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September 2018

Pendency of objections to an arbitral award amounts to a dispute for the purposes of section 9 of IBC

by Ankit Parhar

Recently, in K. Kishan v. Vijay Nirman Company Pvt. Ltd. [See endnote. 1] the Supreme Court had an occasion to decide whether the provisions of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) can be invoked in respect of an Operational Debt where an Arbitral Award has been passed in favour of the Operational Creditor in respect of such Operational Debt, but, the objections against the said Arbitral Award are pending under Section 34 of the Arbitration & Conciliation Act, 1996 (‘A&C Act’).

The facts before the Supreme Court were that VNCP had entered into a sub-contract with KCPL on 01-02-2008, to undertake 50% of Section 2 work of ‘Construction and widening of the existing two lane highway to four lanes on NH 67 at KM 190000 to KM 218215 admeasuring a total of 28.215 KM for and on behalf of KCPL.’ Apart from this Agreement, a separate agreement of the same date was entered into between the KPCL and one SDM Projects as a result of which, a tripartite Memorandum of Understanding was entered into on 09-05-2008 between KCPL, SDM Projects and VNCP.

During the course of the project, certain disputes arose between the parties. The said disputes were referred to arbitration. The Arbitral Tribunal delivered an Award dated 21.01.2017. The Arbitral Tribunal allowed one of the claims of VNCP for a sum of Rs. 1,71,98,302/- and another claim for a sum of Rs. 13,56,98,624/-. Three cross claims that were made by KCPL were rejected.

Thereafter, a notice under Section 8 of the IBC dated 06.02.2017 was sent by VNCP to KCPL to pay an amount of Rs. 1,79,00,166/-. KCPL responded on 16.02.2017 and disputed the invoice that was referred to in the said notice, stating that the said amount was, in fact, the subject-matter of an arbitration proceeding, and as per KCPL’s accounts, VNCP was liable to pay larger amounts to them which were claimed in counter-claims before the Arbitral Tribunal. Subsequently, KCPL filed its objections under Section 34 of the A&C Act challenging the Arbitral Award.

After the filing of the objections by KCPL, VNCP filed a petition under Section 9 of the IBC on 14.07.2017 before the NCLT. In the said petition, VNCP stated that as the amount claimed by it formed part of the Award, it has become an Operational Debt. On the other hand, KCPL submitted that the alleged Operational Debt was disputed all along and that it has also raised its counter-claims for much higher sums. It was also stated that KCPL has filed its objections against the Award under Section 34 of the A&C Act, which were pending and if its objections were allowed and its counter claims were awarded, KCPL would have to make recoveries from VNCP and not the other way around.

The NCLT, by its order dated 29.08.2017, held that as the counsel for the KCPL was fair enough to admit that VNCP is entitled to the said sum of Rs. 1,71,98,302/-. According to the NCLT, the fact that a Section 34 petition was pending was irrelevant for the reason that the claim stood admitted, and there was no stay of the Award. For these reasons, the Section 9 petition was admitted by the NCLT.

Being aggrieved, KCPL filed an appeal before the NCLAT. The NCLAT held that the non-obstante clause contained in Section 238 of the IBC would override the A&C Act. The NCLAT also held that since Form V of Part 5 of the Insolvency & Bankruptcy (Application to Adjudicating Authority) Rules, 2016 requires the particulars of an order of an arbitral panel adjudicating on the default, this would have to be treated as “a record of an operational debt”, as a result of which the petition would have to be admitted. Accordingly, the appeal by KCPL was dismissed.

KCPL came in appeal before the Supreme Court. The parties made various submissions before the Supreme Court. Ultimately, the Supreme Court followed its decision in Mobilox Innovations Private Limited v. Kirusa Software Private Limited[See endnote. 2] and held that the mere factum of challenge of an Arbitral Award under Section 34 of the A&C Act would be sufficient to state that the Corporate Debtor disputes the Award and that such a case would be treated as a case of a pre-existing ongoing dispute.

As far as the non-obstante clause contained in Section 238 of the IBC is concerned, the Supreme Court observed that Section 238 of the IBC would apply in case there is an inconsistency between the IBC and the A&C Act. However, the Supreme Court held that there was no such inconsistency demonstrated in the present case.

Therefore, the Supreme Court held that the pendency of objections under Section 34 or of an appeal under Section 37 of the A&C Act will render the subject matter of the award as a ‘disputed debt’ for the purposes of the IBC and an Operational Creditor cannot invoke the provisions of the IBC to initiate the Corporate Insolvency Resolution Process against a Corporate Debtor.

The facts in Mobilox were that Mobilox was engaged by Star TV for conducting the televoting for one of its reality shows. Mobilox, in turn, sub-contracted the work to Kirusa. Kirusa provided the requisite services and raised monthly invoices. Mobilox and Kirusa also entered into a non-disclosure agreement (NDA). Mobilox withheld payments of the invoices on the ground that Kirusa had breached the NDA by disclosing the fact that it had worked for the said reality show run by Star TV on its website. Various letters and notices were exchanged between the parties. Ultimately, Kirusa filed a petition under the IBC against Mobilox for non-payment of its Operational Debt.

The NCLT dismissed the petition filed by Kirusa on the ground that Mobilox had issued a notice of dispute and the petition was hit by Section 9(5)(II)(d) of the IBC. Kirusa filed an appeal before the NCLAT. The NCLAT held that the defence raised by Mobilox was vague and motivated to evade the liability and allowed the appeal.

Mobilox filed an appeal before the Supreme Court. The Supreme Court held that in cases of an Operational Debt, what is important is that the existence of the dispute or the suit or arbitration proceedings in respect thereof must exist before the receipt of the demand notice. The Supreme Court held that the NCLT has to examine whether:

  1. There is an Operational Debt as defined under the IBC?
  2. The documentary evidence shows that the Operational Debt is due and payable?
  3. There is existence of a dispute between the parties or the record of the pendency of a suit / arbitration filed before the receipt of the demand notice?

The Supreme Court held that in case any one of the said conditions is lacking, the application would have to be rejected. The Supreme Court also held that the word “and” occurring in Section 8(2)(a) of the IBC must be read as “or” as an anomalous situation would arise as disputes would only stave off the bankruptcy process if they are already pending in a suit / arbitration and not otherwise.

In this background, the Supreme Court had held that once the Operational Creditor has filed an application, which is otherwise complete, the NCLT must reject the application under Section 9(5)(2)(d) if notice of dispute has been received by the operational creditor or if there is a record of dispute in the information utility. The Supreme Court had further held that such notice of dispute must bring to the notice of the Operational Creditor the existence of a dispute ‘or’ the fact that a suit or arbitration proceeding relating to a dispute is pending between the parties.

The Supreme Court had also held that all that the NCLT is to see at the stage of admission is whether there is a plausible contention which requires further investigation and that the dispute is not a patently feeble legal argument or an assertion of fact unsupported by evidence. It was also held that at the stage of admission, the NCLT does not need to be satisfied that the defence is likely to succeed. The Supreme Court went on to hold that “So long as a dispute truly exists in fact and is not spurious, hypothetical or illusory, the adjudicating authority has to reject the application.”

The Supreme Court also took note that the original definition of a “dispute” as provided in the bill, which ultimately became the code, has now become more inclusive as the word “bona fide” appearing before “suit or arbitration proceedings” in Section 8 of the IBC has been deleted. Consequently, all disputes (not necessarily bona fide disputes) will also be considered as “dispute” to deny an Operational creditor the right to invoke the jurisdiction of NCLT under the IBC.

Though the judgments in K. Kishan and Mobilox bring some clarity on the meaning of a ‘dispute’ in respect of the Operational Debt, the concept still remains rather subjective and it will have to be determined in the facts of each case whether the dispute truly exists in fact and is not spurious, hypothetical or illusory.

[The author is a Joint Partner, in Commercial Dispute Resolution practice, Lakshmikumaran & Sridharan, New Delhi]

 

Endnote:-

  1. Civil Appeal No. 21824 of 2017 decided on 14.08.2018
  2. (2018) 1 SCC 353

 

 

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