Effect of Moratorium on Arbitration Proceedings

Introduction

Insolvency and Bankruptcy Code, 2016 (IBC/Code) which received presidential assent on 25th May, 2016 is considered as the game-changer in the ‘debt recovery of the distressed entities’ regime. The focus herein is on two major laws governing the corporations in India and around the globe, namely the Insolvency and Bankruptcy Code, 2016 and the Arbitration and Conciliation Act of 1996. On admission of an insolvency application, Section 14(1) of the Insolvency and Bankruptcy Code 2016 (IBC) requires the National Company Law Tribunal (NCLT) to declare a ‘moratorium’. 

The present Code came into force with an objective to realise the maximum value of any distressed entity through expertise and strategies. One of the most important features of the Code is the concept of ‘moratorium’. Section 14 of the Code talks about the moratorium and its effect on any proceeding. The moratorium provides the ‘calm period’ which is to ensure that the already economically distressed corporate debtor maximises the realisation of the assets. Further, the moratorium should also ensure a fruitful resolution without worrying about the disbursal of further assets in parallel proceedings, if any. 

This article shall discuss and analyse several such proceedings which are suspended during the enforcement of a moratorium. Before indulging in the different types of proceedings a basic understanding of the concept and objective of a moratorium is necessary. 

Meaning of Moratorium

A moratorium is a suspension or stay on any legal activity against a particular person. It provides a temporary break from any legal proceedings or trial against the person. Section 14 of the Code imposes an implied Moratorium in favour of any corporate debtor against whom Insolvency proceedings are initiated. 

Objective of Moratorium

The Hon’ble Supreme Court referring to the Report of Insolvency Law Committee of February 2020 iterated the objective of the moratorium which is to “form a scheme which shields the corporate debtor from pecuniary attacks against it in the moratorium period so that the corporate debtor gets breathing space to continue as a going concern in order to ultimately rehabilitate itself.” Thus, the moratorium provides a defence to the corporate debtor by creating a bar on several parallel proceedings and allows a corporate debtor to maximise the value of the company without further encumbrances.

Further, the legislative intent behind introducing the provision of a moratorium was to bar termination or suspension of several grants such as licenses, permits, quotas, concessions by the Government authorities as these grants are fundamental to the operation of any company and to realize the maximum value of any company as a going concern. 

As we discuss the importance of a moratorium in any insolvency proceeding, a careful look at the effect of a moratorium on parallel proceedings under different legislations is required.

Meaning of the term ‘Proceedings’

The word ‘proceedings’ as mentioned in section 14 has proved to be of utmost importance in deciding the nature of cases barred by the section. On multiple occasions, the court has included all sorts of proceedings within the ambit of ‘Proceedings’ thereby granting a suspension on non-corporate affairs of the company as well. This interpretation completely defeats the purpose of sections that seek to protect against financial re-payments and debt, not all sorts of liabilities. The courts finally settled this controversy in the Power Grid Corporation case[1] wherein the court held that the Purposive rule of interpretation shall be applied, stating that the ambit of Section 14 is limited to merely recovering debts against the corporate debtor, and shall not be deemed to be inclusive of ‘all sorts of Proceedings’.

Exception to Moratorium

The courts have attempted to create exceptions to these provisions by way of judicial assessment in the case of Deccan Chronicle[2], where the tribunal held that a moratorium does not imply absolutely and is restricted to Tribunals, however, any proceedings covered under Article 32, 136, 226 and 227 presented before the High Court or Supreme Court will form an exception to the application of moratorium. Furthermore, this power of the Supreme and High Court cannot be curtailed by any provisions of the Act.

Proceedings under Section 138 of Negotiable Instruments Act, 1881 (NI Act)

Until recently, proceedings under Section 138 of NI Act, 1881 was an exception to the moratorium when the NCLAT in the case of Shah Brothers Ispat Pvt. Ltd. v. P. Mohanraj & Ors.[3], allowed Section 138 of NI Act proceedings to continue during the moratorium.

However, on appeal to the Supreme Court, the Apex Court in a three-judge bench ruling, held that where an order of moratorium is passed by the Adjudicating Authority in an insolvency petition, in such cases parallel proceedings under Section 138 of the Negotiable Instrument Act,1881 shall be suspended. 

The Supreme Court of India gave emphasis on the legislative intent of moratorium behind such a decision and stated that it is now a settled position that the parallel proceedings under Section 138 of NI Act shall not be allowed to continue. In an explanation of Chapter XVII of the Negotiable Instruments Act, 1881, the apex court held that “it is clear that a quasi-criminal proceeding that is contained in Chapter XVII of the Negotiable Instruments Act would, given the object and context of Section14 of the IBC, amount to a “proceeding” within the meaning of Section 14(1)(a), the moratorium therefore attaching to such proceeding”.

Thus, the Supreme Court deferred from the NCLAT’s reasoning and interpretation of Section 138 of NI Act,1881 in Shah Brothers judgement[4] and settled the conflicting position on the effect of the moratorium on Section 138 of NI Act,1881 proceedings.

Proceedings under Prevention of Money Laundering Act, 2002 (PMLA) 

PMLA was enacted keeping in mind the international commitments to ensure the prevention of money laundering for illegal activities. Interestingly, both PMLA and IBC provides for the non-obstante clauses which provide for the overriding effect over other laws applicable inconsistent with them. Hence, a peculiar contention came up with IBC vis-à-vis PMLA. In the case of Sterling Sez Infrastructure Ltd. v. Deputy Director, Directorate of Enforcement, Prevention of Money Laundering Act[5] NCLT Mumbai discussed the conflict between the two acts, wherein the property of the Corporate Debtor was attached by the authorities vide the powers of PMLA. Later, an application for initiation of the corporate insolvency resolution process was filed by the financial creditor under Section 7 of IBC.

The NCLT upheld the primacy of IBC by relying on the interpretation of the objective and purport of IBC which is the resolution of the Corporate Debtor by maximizing the value that can be received by the creditors and stakeholders and thereby upholding the importance of moratorium under section 14 of the code. The importance of moratorium was also emphasized in the case of Punjab National Bank v. Deputy Director, Directorate of Enforcement, Raipur[6] where it was held that if a moratorium under IBC is in effect, then the attachments of assets of the corporate debtor under PMLA cannot be made.

 

Proceedings under Arbitration

Bar on arbitration proceeding during the moratorium period under IBC has long been a bone of contention. With divergent views of High Courts, the position of suspension of arbitral proceedings was fairly ambiguous. The answer to this issue was finally resolved in Alchemist Case[7] wherein the Supreme Court held that any Arbitration initiated after the imposition of Moratorium shall immediately become non-est in law. In the present case, Moratorium was declared in favour of the insolvent party, and the case was directed towards arbitration owing to the contractual obligation. The tribunal held that in lieu of Section 14, the adjudicators are mandated to declare a moratorium on any and every proceeding, including arbitration proceedings against the corporate debtor. Therefore, in the above case, the Arbitration proceedings were suspended immediately after insolvency commencement. The case of K.S. Oils Ltd. v. State Trade Corporation of India Ltd. & Anr.[8] further clarified that Arbitration proceedings can be initiated against the corporate debtor, however, if the result of the proceedings leads to recovery of debt, then the corporate debtor will be exempted from the same. Let us look at the relation between several arbitral proceedings and moratorium under IBC.

Bar on Section 34 of Arbitration and Conciliation Act, 1996 Proceedings 

Post arbitral proceedings are when an award given by the tribunal is challenged and is pending under Section 34 or Section 36 of the Act, 1996 wherein the position of suspension of arbitral proceedings under Section 34 of the was fairly ambiguous. Section 34 offers recourse to the parties by allowing applications to set aside the arbitral awards. In a Delhi High Court judgement, it was held that the Section 34 proceeding for an application for setting aside an arbitral award shall not be barred due to moratorium. The court stated that by the reading of Section 14(1) of IBC it is evident that ‘proceedings’ shall not include every proceeding. Careful exclusion of the term ‘by or against the corporate debtor’ implies that awards that benefits the corporate debtor shall not be hit by Section 14 of IBC provisions. Therefore, the continuation of proceedings under section 34 of the Arbitration and Conciliation Act,1996 which do not result in endangering, diminishing, dissipating or adversely impacting the assets of the corporate debtor are not prohibited under section 14(1) (a) of the Code.

The Supreme Court of India in the case of P. Mohanraj & Ors. v. Shah Brothers Ispat Pvt. Ltd.[9]  held that the position in Delhi High Court judgement “does not state the law correctly as it is clear that a Section 34 proceeding is certainly a proceeding against the corporate debtor which may result in an arbitral award against the corporate debtor being upheld, as a result of which, monies would then be payable by the corporate debtor.” Thus it is now a settled position that Section 34 of the Arbitration and Conciliation Act, 1996 shall be barred during the continuance of moratorium against the corporate debtor.

Bar on counterclaims proceedings

This peculiar question on the sustainability of counterclaims in arbitration during moratorium came before the NCLAT in the case of Jharkhand Bijli Vitran Nigam Ltd. v. IVRCL (Corporate Debtor) & Anr.[10] wherein the question arises whether a counterclaim can proceed during the continuance of moratorium especially when the adjudicating authority under the Code allowed the corporate debtor to pursue the claim. The appellate tribunal held that the claims can proceed however the tribunal held that if on determination, it is found that the Corporate Debtor is liable to pay a certain amount, in such case, no recovery can be made during the period of moratorium further relied on in the case of, SSMP Industries v. Perkan Food Processors (SSMP Industries)[11].

Interestingly this judgement differs from the views taken in cases like P. Mohanraj and K.S. Oils Ltd. where a general bar on arbitral proceedings during the continuation of a moratorium was placed. Therefore, it can be easily concluded that the clear position of law on arbitration proceedings vis-à-vis moratorium under IBC is not available. 

Proceedings under Writs

Usually, the moratorium places a suspension on most of the parallel proceedings which is by or against the corporate debtor but when it comes to writ petitions either under Article 32 or Article 226 of the Constitution of India for the Supreme Court and the High Court’s respectively a clear exception is created. Although the bare reading of the provision doesn’t provide for any such exception. However, the nature of such petitions as interpreted by the courts is that the constitutional powers and rights are immune to the moratorium provisions.

The same was held in the case of Canara Bank v. Deccan Chronicle Holdings Limited[12] where the appellant filed an appeal to the NCLAT against the impugned order passed by the adjudicating authority for creating a bar on the proceedings for the recovering of amount. Appellant contended that Adjudicating Authority does not have authority to exclude the jurisdiction of courts including the High Court and the Supreme Court. NCLAT held that ‘moratorium’ shall not affect any suit or case which is pending before the Supreme Court of India pursuant to Article 32 of the Constitution of India or pursuant to Article 136 of the Constitution of India. The jurisdiction of the High Court under Article 226 of the Constitution of India would also not be impaired by the moratorium. 

Conclusion

The intent behind the inclusion of moratorium under IBC and non-obstante clause under section 238 of IBC is to provide a breathing space to the distressed corporate debtor and to put a cork on further depletion of the debtor’s resources and assets. The period of moratorium also allows the corporate debtor to formulate the best suitable resolution plan as the provisions of IBC and to realise the maximum value of the company’s assets. Keeping in mind the same reasoning courts have upheld the supremacy of moratorium under IBC in various parallel proceedings. There are a few lacunas and conflicts still pending which needs to be addressed by the courts however the current position puts moratorium provisions on a higher pedestal as compared to several other legislations.

[1].    O.M.P.(COMM.) 397/2016 reported in REED 2017 Del 12676.
[2].    2017 SCC OnLine NCLAT 255.
[3].    Company Appeal (AT) (Insolvency) No. 306 of 2018 reported in REED 2018 NCLAT Del 07507.
[4].    REED 2018 NCLAT Del 07507.
[5].    M.A 1280/2018 in C.P. 405/ 2018.
[6].    (FPA-PMLA-2633/RP/2018).
[7].    REED 2017 SC 10628.
[8].    Company Appeal (AT) Insolvency No. 284 of 2017 (NCLAT).
[9].    REED 2018 NCLAT Del 07507.
[10].  Company Appeal (AT)(Insolvency) No.285 of 2018.
[11].  CS (COMM) 470/2016.
[12].  Company Appeal (AT) (Insolvency) No. 147 of 2017 reported in REED 2017 NCLAT Del 09510.