Harmonization Of Arbitration And Insolvency Laws In India: Legislative Gaps And Judicial Impediments: Part: 2
- Anish Mishra
- Jan 25
- 7 min read
-- by Anish Mishra, student at Tamil Nadu National Law University
3.3. Proceedings which are Criminal or Quasi-Criminal in Nature
In the case of P. Mohanraj v. Shah Bros. Ispat Pvt. Ltd., 2021, the Hon’ble Supreme Court broadened the scope of Section 14 of the Code. It was observed that with respect to Section 138 of the Negotiable Instrument Act, 1881, the cheque dishonour cases will be covered under the proceedings given in Section 14 of the Code, as they are debt-enforcement mechanisms in disguise. A very instance was taken by the Hon’ble Delhi High Court in the case of Deputy Director Directorate of Enforcement v. Axis Bank, 2019, where it was observed that moratorium does not affect proceedings dealing with the Prevention of Money Laundering Act, 2002, as the act’s objectives differ from the objective of the code.
3.4. Who is excluded from the proceedings under the Moratorium?
The Hon’ble Supreme Court in Anjali Rathi v. Today Homes & Infrastructure Private Limited, 2021, observed that under Section 14 of the Code, the shield is not provided to the promoters and directors, and proceedings against them can be continued. Even regarding personal guarantors, they are also excluded from the ambit of the moratorium, as observed by the Hon’ble Supreme Court in State Bank of India v. Ramakrishnan & Anr., 2018. Later on, through the IBC (Second Amendment) Act, 2018, there was the inclusion of Section 14(3)(b), which provided statutory backing to this judgment.
3.5. Comparative Analysis on Moratorium and Arbitration:
If we do the comparative analysis, and see jurisdictions like the United Kingdom and the United States of America, the stay is provided on the arbitration proceeding, but the insolvency courts are given an option to sometimes allow arbitral claims to go forward. The blanket bar of Indian jurisdiction can be considered as a rigid approach.
Under the Bankruptcy Code of the United States of America, section 362 (a), it provides an "automatic stay" which applies when a bankruptcy petition is filed. To decide whether an arbitration proceeding should be allowed or not, there is a bifurcation between Core Proceedings and Non-Core Proceedings. Core proceedings are central to the administration of the estate, and over them, bankruptcy courts have exclusive jurisdiction. Non-Core Proceedings can exist independently, like breach of contract, or any tort claims.
The assessment is done by the insolvency court under 28 U.S. Code § 157 to decide “core” proceedings. The nature of the claim is scrutinized, such as whether it is regarding a bankruptcy issue. It becomes core if the proceeding can have a substantial impact on the estate of the debtor. The case of In re Gandy, 299 F.3d 489, 494–495 (5th Cir. 2002) given by the U.S. Court of Appeals- Fifth Circuit is important as it was observed that the bankruptcy court may stay the arbitration proceedings if the proceedings involve core bankruptcy claims. In another case of In re Hagerstown Fiber Ltd. Partnership, 277 B.R. 181 (Bankr. S.D.N.Y.) given by U.S. Bankruptcy Court – Southern District of New York, it was observed that contractual issues related to the construction contract can be termed as arbitrable in nature. In this case, the court recognized the non-core issues that can be allowed even when the Bankruptcy petition has been filed.
The court of law in India has definitely played a big role in reducing the legislative gaps by providing clarity. But due to different approaches, there has been uncertainty among stakeholders. The predictability is undermined in the case of excessive judicial discretion. There is a need for uniform guidelines so that conflicting interpretations can be avoided. Learning can also be taken from countries like the United Kingdom and the United States of America, where the equilibrium is established between the objectives of the insolvency proceedings and arbitrations. This will ensure that there is not only certainty in contracts but also that insolvency proceedings are efficient.
Interpretation of the “Dispute” under the Code
The term 'dispute' has been defined in Section 5(6) of the Code. A critical interpretation of the term “dispute” within the code was explained by the Hon’ble Supreme Court in the case of Mobilox Innovations Private Limited v. Kirusa Software Private Limited (Mobilox), 2017, the objective was to prevent Code from being treated as a mere debt recovery tool, and to go with its principles of collective distribution and expediency.
There was a discourse about the meaning of “disputed debt” as a ground to challenge the application of insolvency under the code. An objection can be raised against the insolvency petition by establishing that there is a prior dispute; this power has been given under Section 8(2)(a) and Section 9(5) of the Code. A narrower approach was taken by the AA, where, regarding the dispute, they observed that it must be a pending legal proceeding, like arbitration, or pre-existing. Due to this, for the creditors, there was a “first-mover’s advantage”. Because the debtor who had not yet started any formal legal action would be left without any defence against the notice of insolvency, even if there is a legitimate dispute.
The narrow interpretation was rejected by the Hon’ble Supreme Court, and for the same, they referred to the Bankruptcy Law Reform Committee Report, where it was emphasized that this “calm period” is required for the preservation of the enterprise value. The apex court termed it as a “breathing spell” which helps the CD in reorganizing the operations and preventing actions by the creditors. The legislative history and intent behind the code were also scrutinized. The term “dispute” is not restricted to pre-existing formal proceedings; it also includes disputes that are raised for the first time, like a reply to the creditor’s demand notice. It is to be ensured that the dispute is neither created as “moonshine” nor a specious defense for escaping payment. This step was done to prevent misuse by creditors for contested debts that are genuine in nature.
The reasoning of the Hon’ble Supreme Court becomes important when read with respect to the Arbitration Act. By its very nature, Arbitration focuses on party autonomy. It focuses on resolving the dispute privately. The restrictive interpretation given by the AA, if it had prevailed, the arbitration agreement would have been rendered ineffective, as creditors could have bypassed the arbitration clauses and invoked proceedings under the Code.
The Mobilox judgment, by expanding the meaning of “dispute”, has indeed protected the sanctity of the arbitration clauses. Because of this, the debtor can show the Dispute and stop the insolvency proceedings. This protects the contractual intent of the parties to arbitration, and is not overridden by the Code.
This clarity was hindered by the Hon’ble Supreme Court’s reliance on Article 142 of the Constitution of India in the Lokhandwala Construction case. The AA admitted the insolvency petitions. Once the settlement was reached by the parties, the proceeding was quashed by the Hon’ble Supreme Court by using Article 142. Though they concurred with the AA that such withdrawal was not permissible under the Code.
The Arbitration Act encourages settlement in bilateral disputes, but if we see the Code, it is more of a collective in nature; all the creditors are bound by it, and not just the applicant creditor and the debtor. By allowing such a settlement through Article 142, the Hon’ble Court has directly infringed the collective framework of the Code. There is also a violation of the pari passu principle, which can even lead creditors to extract benefits disproportionately.
Another issue arises with respect to Sections 43 and 44 of the Code, which is regarding the preferential transactions. Allowing a debtor to go for the settlement post-admission of the insolvency proceeding can be termed as a preferential transfer, if within two years, another creditor initiates a proceeding.
This can have two consequences: if the insolvency is admitted later, then that can set aside an arbitral award that directed payment to the creditor. And though sanctioned by the Hon’ble Supreme Court under Article 142, a settlement reached during the insolvency proceeding can be restored due to Section 43 of the Code. The orders/judgments given in accordance with Article 142 are not expressly immunized. Not only is the predictability for creditors under the code undermined, but also the enforceability of the awards given by the Arbitral Tribunals.
To solve this conundrum, a few steps can be taken. Firstly, an insolvency petition should not be used to bypass the arbitration agreement, in case there is a genuine dispute. Mainly, the collective resolution process of the code should not be compromised. Secondly, the Apex Court needs to revisit the use of Article 142 in insolvency petitions. In insolvency proceedings, there should be flexibility but not arbitration-style, as that will hamper the rights of the creditors. Thirdly, once the insolvency petition has been admitted, any private settlements or arbitration should not be enforced to protect the collective nature of the Code. Lastly, the legislator should bring certain amendments to the Code to guide the treatment of arbitral proceedings. This should be done to avoid forum shopping and legal uncertainty. As observed in the previous analysis, harmonisation between the two statutes is important for India’s insolvency and arbitration jurisprudence.
Way Forward and Conclusion
The dynamic nature of India’s Commercial Legal framework can be seen between the intersection of the Code, and the Arbitration Act. Though both legislations have distinct objectives. But due to the overlap between them, they have caused legal challenges. The friction between the legislations is inevitable. Nonetheless, it provides an opportunity to do a harmonious construction between both of them.
Regarding the interface of the two legislations, the judiciary plays an important role. A greater predictability for the stakeholders can be achieved through well-articulated principles. Regarding the scope of arbitrability and the treatment of awards against insolvent entities, there is a need for judicial guidelines. The reconciliation between the conflicting objectives of the two statutes can be achieved in such a way.
Furthermore, interpretation by judicial bodies is not enough to resolve such a conflict. To address the gap, legislative refinement is also needed. Legislators can address recurring conflicts between the legislation, especially regarding the treatment of the arbitration clause, once the insolvency proceedings commence. The scope of prolonged litigation can be prevented by taking care of not only creditors but also individual party autonomy.
There is also a need for a case-specific approach by the AA. A one-size-fits-all approach will not be practical. There should be a careful evaluation of the nature of disputes and what kind of impact they will have on the insolvency resolution process. As insolvency processes are time-sensitive in nature, and sometimes arbitration proceedings can be prolonged, parties should be encouraged to go for amicable settlement through Mediation and conciliation. This can be a bridge between the Code and the Arbitration Act.
A vital role is played by the code in reviving distressed enterprises and safeguarding the creditors, whereas the Arbitration Act provides a mechanism for resolving commercial disputes through a party-driven method. Reconciling both the legislation will strengthen India’s commercial dispute resolution framework.
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