The Insolvency and Bankruptcy Code, 2016 (Code) was introduced as a one stop solution for resolving insolvencies, which previously was a long-drawn process that did not offer an economically viable arrangement. In Swiss Ribbons Pvt. Ltd. v. Union of India, the Supreme Court of India, while upholding the constitutional legitimacy of the Code, emphasized that the Code is a “beneficial legislation which puts the corporate debtor back on its feet, not being a mere recovery legislation for creditors”. Since then, the Supreme Court in various judgements has time and again emphasised that the Code is not a recovery mechanism to recover the dues of the creditors but is rather intended to bring the corporate debtor back on its feet[i]. In the landmark judgement of Vidarbha Industries Power Ltd. v. Axis Bank Ltd. (Vidarbha Judgment), the Supreme Court held that it is not mandatory for the insolvency courts to admit an application to initiate insolvency resolution process, even if the existence of debt and default in payment of debt by the corporate debtor is established (please refer here for our views on the same). This discretion may be exercised by the insolvency courts if certain factors like, the financial health and business is still viable thereby preventing initiation of insolvency of practically solvent companies.
In the recent judgment of Shaikh Mohammed Tariq v. Aegis Forging Ltd. (Shaikh Mohammed Judgment), the National Company Law Appellate Tribunal (NCLAT) has clarified how applications to commence insolvency of the corporate debtor are to be dealt with when an arbitral award on the same subject matter has already been put into execution.
Brief Facts
Aegis Forging Ltd. (Aegis) borrowed money from some investors, for which a personal guarantee was provided by Shaikh Mohammed Tariq (Personal Guarantor). Aegis had assured the Personal Guarantor of relieving him from the liability as a guarantor and had also agreed to provide him a cash security along with interest. The terms agreed between Aegis and the Personal Guarantor were recorded in an agreement which also contained an arbitration clause. As Aegis defaulted on paying the cash security and relieving the Personal Guarantor from all the guarantees, the Personal Guarantor invoked the arbitration clause.
The arbitrator passed an arbitral award in favor of the Personal Guarantor, directing Aegis to pay the cash security amount along with interest. As no payment was made by Aegis despite the arbitral award, the Personal Guarantor initiated execution proceedings against Aegis to enable him to recover the cash security amount along with interest granted to him by the arbitral award. Simultaneously, the Personal Guarantor also filed an application before the National Company Law Tribunal (NCLT) seeking to commence insolvency of Aegis. The order of the NCLT rejecting the Personal Guarantor’s application was challenged before the NCLAT.
Findings of the NCLAT
The NCLAT took note that an arbitral award along with payment of interest had been passed in favor of the Personal Guarantor and he had already filed for executing the same. Relying on the Vidarbha Judgment, the NCLAT observed that it was not obligatory for the NCLT to initiate insolvency of debtors merely on proof of debt and default in the repayment of debt. The NCLAT dismissed the Personal Guarantor’s appeal and affirmed the dismissal order of the NCLT.
Our thoughts
Indian courts have repeatedly held that the provisions of the Code are essentially intended to help the corporate debtor stand on its feet and are not for money recovery. It should be borne in mind that recovery, unlike insolvency resolution, serves the interests of creditors on first come first served basis – the creditor initiating recovery first, realising the highest, while the one who initiates it last, realises the least. Thus, recovery does not keep the firm alive and does not balance the interests of all stakeholders. The Shaikh Mohammed Judgment is consistent with the scheme of the Code which aims to resolve the insolvency of an entity. However, this judgement should not be considered as a precedent to dismiss all insolvency applications filed by arbitral award holders. The admission of an insolvency application by such award holder is to be decided on a case-to-case basis giving due regard to the facts. Where the application has been filed because of the corporate debtor’s inability to repay its debt and to start the insolvency resolution process of the corporate debtor, then insolvency courts may allow the application. However, where the application is merely to recover the amount awarded in the arbitral award, the insolvency court may refuse to admit the application.
It should be noted that the Code provides for a moratorium i.e., a suspension on any proceedings and legal activity against the corporate debtor once insolvency is initiated. This aspect of moratorium has assumed much significance, as many execution proceedings to enforce arbitration awards have been stalled due to the onset of insolvency. The Supreme Court in Alchemist Asset Reconstruction Company Ltd. v. Hotel Gaudavan Pvt. Ltd. held that arbitrations or related proceedings commenced after initiation of insolvency proceedings are considered non-est in law. In the Shaikh Mohammed Judgment, the insolvency courts had the benefit of the arbitration award holder himself applying for insolvency of the corporate debtor. However, there might be instances where an arbitration proceeding initiated by a party against the defaulting party may be stayed due to initiation of insolvency proceedings by a third party. It practically translates to nil payment being awarded to the parties to the arbitral proceedings, leaving these parties remediless. We understand that the architects of the Code did not envisage the Code being used tangentially to defeat the enforcement of arbitration awards. Accordingly, to restore the sanctity of arbitration proceedings, it is recommended that if an award is passed in an arbitration proceeding, the corporate debtor should not be admitted into the insolvency rescue process till the time the arbitration award is not enforced under applicable law. This recommendation may be required to be qualified by the rights of financial creditors under the Code especially if such financial creditor is constituted and licensed to operate as a financial institution under the laws of India and / or other countries. We sincerely believe that unless this situation is remedied expeditiously, the bogey of moratorium will render arbitration proceedings as an ineffective remedy and further burden our judicial system.
Authors: Souvik Ganguly and Altamash Qureshi
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[i] Essar Steel (India) Limited. v. Satish Kumar Gupta, Action Ispat & Power Private Limited v. Shyam Metalics & Energy Limited, P. Mohanraj v. Shah Bros. ISPAT Private Limited.