Supreme Court says arbitral award not operational debt

By Karthik Somasundram and Sneha Jaisingh, Bharucha & Partners

Is an arbitration award against which a challenge is pending under the Arbitration and Conciliation Act, 1996, sufficient to commence insolvency proceedings under the Insolvency and Bankruptcy Code, 2016? “No”, said the Supreme Court in K Kishan v Vijay Nirman Company Private Limited.

Karthik SomasundramPartnerBharucha & Partners
Karthik Somasundram
Bharucha & Partners

Vijay Nirman, the respondent, had entered into a sub-contractor agreement with the appellant, KCPL, an engineering and construction services company, for undertaking 50% of construction and widening of National Highway No 67. However, during the execution, there were disputes, which were referred to arbitration. The arbitral tribunal upheld two claims of Vijay Nirman – one claim for ₹17.1 million (US$166,000) and the other for ₹135.6 million. In arbitration, KCPL raised three counter-claims that were rejected. KCPL challenged the award before the commercial court in Hyderabad.

While this challenge was pending, Vijay Nirman claiming to be an operational creditor by virtue of the award, sent a statutory notice to KCPL claiming ₹17.9 million. KCPL disputed its liability as the claim amount formed the subject matter of arbitration proceedings against which KCPL’s challenge was pending in court; and as per its books Vijay Nirman was liable to pay much higher amounts. The respondent’s petition was admitted by the National Company Law Tribunal (NCLT). NCLT noted that as per the award KCPL’s counsel had admitted that the ₹17.1 million claimed by Vijay Nirman was due.

According to NCLT, the pending challenge to the award was not relevant as the court had not stayed it. KCPL appealed to National Company Law Appellate Tribunal (NCLAT), which rejected it noting that Form V of the rules under the code required particulars of an order of an arbitral tribunal adjudicating on the default and the award would have to be treated as “a record of an operational debt”. NCLAT also ruled that section 238 of the code overrode the Arbitration Act.

Sneha JaisinghManaging associateBharucha & Partners
Sneha Jaisingh
Managing associate
Bharucha & Partners

Before the Supreme Court, KCPL relied on the court’s earlier ruling in Mobilox Innovations Pvt Ltd v Kirusa Software Pvt Ltd (2018) to argue that in defense to a petition by an operational creditor, the respondent had to demonstrate the existence of a real dispute and the code was not a substitute for debt adjudication and enforcement under the Arbitration Act. Vijay Nirman argued that there had been primary adjudication before the arbitral tribunal; there was a judgment debt in its favour; and, any further appeal or challenge would not be a bona fide dispute.

Relying extensively on its Mobilox judgment and the legislative history of the code, the Supreme Court noted that the words “bona fide”, although used in the bill were dropped from the definition of “dispute” in the code, as enacted. So long as a dispute did exist, it was not spurious, hypothetical or illusory, NCLT must reject the petition. NCLT had to only see whether there was a plausible contention without investigating the merits. However, the dispute could not be a patently feeble legal argument or a factual assertion unsupported by evidence.

The court reiterated that the insolvency process cannot be used improperly; or “prematurely or for extraneous considerations or as a substitute for debt enforcement procedures”. The court also stressed the “alarming result” that would follow if the award of a small operational debt could result in the winding up of a solvent company. Operational creditors can resort to insolvency proceedings “only in clear cases where a real dispute does not exist”.

The court rejected NCLT’s reliance on the admission contained in the award that KCPL conceded to the respondent’s claim for ₹17.1 million. Any such admission was of no relevance as KCPL had raised higher counter-claims before the arbitral tribunal. In that context, the court adopted the rationale of the English judgment in Re A Company – Victory House General Partner Ltd v RGB P & C Ltd (2018) that even if a debt had been adjudicated but cross-claims are pending, a winding up order could not be passed. The court also noted the judgment of Singapore High Court in Lim PohYeoh v TS Ong Construction Pte Ltd (2016) that insolvency proceedings did not lie if the debtor had a valid counter-claim in an amount equal to or higher than the judgment debt.

The court noted that KCPL’s claims were far higher than Vijay Nirman’s claims and KCPL’s claim No. 3 had been rejected on merits, therefore, the possibility of the counter-claim being successful was sufficient to dispel the effect of admission of Vijay Nirman’s claim. The court also held that NCLAT’s reliance on section 238 of the code was wrong as there was no inconsistency between the code and the Arbitration Act.

Karthik Somasundram is a partner and Sneha Jaisingh is a managing associate at Bharucha & Partners.

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