Open Access Research Article
Critical Appraisal Of Arbitration Proceeding In Case Of Insolvency
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CRITICAL
APPRAISAL OF ARBITRATION PROCEEDING IN CASE OF INSOLVENCY
AUTHORED BY -
MAHEK SONI
“At all
events, arbitration is more rational, just, and humane than the resort to the
sword.”
- Richard
Cobden
ABSTRACT
This paper deals with
arbitration proceedings in matters relating to situations when parties to
arbitration proceedings become insolvent. Parties can go for both arbitration
and insolvency proceedings for dispute resolution but both proceedings cannot
take place simultaneously.
Insolvency is a situation
where an individual or company becomes unable to meet-up their financial obligations.
It is a non-arbitrable dispute as the right being exercised involves a third
party and they are the proceeding in rem. On the other hand, Arbitration is a
formal dispute resolution mechanism used by parties to resolve their conflicts.
As Arbitration is cost-efficient, time saving, and the award is final and
having a binding effect upon the parties therefore parties opt for it. It is
binding unless challenged by Section 34 of the Arbitration and Conciliation
Act, 1996. It is also important to note that if parties to an arbitration
agreement become insolvent, then the arbitration agreement will not become
invalid on its own rather it will depend upon the facts and adoption of the
contract by the receiver. Provisions relating to cases of insolvency of parties
in an arbitration agreement are provided under Section 41 of the Arbitration
and Conciliation Act, 1996. While considering the insolvency scenario, the following
are circumstances to keep on a note and are the possible terms of the
arbitration clause:
After the date of the insolvency order, After the
commencement of insolvency proceedings, but before passing the insolvency
order, Before the initiation of insolvency proceedings. It also indicates the role of The
National Company Law Tribunal as an adjudicatory authority for insolvency and
bankruptcy proceedings of companies and limited liability partnerships (LLPs)
under the Insolvency and Bankruptcy Code, 2016.
The paper also highlights
the effect of insolvency in arbitration agreements along with the needs and
importance of the Arbitration and Conciliation Act.
The objective of this
paper is to evaluate and examine the procedure of arbitration in matters when a
party to the arbitration agreement becomes insolvent in the context of India by
taking references from case laws. This paper is an attempt to find the answer
to the question of in such a situation which legislation will prevail which is the
Arbitration or Insolvency Act.
KEYWORDS – arbitration,
arbitration agreement, arbitration proceedings, insolvency, insolvency
proceedings
INTRODUCTION
Arbitration is one of the
methods of dispute resolution outside the court. It is a procedure to determine
the legal rights and obligations of the parties with binding effects which are
enforceable by law. People prefer arbitration over court proceedings because it
is flexible and time and cost efficient, moreover parties receive desired
results and confidentiality is maintained. But there are certain categories of
disputes that are non-arbitrable as those disputes involve the right in rem and
affect the right of third party and insolvency is one of those categories. Bankruptcy portrays a circumstance where the indebted person is incapable of meeting his/her commitments, in other words, it could be a state when a person, organization, or other organization cannot meet its money-related commitments for paying obligations as they become due. Arbitration in insolvency cases presents a unique set
of challenges and opportunities. This critical appraisal will explore the
introduction and implications of arbitration proceedings in the context of
insolvency, with a focus on its advantages, potential drawbacks, and overall
effectiveness.
The introduction of
arbitration in insolvency cases is a significant development in the legal
landscape. Traditionally, insolvency matters are resolved through court
proceedings, which can be time-consuming and costly. Arbitration offers an
alternative dispute resolution mechanism that is often faster and more
cost-effective. This can be particularly beneficial in the context of
insolvency, where the preservation of the debtor's assets and the equitable
distribution of assets to creditors are critical objectives.
One of the primary
advantages of arbitration in insolvency cases is its efficiency. Insolvency
proceedings require swift and effective resolution to maximize the value of the
debtor's estate for the benefit of creditors. Arbitration, being a more
streamlined process compared to traditional litigation, can help achieve this
goal. Moreover, the parties involved can choose experienced arbitrators with
expertise in insolvency matters, ensuring a better understanding of the
intricacies of the case.
Arbitration also offers
confidentiality, which can be essential in insolvency cases. In court
proceedings, information about a company's financial distress becomes a public
record, potentially harming its reputation and causing further harm to the
business. Arbitration allows for a more discreet resolution, protecting the
debtor's reputation and sensitive financial information.
However, there are
certain drawbacks to consider. The lack of an established body of case law in
insolvency arbitration can lead to uncertainty and inconsistency in outcomes.
In court proceedings, judges apply well-established legal principles, while
arbitration decisions may vary based on the arbitrator's interpretation of the
law and the specific terms of the arbitration agreement. This can lead to
unpredictable results, which is not ideal for a system designed to provide fair
and equitable resolutions.
Moreover, arbitration
agreements are typically consensual. If one party refuses to participate or
comply with the arbitration process, it can cause delays and complications. In insolvency
cases, where time is of the essence, such challenges can hinder the effective
resolution of the matter. In summary, the introduction of arbitration in
insolvency cases offers several advantages, including efficiency,
confidentiality, and the flexibility to choose arbitrators with relevant
expertise. However, the lack of a consistent legal framework and potential
challenges in enforcing arbitration agreements must be considered. The
effectiveness of arbitration in insolvency cases depends on the willingness of
the parties to cooperate and the expertise of the arbitrators involved. As the
use of arbitration in insolvency cases continues to evolve, it is crucial to
strike a balance between its benefits and potential drawbacks to ensure a fair
and effective resolution process for all stakeholders involved.
NEEDS AND IMPORTANCE OF THE ARBITRATION AND CONCILIATION ACT,1996
In the phase of
industrialization, there is rapid growth in the number of industries, which is
beneficial for the economy of the country. Along with the benefits it also
leads to an increase in disputes which seem to be a burden upon the Courts.
Following are some of the key points that describe the need for propounding the
Arbitration and Conciliation Act, of 1996
Ø Increase in commercial disputes: India is a developing country, and
with the passage of time new industries are established and conflicts also
increasing. So, to resolve those disputes, a dispute resolution mechanism is
required as courts are becoming overburdened, therefore the Arbitration and
Conciliation Act,1996 is introduced and arbitral tribunals are set up.
Ø Reduce the court’s burden: Court proceedings are lengthy and time-consuming,
and the number of cases is increasing rapidly therefore courts are
overburdened. To reduce the burden of court, arbitration as an alternate
dispute resolution mechanism is introduced.
Ø Avoid the Complexity of Court
Proceedings: In comparison
to arbitration proceedings, court proceedings are complex and time-consuming,
which sometimes makes them costly. However, arbitration proceedings are
flexible in nature and save time as well as money of parties as they resolve
the disputes between 6 – 12 months.
Ø Time and cost-efficient: Arbitration proceedings are time and
cost efficient and this unique feature keeps the hope in people regarding easy
and early getting of justice.
Ø Parties’ autonomy: In arbitration proceedings, parties
are in an autonomous state as they are free to choose the arbitrator, language,
and place of arbitration, but in court proceedings, the party cannot choose the
Judge, language, or jurisdiction.
The importance of Arbitration
can be understood for assorted reasons such as:
Ø Arbitration is flexible in nature: It is flexible as parties can choose
the place, time as well as the language of the proceeding. This flexibility
makes sure that parties to the dispute can settle their differences in a
fashion that works for them.
Ø Arbitration is a faster and more efficient
way of resolving disputes: In comparison to litigation, arbitration is faster as it resolves the
disputes within 6-12 months, whereas in litigation, courts take years to
resolve the disputes, and this is one of the reasons for overburdening of the
court.
Ø It is a confidential process: Arbitration proceedings are not open
to the public, which means details of the disputes are not disclosed to the
public. This will help parties maintain confidentiality and their reputation
gets protected.
Ø It is a cost-efficient process: The arbitration proceeding is
cost-efficient in comparison to court proceedings because it is less formal
than slick, and parties do not have to pay for court fees or legal
representation.
RESEARCH OBJECTIVE
·
To
better understand the concept of insolvency in relation to arbitration.
·
To
know if there is any contradiction between the Arbitration and Conciliation Act
and the Insolvency and Bankruptcy Code.
·
To
find the answer that if any contradiction arises between both Acts, then which
legislation will prevail?
STATEMENT OF PROBLEM
1. Are the Arbitration Act and Insolvency
and Bankruptcy Code contradictory?
2. If there is a contradiction between the
Arbitration and Conciliation Act of 1996 and the Insolvency and Bankruptcy Code
of 2016 then which legislation will prevail?
3. What is the international scenario of
conflict between the Arbitration Act and the Insolvency Act?
PROVISION IN CASE OF INSOLVENCY IN THE ARBITRATION ACT
If a party to an
arbitration agreement becomes insolvent then section 41 of the Arbitration and
Conciliation Act,1996 comes into the picture which deals with the provisions
relating to this. This section goes hand in hand with the provisions of the
Insolvency and Bankruptcy Code,2016 (IBC).
Section 41 of the
Arbitration and Conciliation Act,1996 states that
“(1)[1]
Where it is provided by a term in a contract to which an insolvent is a party
that any dispute arising thereout or in connection therewith shall be submitted
to arbitration, the said term shall, if the receiver adopts the contract, be
enforceable by or against him so far as it relates to any such dispute.
(2)[2]
Where a person who has been adjudged an insolvent had, before the commencement
of the insolvency proceedings, become a party to an arbitration agreement, and
any matter to which the agreement applies is required to be determined in
connection with, or for the purposes of, the insolvency proceedings, then, if
the case is one to which sub-section (1) does not apply, any other party or the
receiver may apply to the judicial authority having jurisdiction in the
insolvency proceedings for an order directing that the matter in question shall
be submitted to arbitration in accordance with the arbitration agreement, and
the judicial authority may, if it is of opinion that, having regard to all the
circumstances of the case, the matter ought to be determined by arbitration,
make an order accordingly.
(3)[3] In
this section, the expression "receiver" includes an Official
Assignee.”
Subsequent to the date
of insolvency order -
In this case, the arbitration agreement will become void. Once the party is
declared bankrupt, the arbitration clause may not have a binding effect on the
receiver.
Subsequent to the
commencement of insolvency proceedings, but before passing the insolvency order - In these circumstances, the future
dispute has been referred by the Arbitration clause, the receiver can enforce
the arbitration clause, but the receiver adoption of the contract should take
place. In this situation permission of NCLT is not required for both parties,
but when the insolvent company would be replaced by the receiver handling the
insolvency then it would not be applicable. If the recipient chooses not to
abide by the contract of which the arbitration clause is a part, the party
involved in the arbitration can apply to the NCLT to persuade it to go to
arbitration proceedings. If the dispute is to be decided by arbitration, the
decision will be that of the NCLT alone, considering the circumstances. NCLT
will pass orders accordingly.
Before the initiation
of insolvency proceedings. – In the event that the arbitration agreement is entered into before the
insolvency proceedings come into existence; Then the resolution depends on the
receiver. If the receiver accepts the contract, the party may enforce the
agreement against the receiver.
If the recipient chooses
not to accede to the contract, the party may apply to the NCLT for a reference
to arbitration as explained under condition (b) given above.
ROLE OF RECEIVER
The receiver is an
independent and impartial person, who plays a crucial role in assisting the
court. The appointment of the receiver is done by the court. The receiver has
to take possession of and sell or liquidate the assets secured by the security
agreement so that the outstanding debt can be repaid. The Arbitration and
Conciliation Act provides a significant responsibility to the receiver to
decide whether to choose arbitration or not in cases of insolvency, and he can
only choose to adopt the contract when it is beneficial for the insolvent
party. If the receiver opts for the adoption of a contract, then he must adopt
it completely and fully he cannot opt for it in parts means he cannot reject
the dispute resolution clause. If he agrees to adopt the contract consisting of
an arbitration agreement/ clause, then such contracts can be enforced against
the insolvent party if in future any dispute arises.
INSOLVENCY OF PARTIES
AND IMPACT ON ARBITRATION
Applications can be made
for both arbitration and insolvency proceedings. Still, these two cannot exist
together. Section 41 of the Arbitration and Conciliation Act of 1996 explains
the provisions of an arbitration agreement when one of the parties is
insolvent. When the party becomes insolvent, the question is whether the
arbitration agreement would be valid or not. So, the answer is that it will not
become invalid directly. It will be the decision of the receiver whether he
wants to continue the contract or not. If the receiver adopts the contract,
must adopt it completely, he cannot adopt the agreement in parts and he can
choose to adopt the contract if it is beneficial for the insolvent person. If
the receiver adopts any commercial contract containing arbitration agreement/
clause, then such arbitration agreement is enforceable against the insolvent if
any dispute arises in the future. The contract can be adopted wholly and
exactly. The receiver cannot reject the dispute resolution clause and adopt it
partially.
The different decisions
made by the national company law tribunal in different circumstances. If
bankruptcy judgment has been declared earlier and after that parties signed an
arbitration agreement, then the agreement would be null and void. After a
decision has been taken that the company is insolvent then the arbitration
clause would not bind any party or trust. If the trustee chooses to adopt the
contract it can be enforced against him if Arbitration agreements are
established before the decision given by bankruptcy award and after the filing
of bankruptcy proceedings.
After that, the receiver
or the party becomes insolvent and is not bound to obtain permission from the
national company law tribunal. An insolvent Receiver can replace the insolvent
party or company by accepting the contract or initiating arbitration. If the
recipient refuses to accept the contract, then the insolvent party can approach
the court. Further, it will be at the discretion of the national company law
tribunal that the decision of dispute will be given by the Arbitration court or
not. If the Tribunal or the National Company Law Appellate Tribunal directs not
to consider the arbitration agreement due to the status of the insolvent
company, the parties may litigate a civil action against the receiver.
Therefore, the existing
arbitration agreement will affect the resolution of the bankruptcy proceedings.
In India, insolvency is a dispute that cannot be referred to arbitration
because enforceable rights are substantive and involve a third party.
Arbitration and bankruptcy are two separate proceedings that cannot take place
at the same time.
The timing of the
formation of the arbitration agreement, the decision of the court-appointed
receiver, and the order of the National Company Law Tribunal play an important
role in deciding the procedure and law applicable to a dispute with an
insolvent party.
DISPUTES RELATED TO
INSOLVENCY: NON-ARBITRABLE
There are certain
categories of disputes that are non-arbitrable, and insolvency is one among
them. In the case of Himangini Enterprises vs Kamaljit Singh[4] Supreme
Court held that tenancy disputes where the Transfer of Property Act applies are
non-arbitrable. This case is taken as a reference in Vidya Drolia vs
Durga Trading Corporation[5] in
which the court states that the Himangini judgment was not reasonable here as
the transfer of property act is not a special statute and dispute arising under
this Act is arbitrable along with this Supreme Court also propounded a fourfold
test to determine the arbitrability of a matter which are as follows:
·
When
the subject matter of the dispute and the cause of action relates to action in
rem.
·
When
the cause of action of the dispute affects the right of the third party and
mutual adjudication would not be appropriate.
·
When
the cause of action and subject matter of dispute relates to sovereign and
public interest functions of the state.
·
When
the subject matter of the dispute is explicitly or by necessary implications
non-arbitrable according to obligatory statute.
The court also introduced
the following six categories that are non-arbitrable:
·
Disputes
arising out of the criminal offense.
·
Matrimonial
matters
·
Guardianship
matters
·
Insolvency
and winding up matters.
·
Testamentary
matters
·
Eviction
and tenancy matters.
So, from this case, the
picture becomes clear that disputes related to insolvency are non-arbitrable
because the resolution of an insolvency dispute involves the rights of third
parties. The Supreme Court also in A.
Ayyasamy vs A. Paramasivam & Ors[6] has
observed that ‘insolvency and winding-up matters’ are not arbitrable. The order
of moratorium is valid until completion of the CIRP.[7]
Swiss Ribbons Private Limited v. Union of India[8],
P. Anand Gajapati Raju v. PVG Raju[9], and
Booz Allen and Hamilton v. SBI Home Finance Limited[10] are
some of the examples of those cases where the court differentiated between
right in rem (right against the whole world) and right in personam(right
available against a particular person).
In other words, when the
insolvency proceedings begin against a person, all the other legal proceedings
against such person will have stayed till the disposal of the insolvency
proceedings which includes any pending arbitration proceedings as well.
Apart from the
moratorium's imposition, the statute has no provisions addressing how the
bankruptcy process affects arbitrations. Comparably, the influence of the
corporate insolvency resolution process (CIRP) on arbitrations is not covered
by any provisions in the Arbitration and Conciliation Act, 1996.
It is also noteworthy to
note that there are some overriding clauses in both the Arbitration Act of 1996
and the IBC of 2016. Given that they are both special statutes, it is now
necessary to determine which statute will prevail. The newest ruling by the
Supreme Court in the case of Indus Biotech Private Limited v. Kotak India
Venture Fund [11]provides
answers to all these questions.
ARBITRATION ACT AND
INSOLVENCY ACT: COLLUSION
Indus Biotech Pvt. Ltd. v. Kotak India Venture Fund (2021)[12]
In this case, Kotak
Venture Fund had subscribed to Optionally Convertible Redeemable Preference
Shares which were issued by Indus Biotech Pvt Ltd. After sometimes Kotak
Venture Fund decided to convert the Optionally Convertible Redeemable
Preference Shares into equity shares. A dispute arose between Kotak Venture
Fund and Indus Biotech Pvt Ltd regarding the valuation and calculation for the
same, due to which Indus Biotech referred the dispute for arbitration and Kotak
Venture Fund has filed an application under Section 7[13]
of the IBC initiating Corporate Insolvency Resolution Process(CIRP) before the
NCLT against Indus and the same is challenged by Indus Biotech by contending
that this matter falls within the scope of dispute resolution clause,
arbitration was an appropriate stage in the process, it further argued that
Kotak's application under Section 7 application is a "dressed-up"
scheme to avoid the arbitration process and is intended only as a means of
coercion to extract money from Indus.
In this case, the
National Company Law Tribunal applies the test of arbitrability. After
observing the dispute, the NCLT passed the order in favour of Indus and
referred the matter to arbitration. Aggrieved by this Kotak Venture filed a
Special Leave Petition before the Apex Court of India and Supreme Court
allowing the same held that when the NCLT initiated CIRP under Section 7 of the
IBC, from the same time the insolvency proceeding stops being arbitrable. The
Court also mentions that there is nothing improper in dismissing the
application of section 7 by the NCLT, and mere filing the petition and its
pending status cannot be interpreted as starting an insolvency process to be
treated as proceedings in rem. The matter only becomes non-arbitrable upon the
admission of such an application.
The Supreme Court further
mentioned that the NCLT's responsibility is to figure out whether the company
has defaulted or has any debt that must be paid based on the information that
is provided to it. If there is a default, then automatically the application
under Section 7 of IBC will be admitted and the matter becomes non-arbitrable
on the other hand if there is no default then the application will be
dismissed, and the parties can opt for arbitration. Thus, in this case, the
Supreme Court has upheld the dismissal of the Section 7 application by the NCLT
but observed that the NCLT must first decide the admissibility of the Section 7
application without looking if a Section 8 application is pending or not and the
admission or dismissal of the application under Section 7 will be evaluated on
its own to determine whether or not the issue is arbitrable. As both are
special statutes, the one that is enacted later will prevail over the
other, the Supreme Court ruled in resolving the issue between the non-obstante
clause under Section 5 of the Arbitration and Conciliation Act,1996, and the
overriding effect under Section 238 of the IBC.
THE ARBITRATION ACT
AND THE INSOLVENCY ACT: AN INTERNATIONAL SCENARIO
Elektrim v Vivendi[14], is a cross-border insolvency case
with an arbitration clause, The Swiss courts followed Polish law because it is
a Polish company that is insolvent. The Swiss Supreme Court ruled that “the
arbitration tribunal had no authority because the arbitration clause was
considered ineffective upon the initiation of insolvency proceedings under
Polish law.”
“Disputes concerning
an insolvent corporation that occurs only upon the initiation of the insolvency
process, such disputes, cannot undergo arbitration”, according to Singaporean courts in
the case of Larsen Oil and Gas Pte Ltd v Petroprod Ltd.[15]
However, where the issue concerns the company’s interests before insolvency, it
can be resolved by arbitration.
An insolvency proceeding
would not exclude parties from pursuing arbitration in the United Kingdom. This
position was founded in the case of Fulham Football Club v. Richards,
where the appellate court found that “a shareholder unfair discrimination
lawsuit could be arbitrated. “The appellate court has observed that the
arbitrability of insolvency law cases is contingent on its effect on third
parties.”
SUGGESTIONS
The Indian legislative
still must address several legal and policy difficulties, even though Indian
courts have closed any legal loopholes and attempted to strike a compromise
between the conflicting goals of arbitration and insolvency legislation.
Arbitration proceedings against a CD cannot proceed after a moratorium has been
placed on them, apart from actions that are for the CD's advantage, according
to the legal precedent outlined in the analysis above. From the standpoint of a
claimant in an arbitration procedure, who can be left without any recourse when
an insolvency proceeding is initiated against a respondent in an arbitration
proceeding, this leaves a lot to be desired.
To assess the
arbitrability of insolvency issues, a consistent framework or model like the
Legislative Guide is required because the lack of regulations results in
diversity and unpredictability. For example, a list of core and non-core items
could exist, like what the US Bankruptcy Code does; however, it would be
challenging to incorporate such a list within Swiss substantive law.
It is contended that a
Handbook would benefit national courts and international arbitral tribunals by
promoting a more assured transboundary approach to the arbitrability of
insolvency proceedings, even though such problems are thought to be overcome.
The benefits to the global business community will include more predictability
and certainty, fewer costs associated with arbitration and litigation, and increased
clarity.
CONCLUSION
Arbitration is a
procedure in which the dispute between the parties is submitted to an arbitral
tribunal. The tribunal provides a decision known as an award on the dispute
that is binding on the parties. Supreme Court in the case of Indus
Biotech Pvt. Ltd. v. Kotak India Venture Fund[16]
makes it clear that once insolvency proceedings are admitted the dispute
becomes non-arbitrable. Procedural and substantive are the two aspects of
arbitrability. An arbitration agreement anticipates within its scope an
arbitration of the dispute, while substantive arbitrability refers to whether
the subject matter of the dispute is capable of arbitration as per public
policy is known as Procedural arbitrability.
Thus, the Supreme Court
has a significant role in this regard and as the law is dynamic in nature the
possible recommendations must be implemented to bridge the gap between the idea
and implementation.
REFERENCES
Books
Ø Alternate Dispute Resolution in India
by Anirban Chakraborty
Ø Alternate Dispute Resolution, Third
Edition by S.C Tripathi
Ø Insolvency, The Institute of Company Secretaries
of India
Online sources
[1] Section 41(1) of the Arbitration
and Conciliation Act of 1996
[2] Section 41(2) of the Arbitration
and Conciliation Act of 1996
[4] APPEAL No. 16850 OF 2017, (@
S.L.P.(c) No.27722/2017), (D.No.21033/2017)
[5] (2021) 2 SCC 1 : (2021) 1 SCC
(Civ) 549]
[7] Section 14(4) of the Code: The order of
moratorium shall have effect from the date of such order till the completion of
the corporate insolvency resolution process:
Provided that where at any time during the corporate
insolvency resolution process period, if the Adjudicating Authority approves
the resolution plan under sub-section (1) of section 31 or passes an order for
liquidation of the corporate debtor under section 33, the moratorium shall
cease to have effect from the date of such approval or liquidation order, as
the case may be.
[8] AIR (2019) 4 SCC 17
[9] Civil Appeal No. 5251 of 1993,
(2000) 4 SCC 539
[10] NO.5440 OF 2002
[11] Civil Appeal No.1070 /2021 @ SLP
(C) NO. 8120 OF 2020.
[12] AIR 2021 SUPREME COURT 1638,
AIRONLINE 2021 SC 171
[13] Initiation of Corporate insolvency
resolution process by financial creditor.
[14] [2007] EWHC 571 (Comm) (20 March
2007)
[16] AIR 2021 SUPREME COURT 1638,
AIRONLINE 2021 SC 171
Article Information
Critical Appraisal Of Arbitration Proceeding In Case Of Insolvency
Authors: Mahek Soni, Manu Sharma
- Journal IJLRA
- ISSN 2582-6433
- Published 2024/06/19
- Issue 7
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International Journal for Legal Research and Analysis
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