Supreme Court of India: Corporate insolvency resolution under Indian Insolvency and Bankruptcy Code cannot be invoked in case an arbitral award for the disputed amount is  already under challenge

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In the case of K. Kishan v. M/S Vijay Nirman Company Pvt. Ltd. (Civil Appeal no. 21824 of 2017), the Supreme Court dealt with the issue of whether the Indian Insolvency and Bankruptcy Code, 2016 (‘the Code’) can be invoked in respect of an operational debt where an Arbitral Award has been passed against the operational debtor, which has not yet been finally adjudicated upon. Read the case analysis below:

Factual Matrix

The Respondent sub-contracted some amount of work to third party based on which the said third party entered into a further agreement with fourth party. As a result of this arrangement, a tripartite MOU was signed between the Respondent, the third party and the fourth party. Dispute arouse and matters is referred to arbitration and the tribunal passed an award (the Award) in favour of the Respondent. Thereafter, the Respondent sent a demand notice (the Notice) to the third party under Section 8 of the Code. The Notice was disputed by the third party arguing that the amount claimed under the Notice was the subject-matter of the arbitration proceeding. Subsequently, the third party challenged the Award under Section 34 of the Indian Arbitration Act (the Act). Then, the Respondent filed a petition under Section 9 of the Code before the National Company Law Tribunal of India (the NCLT) claiming that the amount awarded in the arbitration has become ‘Operational Debt’ to be paid by the third party as defined under Section 3(11) of the Code. Per contra, the third party argued that the said award is under challenge and the challenge proceedings are sub judice. The NCLT admitted the Section 9 petition and held that a challenge petition was pending was irrelevant for the reason that the claim stood admitted, and there was no stay of the Award. In appeal, the Appellate Tribunal upheld this decision stating that the non-obstante clause contained in Section 238 of the Code would override the Act.

Applicable Legal Principle

Section 8 of the Code

Insolvency resolution by operational creditor.

(1) An operational creditor may, on the occurrence of a default, deliver a demand notice of unpaid operational debtor copy of an invoice demanding payment of the amount involved in the default to the corporate debtor in such form and manner as may be prescribed.

(2) The corporate debtor shall, within a period of ten days of the receipt of the demand
notice or copy of the invoice mentioned in sub-section (1) bring to the notice of the operational creditor—
(a) existence of a dispute, if any, and record of the pendency of the suit or arbitration proceedings filed before the receipt of such notice or invoice in relation to such dispute;

(b) the repayment of unpaid operational debt—

(i) by sending an attested copy of the record of electronic transfer of the unpaid amount from the bank account of the corporate debtor; or

(ii) by sending an attested copy of record that the operational creditor has encashed a cheque issued by the corporate debtor.

Explanation.—For the purposes of this section, a “demand notice” means a notice
served by an operational creditor to the corporate debtor demanding repayment of the
operational debt in respect of which the default has occurred.

Section 238 of the Code

Provisions of this Code to override other laws.

238 The provisions of this Code shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.

Parties’ Contentions

The third party (Appellant herein) argued that the object of the Code is not to replace debt adjudication and enforcement under other Acts including the Act. According to the Appellant, the fact of pending challenge proceedings shows that there is a dispute insofar as an operational debt that is stated to be owed, and therefore, the Act can be relied upon for this purpose. It was further argued that the Act is not inconsistent with the Code.

The Respondent appreciated the decision of the Appellate Tribunal relying on the laws of the United Kingdom and Singapore to the effect that once it is found that there is a primary adjudication between the parties which indicates the existence of a debt, any further dispute which may be pending in appeal or otherwise over the debt could not be said to be bona fide disputed by the debtor.

Analysis

While referring to the Legislative Guide on Insolvency Law of the United Nations Commission on International Trade Law (the Guide) from its earlier ruling in Mobilox Innovations Private Limited vs. Kirusa Software Private Limited, (2018) 1 SCC 353, the Court observed that the Guide noted that improper use of the insolvency process would occur in cases where a creditor uses insolvency as an inappropriate substitute for debt enforcement procedures, even though they may not be well developed. The Court pointed out that after referring to Section 8, the judgment went on to hold that what is important is that the existence of the dispute and/or a suit or arbitration proceeding must be pre-existing i.e. it must exist before the receipt of the demand notice or invoice, as the case may be. Therefore, the Court concluded that NCLT, while examining an application under Section 9 of the Code will have to determine the following:-

  • Whether there is an “operational debt” as defined exceeding Rs 1 lakh? (Section 4 of the Code)
  • Whether the documentary evidence furnished with the application shows that the aforesaid debt is due and payable and has not yet been paid? and
  • Whether there is existence of a dispute between the parties or the record of the pendency of a suit or arbitration proceeding filed before the receipt of the demand notice of the unpaid operational debt in relation to such dispute?

Conclusions

The Court concluded that the operational creditors cannot use the Code either prematurely or for extraneous considerations or as a substitute for debt enforcement procedures. The object of the Code, at least insofar as operational creditors are concerned, is to put the insolvency process against a corporate debtor only in clear cases where a real dispute between the parties as to the debt owed does not exist.

Under the Code, insofar as an operational debt is concerned, all that has to be seen is whether the said debt can be said to be disputed, and that the filing of a Section 34 petition against an Arbitral Award shows that a pre-existing dispute which culminates at the first stage of the proceedings in an Award, continues even after the Award, at least till the final adjudicatory process under Sections 34 & 37 has taken place. The Court also held that there is no inconsistency between the Code and the Act.

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