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Supreme Court rules that dispute become non-arbitrable once application u/s 7 of IBC is admitted
A Full Bench of the Hon’ble Supreme Court comprising Justices S.A. Bobde, A.S. Bopanna, and V. Ramasubramanian in the matter of Indus Biotech Private Limited v. Kotak India Venture (Offshore) Fund and Others, REED 2021 SC 03573 held that once an insolvency resolution application filed under Section 7 of the Insolvency and Bankruptcy Code, 2016 is admitted, the dispute thereafter becomes non-arbitrable and consequently, an application filed under Section 8 of the Arbitration and Conciliation Act, 1996 to refer the parties to arbitration also becomes non-maintainable. This post elucidates the factual background of the case, the issues involved and the ruling pronounced by the Supreme Court.
Kotak India Venture Fund (Kotak) had subscribed to Optionally Convertible Redeemable Preference Shares (OCRPS) issued by Indus Biotech Private Limited (Indus) and the terms of conversion and redemption of the OCRPS were agreed in the parties’ Share Subscription and Shareholders Agreements (Agreements) which also contained an arbitration clause. Subsequently, Indus decided to make a Qualified Initial Public Offering (QIPO) that made it necessary for Kotak to convert its OCRPS into equity shares as mandated by Regulation 5(2) of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
Thereafter, a dispute arose between Kotak and Indus regarding the calculation and conversion formula applicable for converting Kotak’s OCRPS into paid-up equity shares and on the amount of refund, if any. While Kotak claimed that it would be entitled to 30% of the total paid-up share capital in equity shares, Indus Biotech claimed that Kotak would be entitled to 10% of the total paid-up share capital. Subsequently, Kotak claimed that a sum of INR 367.08 crores became due and payable on redemption of OCRPS which Indus failed to pay and hence, filed an application under Section 7 of the Insolvency and Bankruptcy Code, 2016 (IBC) against Indus before the National Company Law Tribunal (NCLT). In the same matter, Indus also filed a miscellaneous application to refer the matter to arbitration under Section 8 of the Arbitration and Conciliation Act, 1996 (Arbitration Act). The NCLT allowed the Section 8 application, and as a consequence, the petition under Section 7 of the IBC was dismissed.
Aggrieved thereof, Kotak filed a special leave petition before the Supreme Court against the order of NCLT and an arbitration petition was also filed by Indus seeking the appointment of an arbitrator under Section 11 of the Arbitration Act to adjudicate upon the disputes that had arisen.
Kotak submitted that the Agreements provide that the OCRPS when redeemed is payable, within 15 days from the date of redemption and also has a clause that stipulates that the redemption value ‘shall’ constitute a debt. Hence, according to Kotak, the event enabling the petition under Section 7 of IBC had occurred and the dispute sought to be raised was not arbitrable after the insolvency proceeding commenced which was an action in rem. On the other hand, Indus argued that the NCLT had adopted the correct approach, and since there was no existence of a default under the IBC, the dispute should be referred to arbitration.
Placing reliance on Vidya Drolia and v. Durga Trading Corporation 2021 2 SCC 1, the Supreme Court noted that a dispute becomes non-arbitrable when the cause of action and subject matter of the dispute relates to actions in rem, that do not pertain to subordinate rights in personam that arise from rights in rem. In the context of IBC, adverting to Swiss Ribbons Private Limited v. Union of India (2019), REED 2019 SC 01504 the Supreme Court observed that insolvency proceeding becomes in rem only after it is admitted since an admission leads to the creation of a third party right in all the creditors of the Corporate Debtor, thereby creating an erga omnes effect. Resultantly, the mere filing of the petition and its pendency before admission under the IBC cannot be construed as the triggering of a proceeding in rem.
To sum up, the Supreme Court’s legal position, if the application under Section 7 of the IBC is admitted, any application made thereafter under Section 8 of the Arbitration Act becomes non-maintainable. Further, even in a case where the petition under Section 7 of IBC is yet to be admitted, and an application under Section 8 of the Arbitration Act is kept alongside for consideration, the NCLT has to first consider the application under the IBC and adjudicate the same. Only if the petition under IBC is rejected, the parties will be at their discretion to secure the appointment of the Arbitral Tribunal in appropriate proceedings as contemplated in law and the need for the NCLT to pass any orders on such application under Section 8 of Arbitration Act would not arise.
In the present matter, a perusal of documents placed on record demonstrated that in the meetings held by both the parties in March and April of 2018, the dispute regarding the allotment and calculation of equity shares against the OCRPS because of the QIPO was still a matter of discussion and no conclusion had been arrived at to conclude that there was a default in respect of a debt.
Accordingly, in light of the foregoing reasons, the Supreme Court dismissed the application filed by Kotak under Section 7 of IBC. Further, the Arbitration application filed by Indus was allowed and an Arbitral Tribunal was constituted to adjudicate the dispute between the parties.