Sirpur Paper Mills: The Arbitration-Insolvency Conundrum

Pratik Sahai and Vijayaditya Reddy[i]

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In this paper, the authors evaluate the status of the claims which could not form a part of the final resolution plan as under Section 31 of the Insolvency and Bankruptcy Code, 2016 (“IBC”). This could be the case if the debt could not crystalize due to a pending Section 34 (“S.34”) challenge to the award against the corporate debtor. The questions that arise then are (i) What should be the status of the S.34 proceedings after the moratorium is lifted?; and (ii) What remedies is the creditor/award holder entitled to if the S.34 challenge is not permitted to run its course? Such a situation presented itself before the Calcutta High Court in Sirpur Paper Mills Ltd v I.K. Merchants Pvt Ltd, wherein the Court held that an award-holder who fails to lodge a claim before the Resolution Professional can no longer proceed against the award-debtor. The Court ruled that the award-holder’s claim extinguishes upon approval of the award-debtor’s resolution plan even where a challenge to the award is pending under S.34 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act”). Upon approval of the resolution plan on 16 May 2018, the moratorium was lifted on 19 July 2018, pursuant to which the S.34 proceedings were resumed. At this juncture, the corporate debtor filed an application to quash the S.34 proceedings, and the same was accepted by the Court, essentially leaving the award-holder remediless.

Interestingly, the Court dismissed the same application previously vide its January 2020 order which was affirmed in the February 2020 order. This time, the Court relied on Committee of Creditors of Essar Steel India Ltd v Satish Kumar Gupta & Ors (“Essar”) and Ghanashyam Mishra and Sons Pvt Ltd v Edelweiss Asset Reconstruction Company Ltd & Ors (“Edelweiss”) wherein the Supreme Court held that any claim which does not feature in the final list of claims shall be deemed to have been waived and extinguished upon the approval of the resolution plan under Section 31 of the IBC. However, it is submitted that the Calcutta High Court failed to consider certain material facts and made questionable observations across its orders in this matter.

This brings us to the case of K. Kishan v M/S Vijay Nirman Company Pvt Ltd (“K. Kishan”). In this case, the award-holder sought to initiate Corporate Insolvency Resolution Process (“CIRP”) when the award being relied upon had been challenged. The Supreme Court, relying on Mobilox Innovations Pvt Ltd v Kirusa Software Pvt Ltd, held that the adjudicating authority has to reject the application when there is a dispute related to the debt pending between the parties. On the facts, the Court emphasized that the debt was disputed before disallowing the petitioner from initiating CIRP but the S.34 proceedings were allowed to continue. The Court also noted that there existed counterclaims of sizeable amounts which, if ruled in the award-debtor’s favour, would materially change the liabilities of the parties. In sum, the theme evident throughout the judgment was that the IBC ought neither be used as a substitute to the debt-recovery mechanism nor be used in terrorem to extract the amount in question.

Analysis

The Calcutta High Court wrongly observed that the decision in K. Kishan does not apply to the present case. It is to be noted that the facts of the present case are different from K. Kishan in at least two ways:

i. K. Kishan dealt with a situation at the stage of admission of an application to initiate CIRP and not with a situation arising post the approval of the resolution plan;

ii. In K. Kishan, the award-holder initiated CIRP while the award-debtor sought to maintain the proceedings under S.34. In the present case, the award holder seeks to maintain the proceedings under S.34 while the award-debtor filed the present application for setting aside the pending proceedings.

However, the intended object of K. Kishan needs to be applied in this case as the verdict was delivered with the intent of disallowing operational creditors from initiating CIRP against companies as a debt recovery mechanism. The intention was not to leave award-holders remediless, as is the case here. This argument is bolstered in light of the following observations of the Court.

i. The Court had noted in its 2020 orders that the award-holder could not have filed the claim before the Resolution Professional as no adjudicated or final claim existed as on that date. This observation ignores the ruling of the Supreme Court in Swiss Ribbons Pvt Ltd v Union of India, wherein it was held that the role of a Resolution Professional is merely administrative in nature and thus, as per Sections 3(6) and 18(b) of the IBC, the Resolution Professional has to collate all claims, even if they are disputed.

ii. As observed by the Court in its May 2021 order, the award-holder’s amount in dispute was noted in the Information Memorandum as of 2014. Thus, the award-holder had participated in the CIRP and a waiver of right or estoppel argument cannot justifiably be made against the award-holder. The Court did not engage with this point any further and dismissed it merely on procedural violations. Further, contrary to its previous stance in the 2020 order, the Court ruled that the award-holder ought to have taken active steps under the IBC.

Possible means of recovery had the Section 34 proceedings not been quashed

The Court overlooked the participation of the award-holder in the CIRP whilst observing in its initial order that the submission of a claim by the award-holder was not feasible. Further, the Court erroneously quashed the S.34 proceedings thereby leaving no recourse for the award-holder to enforce his decree against the erstwhile management of the corporate debtor. However, the award-holder could proceed against the personal guarantors of the corporate debtor as per the recent case of Lalit Kumar Jain v Union of India, which upheld the constitutionality of the notification dealing with the insolvency of personal guarantors. The Supreme Court held that the approval of a resolution plan does not ipso facto discharge a personal guarantor of his or her liabilities. The guarantee given by a personal guarantor arises out of an independent contract and the release of the corporate debtor after the insolvency process does not absolve the liability of personal guarantors.

Alternatively, the award-holder could make the erstwhile promoters liable by piercing the corporate veil of the debtor company. The issue here is that while courts have entertained such a possibility at the execution stage, the law on the same is in no way settled to make directors/promoters personally liable and a case for it needs to be specifically made out which is absent here on facts. Further, this is an exceptional remedy and requires a high threshold to be met. This is rightfully the case as piercing the corporate veil or going behind the decree runs the risk of obliterating the basic distinction between a private limited company and a partnership firm in terms of the liability of its management.

A more practical recourse would have been for the Resolution Professional to take note of the disputed claim from the data available in the Information Memorandum and admit it notionally at Re. 1 as was done in the CIRP of Bhushan Steel Ltd as evident from the Bombay High Court ruling in M/S Tata Steel BSL Ltd v Varsha W/O Ajay Maheshwari & Ors. The litigation therein is comparable as the creditor resumed the summary suit for recovery of money under Order XXXVII of the Code of Civil Procedure 1908 upon lifting of the moratorium and the same was contested by the successful resolution applicant as being infructuous. It was the case of the creditor that the suit must be permitted to come to its logical end so that the exact debt amount can be crystalized and a proportionate sum can be claimed from the sum earmarked for other operational creditors in the resolution plan. The Court noted how the creditor had participated in the CIRP and therefore did not extinguish the pending litigation merely because the resolution plan was approved. It must be noted that this approach of notionally admitting disputed claims is a practice that has been affirmed by the Supreme Court in Essar and its importance is evident from the situation that arose after the Sirpur Paper Mills order which left a possibly genuine creditor stranded.

It is undisputed that the status of the debtor-company must be preserved as a ‘going concern’ and its assets must be appropriately handled. At the same time, an award-holder whose execution decree will attain finality once the process under Section 34 or 37 of the Arbitration Act comes to an end, must not be left remediless. In this case, the Court found the proceedings under S.34 to be infructuous as the resolution plan had been approved, thereby putting the award-holder in a place where he could neither proceed under the IBC nor the Arbitration Act. In crux, while it is accepted that the award had not attained finality and the corporate debtor might not owe any amount at the end of the proceedings, at the same time, the award cannot be overlooked as it might be upheld and for this reason, the proceedings under S.34 must not have been interfered with at this stage. While the order resonates with the views of the Supreme Court in Essar and Edelweiss, as far as the importance of Section 31 of the IBC is concerned, the Court has incorrectly interpreted the intended object of K. Kishan and overlooked the participation of the award-holder in the CIRP, leaving the award-holder remediless.

The Supreme Court in Essar has rightly held that an approved resolution plan is binding on all the stakeholders and this decision is in line with the spirit of the Code. However, the Supreme Court’s lapse in clarifying the status of unquantified claims has operated harshly on such creditors. The lacuna in the law as highlighted above needs to be judicially or legislatively addressed to safeguard the interests of bonafide creditors. As argued by this paper, the decision of the Supreme Court should not be interpreted so as to extinguish such claims completely. Ideally, the resolution professional should include such claims as a contingent liability and the committee of creditors has to take unquantified claims into consideration before finalising the resolution plan. It is hoped that the Supreme Court clears the air by addressing this issue with an authoritative pronouncement.

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Pratik Sahai and Vijayaditya Reddy are fifth-year students at NALSAR University of Law, Hyderabad.

Sirpur Paper Mills The Arbitration-Insolvency Conundrum (1)

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