Introduction
The Insolvency and Bankruptcy Code 2016 (“IBC”), a law that aims to ensure the time-bound and efficient resolution of insolvency and bankruptcy processes in India, includes Section 14, which establishes a moratorium period during which all legal proceedings, including arbitral proceedings, are suspended against the debtor. Additionally, Section 238 grants the code and its provisions overriding authority over other laws, serving as a basis for applying Section 14. While the power conferred by Section 238 is broad, several instances have highlighted its limitations. One such limitation can be observed in the context of the Alternative Dispute Resolution ("ADR") process as outlined under the Arbitration and Conciliation Act, 1996, where the incorporation of insolvency and bankruptcy proceedings between the ADR process, with the help of the overriding effect of Section 238 and 14, may potentially affect the welfare of both the debtor and creditor by derailment of the process and effecting the parties financially.
Considering the same, this piece analyses the relation between Sections 238 and 14, highlighting its limitation under the ADR process in insolvency and bankruptcy proceedings. Furthermore, it explores potential solutions to address these limitations by examining alternative views and approaches adopted by major jurisdictions worldwide.
Sections 238 And 14 Of The IBC, Along With Their Judicial Interpretation
Sections 238 and 14 of the IBC share a derivative relationship because the authority of the moratorium clause under section 14 which stays other proceedings under different laws, derives from Section 238. Section 238 provides overriding authority to clauses like Section 14 of the IBC in comparison to other laws. This relationship was exemplified in the Indus Biotech case, where the Supreme Court (“SC”) ruled in favour of IBC's overriding effect when deciding between the filing of an arbitration agreement under section 8 of the Arbitration and Conciliation Act, 1996 and Corporate Insolvency Resolution Process (“CIRP”) under section 7 of the IBC. The court held that the parties could refer to the arbitration only before the acceptance of the CIRP by the court, as after that, the moratorium period, provided under Section 14 comes into play, staying all other proceedings.
However, the Indus Biotech case has been criticized for its restrictive reference to ADR and violation of legal principles like the harmonious rule of interpretation, where the court must harmoniously construe the operation of both statutes within their respective domains. Like in the Central Bank of India v. State of Kerala, the SC decided not to give overriding effect to the non-obstante provisions of RDDBFI and SARFAESI over the Sales Tax statutes, noting that these statutes were designed to ensure speedy recovery for banks, not to grant them priority over first charges created by state taxation laws, thus relying on the harmonious rule of interpretation.
Moreover, the application of Sections 14 and 238 as seen in Indus Biotech, can violate the interests of both creditors and debtors. On one hand, debtors can use these provisions to avoid pre-existing obligations and agreements, while on the other, creditors can use the CIRP process and Section 14 to force debtors into insolvency proceedings even if a better option for the debtors exists through the ADR process. This concern was highlighted in Rakesh Malhotra v. Rajinder Kumar Malhotra, where the court acknowledged its responsibility to monitor unscrupulous applications made by creditors and debtors under Sections 7 and 94 of the IBC respectively. Declaring such matters as blatantly ‘non-arbitrable’ gives unchecked powers to creditors and debtors to invoke insolvency, even if there is a better option through the ADR mechanism.
To date, courts have recognized the limited application of non-obstante clauses as a general rule. Additionally, under the IBC, courts have identified the potential abuse of the process by both creditors and debtors, where the initiation of an insolvency resolution can cause a stay of other proceedings through the use of Sections 14 and 238. However, in India, there is no clear precedent in place, offering a solution or exception to this overriding issue, resulting in the formation of a grey area.
International Jurisdictions
As seen in the previous head, Sections 14 and 238 continue with the overriding power without any sort of exception mechanism in place. Considering the same, this head would analyse the practices adopted by major jurisdictions like the U.K., U.S.A., and Canada in their insolvency and bankruptcy laws to cater balance between ADR practices and insolvency and bankruptcy proceedings.
United Kingdom (U.K.)
In parallel to Section 238 of IBC, Section 130(2) of the UK Insolvency Act 1986 imposes a stay on legal proceedings (including arbitral proceedings) against a company once a winding-up order is made, requiring court’s approval for any further actions. Additionally, Section 183 of this Act further restricts creditors’ rights to execute or attach the goods, land, or debts once a winding-up order is in place.
Considering the same, in Sian Participation Corp (In Liquidation) v. Halimeda International Ltd, the UK Privy Council established that winding-up proceedings should only be stayed for arbitration if the debt is genuinely disputed on substantial grounds, which means the debt must be based on credible, real and serious issues. However, in its prior ruling of Salford Estates (No. 2) Ltd. v. Altomart Ltd. (No. 2), the proceedings were allowed a stay merely based on a debtor's non-admission of the debt, even in the absence of substantial grounds of dispute. In this case, the court respected the favourable aspect of an arbitration clause in a commercial contract, allowing parties to resolve their conflicts in a chosen forum. However, the risk of misuse of arbitration clauses to delay legitimate insolvency claims was also recognized.
Talking about moratoriums, the UK Insolvency Act, 1986 provides two types of moratoriums; the administrative moratorium and the independent moratorium. In the former, when a party enters insolvency, a moratorium is automatically imposed. In the latter, a company or an individual applies for a moratorium independent of insolvency proceedings. Both moratoriums prohibit the continuation or initiation of any legal proceeding, including arbitration, against the company, without the approval of administrators or the court.
The same was upheld in Rusant Ltd v Traxys Far East Ltd, wherein the English High Court recognized the overriding power of the administrative moratorium over arbitration and ADR proceedings, interpreting ADR proceedings as falling under legal proceedings. However, in Eco Measure Market Exchange Ltd v Quantum Climate Services Ltd, the court deviated from this general rule, allowing arbitration to proceed due to the contractual nature of the dispute. The court found that the dispute did not involve broader creditor protection issues and that arbitration would have minimal impact on the insolvency process.
United States of America (USA)
The USA bankruptcy laws do not specifically provide for non-obstante clauses; however, Section 105(a) under Title 11 of the U.S. Code (also known as the “power of court”) grants broad powers to the courts, including actions to enforce the provisions of the bankruptcy code, even if these actions contradict other laws.
Regarding the Moratorium period, Section 362, provides for an automatic stay, which halts any process whether judicial or administrative as well as any proceedings (including arbitral proceedings) related to the debtor. However, In re Drexel Burnham Lambert Inc., an American multinational investment bank was forced into bankruptcy and despite an automatic stay under Section 362, the arbitral proceedings were permitted due to their minimal effect on the bankruptcy process, illustrating the flexible application of the moratorium clause and balancing the moratorium period with arbitral proceedings.
But the same does not apply to Section 105(a), where in cases like Butner v. United States and In re Lehman Brothers Holdings Inc., the provisions of Title 11 conflicted with the state law and the court upheld the supremacy of federal bankruptcy law over the applicable state laws. Similarly, In re Enron Corporation a major energy company with numerous arbitration agreements with creditors and suppliers filed for bankruptcy, the court exercised its authority to stay arbitration proceedings under Section 105(a) if they interfered with the administration of the bankruptcy case. These cases highlight the broad discretionary power of courts to determine whether a law contradicts the bankruptcy code or whether an arbitration proceeding affects the bankruptcy process.
However, to check the court's broad jurisdiction certain rulings have placed limits on this authority. In United States v. Whiting, the court’s exclusive jurisdiction over bankruptcy-related matters was challenged. The U.S. Supreme Court ruled against unrestricted jurisdiction, stating that the powers granted under Section 105(a) must be strictly exercised within the framework of Title 11. Additionally, In re Pacific Gas and Electric Company, the court’s power to amend any pre-existing arbitration agreement in bankruptcy cases was constitutionally constrained, requiring the court to respect the contractual rights of the parties.
Canada
The Canada Bankruptcy and Insolvency Act 1985 (“BIA”) contains Section 72(1), which is similar to Section 238 of IBC. Section 72(1) addresses the application of other substantive law, stating that provisions of any other law or statute relating to property and civil rights, that are not in conflict with the BIA, will not be deemed superseded or abrogated by the provisions of this Act. This principle was upheld by the Supreme Court of Canada in Husky Oil Operations Ltd. v. Minister of National Revenue, where a conflict arose between the provincial oil and gas lien statute and the BIA’s treatment of secured creditors. The court ruled that federal bankruptcy law takes precedence over provincial statutes that are inconsistent with the BIA.
Further, Section 69(1) of the BIA provides for a moratorium period, which imposes an automatic stay of proceedings (including arbitral proceedings) against the debtor once bankruptcy is declared. This provision was upheld by the Supreme Court of Canada in Sam Lévy & Associés Inc. v. Azco Mining Inc., where arbitral proceedings including those in foreign jurisdictions, were stayed after the commencement of bankruptcy proceedings. However, there are exceptions to this moratorium. For instance, in Naylor Group Inc. v. Ellis-Don Construction Ltd., a dispute arose between two firms concerning a construction contract, where one firm went into bankruptcy. The other firm sought to continue arbitration proceedings against the bankrupt firm despite the moratorium. The Supreme Court of Canada allowed the arbitration proceedings as it had already been initiated and was not deemed to harm the integrity of the insolvency proceedings, reflecting a flexible interpretation of the moratorium clause.
Regarding exceptions to Section 72(1) of the BIA, the Alberta Court of Appeal in National Bank of Canada v. Merit Energy Ltd., adjudicated between the dispute of creditor arbitration agreement and BIA provisions, ruling that arbitration agreements that coexist with the BIA may not be overridden by it, thereby promoting a harmonious construction between them and promoting a complementary role of arbitration. Additionally, in UBS Securities Canada Inc. v. Sands Brothers Canada Ltd, the Ontario Court of Appeal allowed arbitration to proceed alongside insolvency proceedings, where core insolvency issues stayed. Still, other issues were permitted to be resolved through arbitration. This reflects the court’s “core” approach, respecting both the insolvency process and the parties' contractual obligations.
Solutions For The Limitations In Sections 14 And 238
The measures adopted by the U.K., U.S., and Canada, as discussed above, can be applied to Sections 238 and 14 through the adoption of the following measures:-
Clarifying the Positions Upon the Insolvency Stays and ADR Proceedings
Sections 238 and 14 of the IBC, which grant overriding power to insolvency proceedings over ADR clauses in pre-existing contracts, directly interfere with issues related or unrelated to the bankruptcy process. There is a need to clarify when the non-obstante clause and the moratorium should not be unnecessarily applied to ADR proceedings that are unrelated to the IBC code. The same approach can be drawn from cases such as Sian Participation Corp and Drexel Burnham Lambert Inc., where arbitration was allowed to proceed during insolvency if the debt was genuinely disputed on substantial grounds or if the arbitration proceedings had minimal impact on the insolvency process. A similar approach can be adopted in the context of Sections 238 and 14 through flexible judicial interpretation. Where even after the stay of ADR proceedings, the same may still be allowed if the subject matter does not directly interfere with the insolvency process or if the dispute is based on such substantial grounds, making it necessary to proceed in the interest of the parties to the contract.
Harmonizing ADR and Insolvency Law
Sections 238 and 14, provide overriding powers to insolvency proceedings over any other legal proceedings. However, these provisions should not be used to negate the effect of ADR proceedings. Rather the courts should harmoniously interpret the intent of these provisions to give effect to both, without rendering the other legislation outrightly futile. A similar approach can be observed in UBS Securities Canada Inc. v. Sands Brothers Canada Ltd., wherein the court allowed the continuation of “non-core matters”, which do not jeopardise the bankruptcy process via arbitration, while imposing moratorium only on the “core matters” that involved substantive rights arising from and under the Bankruptcy Code. Similarly, while the US Court permitted the arbitral proceedings in re Drexel Burnham Lambert Inc, as it had minimal effect on the bankruptcy process, it stayed arbitral proceedings in the re Enron Corporation, when they interfered with the bankruptcy proceeding. The same approach can be applied in the context of section 238 and 14, where even after the acceptance of the CIRP, arbitration may be allowed if the issue pertains to a “non-core matter” or one that does not interfere with the bankruptcy process.
Protecting against Misuse of ADR Clauses
The overriding power conferred under Sections 238 and 14 cannot be completely diluted, as allowing the usage of ADR provisions to debtors could enable them to promote their hidden interest by delaying the insolvency process, thereby affecting the rights of the creditors, as seen in the Salford Estates case. The solution lies in adopting the U.K. approach, as seen in Sian Participation Corp, where the courts addressed the misuse of arbitration clauses, by allowing arbitration only when a genuine dispute exists on substantial grounds. The same interpretation can be applied towards Sections 238 and 14, by describing substantial grounds as per the Indian context such as the bona fide nature of the case, the existence of cross-claims or set-offs, and procedural defects in contract execution. If the debtor satisfies any of these criteria, then he may be acknowledged with the establishment of substantial grounds and may be provided except the ADR proceedings. However, if he fails then the normal insolvency and bankruptcy proceedings may be allowed to proceed.
Conclusion
Hence, it can be concluded that, though Sections 238 and 14 of the IBC serve to ensure the supremacy of insolvency processes, their overriding application risks undermining the legitimate ADR mechanisms, which may potentially lead to delay of justice and the creation of imbalance between debtors and creditors. Adoption of a nuanced approach, extracting international practices like those practised in the UK, US, and Canada can offer a solution. By permitting arbitration in cases where substantial grounds exist and clarifying the positions between insolvency stays and ADR proceedings courts can harmonize insolvency and bankruptcy law with ADR proceedings. Moreover, this equilibrium can be used in the preservation of the integrity of the insolvency and bankruptcy process, while at the same time respecting parties' contractual obligations, which can help in the establishment of fairness and efficiency in the process.
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