Arbitrability of Notional Claims: Dilemma for Creditors?
Adv. Vishesh Gupta
Upcoming LL.M Candidate at London School of Economics
Introduction
The clean slate theory has been a well-established IBC principle laid down by the Supreme Court (SC) in the Committee of Creditors of Essar Steel India Limited through Authorised Signatory v. Satish Kumar Gupta & Ors.[1] (Satish Kumar) and upheld in Ghanashyam Mishra and Sons Pvt. Ltd. v. Edelweiss Asset Reconstruction Company Ltd.[2] (Ghanashyam). According to this theory, once the resolution plan is passed, all the claims against the corporate debtor are extinguished, and the resolution applicant gets a fresh start. The Delhi High Court in IOCL v. Arcelor Mittal Nippon Steel[3] (IOCL Judgment) took a step further by holding that contingent claim, in this case having a notional value of INR 1, become non-arbitrable once the resolution plan was approved as the notional claim was extinguished according to the clean slate theory. The SC[4] set aside this judgment but only due to the parties consenting to arbitrate the contingent claim and not on the principles of law discussed by the Delhi High Court. In this article, I have examined the IOCL Judgment and highlighted key issues that arise out of it.
Factual background
IOCL initiated arbitration proceedings against the former Essar entity. Subsequently, the financial creditors of Essar filed for insolvency, which was duly admitted by the National Company Law Tribunal (NCLT). IOCL submitted its claim as an operational creditor (OC). However, the Resolution Professional (RP) acknowledged a meagre claim of INR1 from IOCL, attributing it to an ongoing dispute between the parties. The plan also had a clause stipulating that any claims not expressly outlined in the plan would stand extinguished after its approval. Subsequently, the NCLT declined to approve the resolution plan on the grounds that it would deprive the OC of its contingent claim. This decision was subsequently affirmed by the National Company Law Appellate Tribunal (NCLAT). Nevertheless, the SC later overturned this ruling, invoking the clean slate theory as grounds for its decision.
Despite the SC ruling, IOCL again invoked arbitration and filed a section 11 petition before the Delhi High Court for the constitution of the arbitration tribunal. IOCL submitted that the contract and the obligations arising between the parties would continue till 2028. Thus, the cause of action was still valid, notwithstanding the closure of IBC proceedings.
Further, the court’s jurisdiction under section 11 of Arbitration and Conciliation Act was also debated in context of unenforceable claims. Essar submitted that as notional claims of OC were extinguished by the passing of the resolution plan, the claim was unenforceable and therefore, not arbitrable.
Issues before the court were whether:
(a) Whether the approval of the resolution plan results in an extinguishment of all claims
(b) Would the resolution plan’s approval render the notional claims of the OC non-arbitrable?
Delhi High Court view
On the first issue, the court followed the Ghanshyam judgment and held that all claims stand extinguished after approval of the resolution plan. The court reiterated the rationale of the clean slate theory, stating that the intent of IBC is to revive the corporate debtor. If claims are allowed post-approval, the entire plan may become unworkable, ultimately hampering the revival of the corporate debtor. The court further explained by stating that RP and Adjudicating authority duly consider all claims submitted during CIRP as they undertake a thorough process to identify the creditors and ascertain their claims.
On the second issue, the court ruled on its jurisdiction under section 11 petition of the Arbitration and Conciliation Act, 1996. It stated that claims not enforceable under the law are dead disputes and, therefore, fall in the category of non-arbitrability. Non-arbitrability of claims comes under review by the court in a section 11 petition. Based on this, the court held that once the claims are extinguished, they cannot be enforced under the law and are not arbitrable. The court reasoned that if extinguished claims are allowed, it would lead to the reopening of the resolution plan, which would violate the clean slate theory. Therefore, the court pronounced the claim of IOCL as extinguished and non-arbitrable.
Analysis
The clean slate theory has become an integral part of the IBC. However, instances such as this case show that there are loopholes in this concept, and it needs a relook. Once CIRP is admitted, a moratorium is enforced, stopping any ongoing arbitration proceedings against the corporate debtor. Creditors retain the right to submit their claims to the RP, but instances arise, as in this case, where only a nominal sum, even as low as INR 1, is admitted due to ongoing arbitration. The quandary arises: When can such disputes be adjudicated? The moratorium during CIRP precludes adjudication. Post-CIRP, as per the clean slate theory, claims are extinguished and deemed non-arbitrable. This leaves creditors without recourse for their nominal/contingent claims.
The SC’s verdict in the case of Fourth Dimension v. Ricoh[5] (Fourth Dimension) offers a lifeline. In this case, OC’s claim was marked as ‘nil’ by the RP due to an ongoing arbitration and the resolution plan was approved. The OC challenged the plan but to no avail as NCLT and NCLAT, based on clean slate theory, upheld the resolution plan. On appeal, SC, taking note of the pending arbitration, allowed the parties to pursue their claims on merit despite the approval of the resolution plan. However, the court did not expound on the rationale behind this decision, nor did it delve into the nuances of the clean slate theory.
NCLAT Delhi in Shapporji Pallonji and Co. Pvt. Ltd. v. Kobra West Power Company Limited and Ors[6] followed the Fourth-dimension judgment by allowing the continuation of the pending arbitration after approval of the resolution plan. This judgment is pertinent as NCLT considered both the Fourth Dimension and Ghanshyam judgment before coming to this conclusion. This judgment can be differentiated from the IOCL judgment on facts as there was a section 10 IBC (application by the corporate debtor) petition, whereas, in the IOCL judgment, a section 7 petition (application by financial creditors) was filed. The differentiation can become necessary because when a corporate debtor applies for CIRP under section 10 post initiation of arbitration or based on potential arbitration, a case for mala fide intention can be made out. However, the same cannot be applied with equal force in cases where the financial creditor files for CIRP, as this petition is not controlled or planned by the corporate debtor.
NCLT Ahmedabad’s decision in Bhavi Shreyansh Shah, Resolution Professional for VS Texmills Private Limited v. Canara Bank and Ors, is also important for this discussion. NCLT held that automatic waiver/abatement of legal proceedings could not be permitted through a resolution plan and that such proceedings would be the subject matter of the concerned competent authorities. Allotting “nil” value to a pending arbitration in a resolution plan is equivalent to abating such dispute if the claim is considered dead after passing the resolution plan.
One potential avenue to address the issue of notional claims of negligible value without deviating from the clean slate theory could be incorporating clauses within the resolution plan, designating a specific sum for creditors embroiled in pending disputes with the corporate debtor. For instance, the resolution plan in JSW Steel Ltd. v. Mahendra Kumar Khandelwal & Ors.[7] provided for contingent liabilities in the following manner: “identified contingent creditors (totalling to approximately Rs.5000 Crores) are to receive 10% of their claim, only and only if their claim crystalizes within two years from the date of approval of the ‘Resolution Plan’, subject to a maximum of 35 Crores.” This may provide a more equitable resolution for all parties involved rather than leaving the creditor with a contingent claim entirely remediless. NCLT has also upheld resolution plans with such contingent provisions in Tata Steel BSL Ltd. v. Varsha w/o Ajay Maheshwari[8] and Office of the Specified Officer v. Mr. V. Venkatachalam.[9]
In conclusion, the IOCL judgment aligns with the Ghanasyham judgment, but it poses challenges for creditors whose claims are not crystalized before the initiation of CIRP. Even though the SC has overruled the IOCL judgment due to consent by the parties involved, clarity from the legislators is required to protect the rights of the creditors.
References:
[1] Committee of Creditors of Essar Steel India Limited through Authorised Signatory v. Satish Kumar Gupta & Ors, (2019) ibclaw.in 07 SC.
[2] Ghanashyam Mishra and Sons Pvt. Ltd. v. Edelweiss Asset Reconstruction Company Ltd., (2021) ibclaw.in 54 SC.
[3] IOCL v. Arcelor Mittal Nippon Steel, (2023) ibclaw.in 817 HC.
[4] IOCL v. Arcelor Mittal Nippon Steel, (2024) ibclaw.in 57 SC.
[5] Fourth Dimension v. Ricoh, (2022) ibclaw.in 06 SC.
[6] Shapporji Pallonji and Co. Pvt. Ltd. v. Kobra West Power Company Limited and Ors, (2023) ibclaw.in 146 NCLAT.
[7] JSW Steel Ltd. v. Mahendra Kumar Khandelwal & Ors., (2020) ibclaw.in 217 NCLAT.
[8] Tata Steel BSL Ltd. v. Varsha w/o Ajay Maheshwari, (2019) ibclaw.in 15 HC.
[9] Office of the Specified Officer v. Mr. V. Venkatachalam, (2020) ibclaw.in 19 NCLAT.
