The Supreme court on March 26, 2021 settled the most debatable issue among the legal fraternity regarding the relationship between arbitration and insolvency in the case of Indus Biotech Private Limited v Kotak India Venture (Offshore) Fund & Or [1] and held on an application under 7 of IBC brought before NCLT, it must first ascertain the presence of "default" within IBC and it is only after such default is proven, that the issue cannot be referred to arbitration.

Factual Background
Indus Biotech Pvt. Ltd. (hereinafter referred as Indus) filed an application in the Supreme Court under  11 of the Arbitration and Conciliation Act, 1996 for appointment of the arbitral tribunal against Kotak India Venture (hereinafter referred as Kotak) as per Share Subscription and Shareholder agreement (hereinafter referred as SSSA) signed between the parties in 2017 which included the included the arbitration clause.. Under SSSA, Kotak India subscribed to Optionally Convertible Redeemable Preference Shares (hereinafter referred to as OCRPS) issued by Indus

In 2018 , Kotak decided to convert OCRPS into equity shares in order to make Qualified Initial Public Offering (QIPO). However, during the conversion process, a dispute arose between the parties w.r.t., calculation and conversion formula used for the conversion of OCRPS into Equity share.

According to the formula sought to be applied by Kotak , they were to be given approximately 30% of the paid-up share capital of Indus, whereas, according to the formula sought to be applied by Indus, Kotak would get 10% of the total paid-up share capital of Indus Thereinafter, Indus refused to pay the redemption amount to Kotak giving rise to the dispute. Kotak thereby filed a petition with the National Company Law Tribunal , Mumbai ("NCLT") under 7 of IBC to initiate the corporate insolvency process against Indus

Subsequently, in response, Indus filed an interlocutory application before NCLT requesting the matter to be referred to arbitration[2] by invoking the arbitration clause in the SSSA, contending that the application filed by Kotak be dismissed and the parties be referred to arbitration.

NCLT's Decision

The NCLT observed that for an application filed under  7 of IBC, the tribunal must first determine whether there has been a "default" within the meaning of  3(12) of the IBC. The tribunal further observed that Indus was a solvent, financially sound and profitable company and that no default had occurred in the instant case since, the dispute between the parties was purely of contractual nature .Therefore the parties should be referred to arbitration, henceforth, dismissing the Insolvency application.

In response to the NCLT's decision, Kotak petitioned the Supreme Court by SPL u/a 136 of the Constitution arguing that the subject matter of the dispute in the instant case was a matter in rem and, as such, not arbitrable. Indus, on the other hand affirming to NCLT's approach asserted that since there was no default under the Code as per 3(12) of the Insolvency and Bankruptcy Code, the dispute should be referred to arbitration.

Supreme Court's Decision
At the outset before proceeding, the Court clarified that under normal circumstances appeal for order passed by NCLT under 7 of the IBC would have been heard by NCLT but since  11 petition was already pending before the Court at the time the NCLT made its order, the Court is hearing the matter on merits.

1. Whether the NCLT was justified in issuing an order u/s 8 of Arbitration act for petition filed under  7 of the IBC?
   Reliance was laced by Court on the case of Vidya Drolia v. Durga Trading Corporation[3] and upholding the decision of NCLT, it was held that a mere existence of a debt is not a determining factor for the establishment of a default.
   
   A proceeding under  7 petition of the Insolvency and Bankruptcy Code becomes a proceeding in rem only after the adjudicating authority has determined the existence of a "default" as per 3(12) of IBC which then leads to the creation of third party rights in favour of all creditors of the corporate debtor, thus having an erga omnes effect on the admission of which the dispute becomes inarbitrable.
   
   Accordingly, in the instant case, the Supreme Court held that since that primary dispute between the parties was regarding the conversion formula to be adopted for the conversion of the preference shares to equity shares was potentially a contractual matter and at the given stage it was premature to determine if default had actually occurred as per 3(12) of IBC. Therefore, the Supreme Court upholding the decision of NCLT citing that default could not be established, dismissed the petition under 7 IBC and allowed the application under 8 of the Act.
    
2. If there are different arbitration agreements and one of the respondents is a foreign corporation, can a single arbitral panel be appointed?
   The Supreme Court held that since the petition under � 7 of the IBC was correctly dismissed, the petition under � 11 of the Arbitration Act is maintainable . The Court taking into consideration the M/s Duro Felguera v. M/s Gangavaram Port Ltd[4]., case held that a single arbitral tribunal cannot be constituted when the parties have entered into separate arbitration agreements.
   
   However, taking into consideration the fact and circumstances of the case and resemblance in the nature of disputes among different arbitration agreements, the court held that different arbitral tribunals should be constituted , however the members of the tribunal can be the same. But for the international arbitration proceedings a separate tribunal should be constituted.

Judgemnt Analysis

1. The absence of a "default" and its impact on a � 8 application
   The Court in the case of Indus Biotech correctly observed that the decision taken by NCLT and held that the court must prima facia decide on the question of default in an application filed under 7 of IBC taking into consideration the facts and circumstances of the case and material placed on record and if the NCLT determines that no default exists as per 3(12) , the parties are free to secure the appointment of the Arbitral Tribunal through an appropriate legal proceeding.
    
2. Arbitrability of dispute
   Initially before Indus Biotech case , the arbitarbility and non-arbitrability of dispute has been dealt in detail in Booz Allen and Hamilton Inc. v. SBI Home Finance Ltd.[5] which was a celebrated judgement of the time for determing the arbitrability of the dispute wherein the Supreme Court distinguished using the right-based formula approach between the rights as rights in personam which were held to be arbitrable and rights in rem which were characterized as being inarbitrable.
   
   The court thereafter in the case of Vidya Drolia II[6] laid down the following test to determine as to when a dispute becomes inarbitrable:
   
   
   1. i. It relates to actions in rem or actions that do not pertain to subordinate rights in personam that arise from rights in rem; or
   2. ii. It relates to actions that do not pertain to subordinate rights in personam that arise from rights in rem. It affects third-party rights; has erga omnes effect; necessitates centralized adjudication, and mutual adjudication would be ineffective and unenforceable.
   3. iii. It relates to the state's inalienable sovereign and public interest functions; and
   4. iv. It is expressly or impliedly non-arbitrable under mandatory statute.
   
   Recently, the court in the Indus Biotech case placing reliance upon the exhaustive test laid down in Vidya Drolia II recognised the dispute does not become inarbitrable merely by filing an application , it is only when there is admission of default on the part of the corporate debtor as per 3(12) of IBC that the third party rights are created which have an erga omnes effect due to which the dispute becomes inarbitrable and not due to the mere involvement of rights in rem.
    
3. Avoiding unnecessary delay in proceedings by forum shopping
   By holding that an insolvency proceeding becomes in rem only upon admission, the Court in Indus Biotech arguably established a system that would prevent forum shopping and help in avoiding unnecessary delay in arbitration proceedings due to frivolous applications.

Therefore, by the clarification given by the court in Indus Biotech case , an insolvency application would no longer allow a financial/operational creditor to avoid arbitration. The NCLT would have to first determine whether there is a default under 3(12) IBC , and if there isn't, the dispute could be referred to arbitration.

End-Notes:

1. Indus Biotech Private Limited v Kotak India Venture (Offshore) Fund and Or, MANU/SC/0231/2021
2. 8 of the Arbitration and Conciliation Act, 1996
3. Vidya Drolia and Or v Durga Trading Corporation, MANU/SCOR/25691/2018
4. (2017) 9 SCC 729
5. Booz Allen & Hamilton v. SBI Home Finance Ltd, MANU/SC/0533/2011
6. Vidya Drolia and Or v Durga Trading Corporation, MANU/SCOR/25691/2018

Written By: Sehar Sharma, LL.M student at Mahrashtra National Law University, Mumbai)