nirman Co. Pvt. Ltd., 2018, held that an arbitral award can be treated as a valid proof of debt. With respect to awards that are contested, they themselves cannot trigger insolvency proceedings.
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