Arbitral Award and Insolvency Proceedings: Supreme Court’s Ruling on Operational Debt

The Supreme Court of India, in the landmark case of K. Kishan vs. M/S Vijay Nirman Company Pvt. Ltd., addressed a crucial legal issue concerning the interplay between arbitration and insolvency proceedings. The primary question before the court was whether an operational debt under the Insolvency and Bankruptcy Code, 2016 (IBC) can be enforced through insolvency proceedings when an arbitral award has been passed against the operational debtor but has not yet attained finality due to pending adjudication.

This judgment has significant implications for corporate debt resolution and the use of insolvency proceedings in cases where arbitral awards are under challenge.

Background of the Case

The dispute arose between M/S Vijay Nirman Company Pvt. Ltd. (respondent) and K. Kishan (appellant) over a sub-contract agreement for road construction under a tripartite Memorandum of Understanding. Due to disagreements, the matter was referred to arbitration, and the arbitral tribunal issued an award on 21 January 2017. The key findings of the award included:

• The respondent was entitled to Rs. 1,71,98,302 arising out of certain interim payment certificates.
• The respondent was further awarded Rs. 13,56,98,624 due to higher rates of payment.
• Three cross-claims made by the appellant were rejected.

Following the award, the respondent issued a demand notice under Section 8 of the IBC on 6 February 2017, demanding payment of Rs. 1,79,00,166. The appellant disputed the claim within 10 days, stating that the amount was part of an arbitration proceeding and counterclaims had been filed.

On 20 April 2017, the appellant challenged the award by filing a petition under Section 34 of the Arbitration and Conciliation Act, 1996. Despite this, the respondent proceeded to file a petition under Section 9 of the IBC on 14 July 2017, seeking initiation of insolvency proceedings.

Arguments of the Petitioner

The petitioner, K. Kishan, challenged the initiation of insolvency proceedings on the following grounds:

• The Insolvency Code is not a substitute for debt adjudication and enforcement under other laws, including the Arbitration Act.
• The very existence of a pending Section 34 petition against the arbitral award constituted a dispute, which should have prevented insolvency proceedings under the IBC.
• The respondent’s claim was not undisputed, as the appellant had filed counterclaims that exceeded the awarded amount.
• The National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) erred in treating the arbitral award as final when it was still subject to judicial review.

Arguments of the Respondent

The respondent, M/S Vijay Nirman Company Pvt. Ltd., defended the insolvency proceedings on the basis that:

• The arbitral award had already determined the liability of the appellant, making it an operational debt under the IBC.
• The counterclaims made by the appellant had been rejected in arbitration, and their mere challenge in Section 34 proceedings did not constitute a dispute under the IBC.
• The IBC provides a summary mechanism for debt recovery, and allowing challenges under the Arbitration Act to stall insolvency proceedings would defeat the purpose of the IBC.

Supreme Court’s Observations

The Supreme Court examined the provisions of the IBC, particularly Section 9(5), and reaffirmed the principles laid down in Mobilox Innovations Pvt. Ltd. vs. Kirusa Software Pvt. Ltd. The key observations of the Court included:

• “It is clear, therefore, that once the operational creditor has filed an application, which is otherwise complete, the adjudicating authority must reject the application under Section 9(5)(ii)(d) if notice of dispute has been received by the operational creditor or there is a record of dispute in the information utility.”
• “The adjudicating authority does not need to be satisfied that the defense is likely to succeed. The court does not at this stage examine the merits of the dispute except to determine whether it is genuine and not spurious, hypothetical, or illusory.”
• “The existence of a pending Section 34 petition against an arbitral award indicates the presence of a pre-existing dispute. An operational debt under the IBC must be undisputed for insolvency proceedings to be initiated.”

Final Judgment

The Supreme Court ruled in favor of the appellant, holding that insolvency proceedings cannot be used as a means to enforce an arbitral award that is under judicial challenge. The Court set aside the NCLT and NCLAT orders, stating:

“Operational creditors cannot use the IBC prematurely or for extraneous considerations or as a substitute for regular debt enforcement procedures. An arbitral award that has been challenged under Section 34 of the Arbitration Act constitutes a dispute under the IBC, preventing the initiation of insolvency proceedings.”

With this ruling, the Supreme Court provided clarity on the interaction between the Arbitration Act and the Insolvency Code, ensuring that corporate debtors are not subjected to insolvency proceedings based on contested arbitral awards.

Petitioner Name: K. Kishan.
Respondent Name: M/S Vijay Nirman Company Pvt. Ltd..
Judgment By: Justice R.F. Nariman, Justice Indu Malhotra.
Place Of Incident: Hyderabad.
Judgment Date: 14-08-2018.

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