Posted in Insolvency and Bankruptcy Law

Scope of Moratorium under Insolvency and Bankruptcy Code, 2016: Arbitration and the Test of Detrimental Effect

It is an interesting observation in the realm of insolvency that the subject of moratorium under Section 14 of the Insolvency and Bankruptcy Code, 2016 (“Code”) has seen many instances of interpretation. The specific issue most of the times relates to the exclusion or inclusion of a particular proceeding under the ambit of moratorium.

The aim and function of a Moratorium is defined under Bankruptcy Law Reform Committee Report as:

One of the goals of having an insolvency law is to ensure the suspension of debt collection actions by the creditors, and provide time for the debtors and creditors to re-negotiate their contract. This requires a moratorium period in which there is no collection or other action by creditors against debtors.[1]

The case of Alchemist Asset Reconstruction Company Limited vs. M/s. Hotel Gaudavan Private Limited & others[2] is yet another pertinent judgement on the subject of moratorium. It has cleared a conundrum regarding clash of arbitration with insolvency proceedings under the Code. Before the analysis of the case is done it is important to know the facts of the case. The facts of the case, in brief, were as :-

Facts of the case

  1. Hotel Gaudavan Private Limited (“Corporate Debtor”) was given a loan of Rs 24,00,00,000 (Rupees Twenty Four Crore only) and limited credit of INR 1,00,00,000 (Rupees One Crore only) by the State Bank of India (“SBI”) (“Financial Creditor”) on January 4, 2008.
  2. The Corporate Debtor became irregular on repaying the loan and interest amount.
  3. Subsequently, the bank looking at the irregularity gave notice to the Corporate Debtor calling back the loan amount. A petition was filed before the Debt Recovery Tribunal, Jaipur, (“DRT”) to recover the amount of loan.
  4. State Bank of India (“SBI”) through an assignment agreement under Section 5 of the Securities and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 assigned the debt of the Corporate Debtor to a company named as Alchemist Asset Reconstruction Company Limited.
  5. In effect, the Financial Creditor had replaced SBI in the ongoing proceedings in DRT, Jaipur.
  6. The Financial Creditor then approached the Principal Bench of the National Company Law Tribunal at New Delhi by making an application under Section 7 of Code. This application was accepted and admitted by the bench and the tribunal declared Moratorium against Corporate Debtor under Section 14 of Code.
  7. Once the Moratorium was declared, the Corporate Debtor invoked the arbitration clause between the Financial Creditor and the Corporate Debtor and appointed an arbitrator as per the loan agreement.
  8. The bench decided that the appointment of an arbitrator and the arbitration proceeding were unlawful and not tenable. Moreover, the bench restrained from holding any arbitration proceeding against the Corporate Debtor.
  9. Even after the above ruling, the Corporate Debtor filed an appeal before the District Court of Jaisalmer, Rajasthan under Section 37 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act, 1996”) and the court passed an order for the appeal to be registered and a notice seeking reply was issued.
  10. It was against the admission of this application that an appeal was preferred before the Supreme Court.

Findings of the Supreme Court

The Court observed that the mandate of the Code is that the moment an insolvency petition is admitted, the moratorium period stands initiated under Section 14 (1) (a) of the Code, and then it bars any admission of fresh proceedings or continuation of any pending suit against a Corporate Debtor.

Section 14(1)(a) of the Code reads as:-

“14. (1) Subject to provisions of sub-sections (2) and (3), on the insolvency commencement date, the Adjudicating Authority shall by order declare moratorium for prohibiting all of the following, namely-

  1. The institution of suits or continuation of pending suits or proceedings against the corporate debtor including execution of any judgment, decree or order in any court of law, tribunal, arbitration panel or other authority”

The court observed that the effect of Section 14 (1) (a) is that the arbitration that has been instituted after the Moratorium is “non est” in law. On such findings, the Court set aside the order of the District Court of Jaisalmer.

Analysis

The issue in such cases relates to the word “proceedings” used in Section 14(1)(a) of the Code, that it be interpreted so as to include ‘all legal proceedings’ or should it be construed to mean a particular or specific type of legal proceeding such as debt recovery proceedings which may have a detrimental effect on the debtor’s assets during the ongoing insolvency proceedings.

The plain reading of Section 14 makes it clear that it includes legal proceedings of any nature. The intention of the legislature with regards to moratorium is that there must be a standstill period during which actions of debt recovery cannot be initiated against the debtor. If any legal action against the debtor is allowed it will nullify the very object of the insolvency proceedings under the Code.

The issue of arbitration proceedings as against the period of moratorium arose earlier in the case of Power Grid Corporation of India Ltd. v. Jyoti Structures Ltd.[3]  In this case, a petition was filed under Section 34 of the Arbitration and Conciliation Act, 1996, for setting aside the arbitral award passed by the arbitral tribunal in favour of a Corporate Debtor. The locus classicus argument given by the respondent (Corporate Debtor) was that if the arbitration proceedings are stayed, the respondent would be unable to execute the arbitration award and recover his own debts, thereby further affecting his financial condition.

Delhi High Court ruled in the favour of the respondent and also observed that the object of the Code is to provide relief to the corporate debtor by providing a standstill period and as a supplement, during which it can strengthen its financial position to pay off the debts. It was observed that rendering the award not executable would prevent the corporate debtor from recovering money due to it and adding to its financial woes. Thus, moratorium under Section 14 of the Code would not apply to the proceedings which are for the benefit of the corporate debtor as these proceedings cannot be labelled as a debt recovery action.

Therefore, whether a moratorium under Section 14 of the Code shall apply in arbitration proceedings ultimately depends upon the nature of arbitration proceedings and peculiar facts and circumstances of each case, if the proceedings are in detriment to the financial position of the Corporate Debtor the moratorium shall have an effect and in case it does not have such an effect the moratorium shall not apply.

[1] The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design, November 2015.

[2] Alchemist Asset Reconstruction Company Limited vs. M/s. Hotel Gaudavan Private Limited & others (IB)-23(PB)/2017, decided on 13.12.2017.

[3] Power Grid Corporation of India Ltd. v. Jyoti Structures Ltd, O.M.P. (COMM) 397/2016, decided on 19.12.2017.


ABOUT THE AUTHOR

Jai Bajpai

Capture

Jai Bajpai is a student at School of Law, University of Petroleum and Energy Studies, Dehradun.

Author:

A project by Law Matters Centre for Research, Education, and Social Action (LaMCRESA).

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s