Delhi & Bombay High Court: Whether Section 34 proceedings needs to be stayed if corporate insolvency against an award creditor corporate debtor is initiated during its pendency?

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Once an application seeking initiation of corporate insolvency resolution process (CIRP) of a corporate debtor is admitted by the National Company Law Tribunal, a moratorium is imposed under Section 14(1)(a) of the Insolvency & Bankruptcy Code, 2016 (Code), prohibiting institution of suits or continuation of pending suits or proceedings against the Corporate Debtor.

Consider a situation where an award creditor is a corporate debtor against whom the CIRP was initiated by another financial creditor under Section 7 of the Code. If the award is in challenge under Section 34 (application to set aside an award) of the Arbitration & Conciliation Act, 1996 (Arbitration Act) at the time of initiation of CIRP, does that mean such Section 34 proceedings will be stayed due to the moratorium under Section 14(1)(a) of IBC?

One argument is that if Section 34 proceedings are stayed, such corporate debtor would be unable to execute the award given in its favour for an extended period till the moratorium exists and be unable to recover its dues thereby further impeding its financial condition.

Hence, the issue is if the word “proceedings” used in Section 14(1)(a) of the Code be read to mean “all legal proceedings” or be read restrictively to mean a particular type of legal proceedings viz., “debt recovery action” which may have an effect of dissipating or diminishing the debtor’s assets during the period of its insolvency resolution.

In Power Grid Corporation of India Ltd. v Jyoti Structures Ltd., a Ld. Single Judge of the Delhi High Court observed that the term “proceedings” as is mentioned in Section 14(1)(a) of the Code is not preceded by the word “all” to indicate the moratorium provisions would apply to all the proceedings against the corporate debtor. In the above scenario, unexecutability of the award would rather prevent the corporate debtor from recovering money due to it and adding to its financial corpus, which would infact be directly contrary to the object of the Code.

Keeping in mind, the purpose and objective behind imposing moratorium under Section 14 of the Code, the Court held that Section 14 of the Code would not apply to the proceedings which are in the benefit of the corporate debtor, in as much these proceedings (Section 34 proceedings) are not a “debt recovery action” and its conclusion would not endanger, diminish, dissipate or impact the assets of the corporate debtor in any manner whatsoever and hence shall be in sync with the purpose of moratorium which includes keeping the corpora debtor’s assets together during the insolvency resolution process and facilitating orderly completion of the process envisaged during the insolvency resolution process and ensuring the company may continue as a going concern.

Thus, answering the subject question in negative, the Delhi High Court held that stay of Section 34 proceedings against an award in favour of the corporate debtor would rather be stalking the debtor’s effort to recover its money and hence would not fall in the embargo of Section 14(1)(a) of the Code.

The Court also noted that the Arbitration Act draws a distinction between proceedings under section 34 (i.e. objections to the award) and under section 36 (i.e. the enforceability and execution of the award). The proceedings under section 34 are a step prior to the execution of an award. Only after determination of objections under section 34, the party may move a step forward to execute such award and in case the objections are settled against the corporate debtor, its enforceability against the corporate debtor then certainly shall be covered by moratorium of section 14(1)(a).

Applying the above reasoning, the Delhi High Court in SSMP Industries Limited vs. Perkhan Food Processors Pvt. Ltd., 2019 SCC OnLine Del. 9339, addressed the issue of whether, in a suit for recovery, the adjudication of the counter claim of a defendant/creditor against a corporate debtor, who went into CIRP,  would be liable to be stayed in terms of Section 14 of the Code if CIRP is initiated during the pendency of such suit.

In that case, the Defendant/creditors’ position was that no amount is recoverable from it by the Plaintiff/corporate debtor but that it is, in fact, entitled to recover monies from the Plaintiff. However, the counter claim of the Defendant/creditor was much lower than the claim of the Plaintiff/corporate debtor such that even if the counter claim is decreed fully and the claim of the Plaintiff/corporate debtor is also allowed, the Plaintiff would, in fact, be entitled to recover and not the Defendant/ creditor.

The Ld. Single Judge relied on the test enunciated in Power Grid and held that until and unless the proceeding has the effect of endangering, diminishing, dissipating or adversely impacting the assets of corporate debtor, it would not be prohibited under Section 14(1)(a) of the Code. Applying the test, the Court held that till the defence of the Defendant/ creditor is adjudicated, there is no threat to the assets of the corporate debtor and the continuation of the counter claim would not adversely impact the assets of the corporate debtor. Once the counter claims are adjudicated and the amount to be paid/recovered is determined, at that stage, or in execution proceedings, depending upon the situation prevalent, Section 14 could be triggered. In view thereof, the Court refused to stay the suit and counter claim under Section 14 of the Code.

Similar issue has been decided by the Bombay High Court recently in Palladian Hotels Private Limited v. Hotel Horizon Private Limited Company Application no. 282 of 2019 decided on 2 January 2020. In the facts of that case, the issue before the Court was whether the bank guarantee furnished by the corporate debtor pursuant to an order passed by the Bombay High Court prior to imposition of moratorium could be encashed by the Prothonotary & Senior Master of the Court for Palladian or not in view of section 14(1) of the Code and thereafter if encashed, Palladian could apply for release of the amount lying with the Court or not.

In this case, the dispute was referred to an arbitrator who rendered an award in favour of Palladian against the corporate debtor. However, during the pendency of the arbitration proceedings, CIRP against the corporate debtor was admitted and a moratorium was imposed in terms of Section 14(1) of the Code. The corporate debtor challenged the award under Section 34 of the Arbitration Act.

While Section 34 proceedings were pending, Palladian sought directions from the Bombay High Court to direct the Prothonotary & Senior Master of the Court to encash the bank guarantee furnished by the corporate debtor and from such sum release the sum equivalent to its debt to Palladian. However, the corporate debtor argued that the relief sought by the debtor (applicant) is in the nature of execution of award (Section 36 of the Arbitration Act).

In deciding this issue, the Bombay High Court relied on the Supreme Court case of State Bank of India vs. V. Ramakrishnan & Ors wherein the Court inter alia held that the bank guarantee furnished by the Indian Bank in favour of the learned Prothonotary & Senior Master of the High Court would not enjoy the benefit of moratorium as envisaged under section 14 of the Code.

The court also noted that under section 126 of the Indian Contract Act, 1872, it is provided that the person who gives the guarantee is called “surety”. In this case, sub-clause 3 of Section 14 was in moot. Under section 14(3)(b) of the Code, it is provided that the provision of Section 14(1) shall not apply to a surety in a contract of guarantee to a corporate debtor (in this case Palladian). Thus, the Court held that the corporate debtor was a surety in a contract of guarantee given to the Palladian for carrying out the acts set out in section 14(1) of the Code and therefore, section 14(1) would not apply in the case of surety in a contract of guarantee to a corporate debtor.

In Court’s view, the bank guarantee furnished by the corporate debtor in favour of Palladian was an independent transaction and was issued pursuant to a consent order passed by the Court. The said bank guarantee thus encashed was not a step in execution of any arbitral award and thus would not fall under section 14(1) of the Code and therefore can be rightly encashed.

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Thus, it is clear that in this case, the Bombay High Court has not followed the test enunciated by the Delhi High Court qua Section 14(1) in Power Grid and followed by SSMP Industries i.e. until and unless the proceeding has the effect of endangering, diminishing, dissipating or adversely impacting the assets of corporate debtor, it would not be prohibited under moratorium. One of the reasons for departing from this reasoning is that Section 14(3) in no clear terms provides an exception to the moratorium imposed under Section 14(1).

However, following Section 14(3) and Bombay High Court reasoning, if a bank guarantee provided by a corporate debtor is allowed to be encashed when it is undergoing CIRP and a moratorium is in effect then will it not impute additional stress on the assets of such corporate debtor? Further, the object of the Code is to provide relief to the corporate debtor through “standstill” period during which its assets are protected from dissipation or diminishment, and as a corollary, during which it can strengthen its financial position. Such a consequence would infact be directly contrary to the object of the Code.

The reasoning in Power Grid provides that Section 14 of the Code would not apply to the proceedings which are in the benefit of the corporate debtor. As a sequitur, what can be inferred from this ratio is that Section 14 would apply to the proceedings which are detrimental to the corporate debtor. Hence, encashment of bank guarantee which will definitely diminish such corporate debtors assets are detrimental to the interest of corporate debtor and by applying the ratio of Power Grid qua Section 14(1) in a similar way on Section 14(3) the proceedings for the encashment of bank guarantee may also be covered by moratorium.

Disclaimer: The views expressed on this post are mine and do not reflect the views of the organisation(s) I am engaged with

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