Insolvency of Parties and Impact on Arbitration


An application can be made for both arbitration and insolvency proceedings. Yet, these two cannot take place simultaneously. Section 41 of the Arbitration and Conciliation Act, 1996, explains provisions in cases of insolvency of parties in an arbitration agreement. If parties to an arbitration agreement become insolvent, then the arbitration agreement will not become invalid automatically. It will depend on the facts and adoption of the contract by the receiver. This section is read along with the provisions of the Insolvency and Bankruptcy Code, 2016. 


The receiver is appointed by the court to take possession of and sell or liquidate the assets secured by the security agreement so that the outstanding debt can be repaid. Under the Arbitration and Conciliation Act, 1996, a significant responsibility is given to the receiver to decide whether to choose arbitration or not in cases of insolvency. The receiver chooses to adopt the contract only when it is beneficial for the insolvent company. Therefore, if the receiver adopts any commercial contract consisting of an arbitration agreement, then such contracts can be enforced against the insolvent party whenever a dispute may arise. Also, a contract must be adopted completely and fully. A receiver is not given any choice to adopt a certain part of the contract and reject the dispute resolution clause. 


The National Company Law Tribunal has ruled differently in different circumstances. If the arbitration clause has been signed after an insolvency order, then such arbitration agreement shall be void. After a company is declared insolvent, any arbitration clause made by an insolvent party cannot have a binding effect on the receiver. Any arbitration clause which is made before an insolvent order and after the commencement of insolvency proceedings can be enforced by or against the receiver (when he has chosen to adopt the contract). Also, the receiver or insolvent parties would not have to seek permission from the National Company Law Tribunal. If the receiver accepts the contract and proceeds with the arbitration, then the insolvent party or company would be replaced by the same receiver handling the insolvency. The party may approach the National Company Law Tribunal if the receiver has rejected to adopt the contract. National Company Law Tribunal shall have the sole discretion to decide whether the existing dispute between the parties should be adjudicated by arbitration or not. When an arbitration agreement is made before the insolvency proceedings commence, it will depend upon the receiver to adopt the contract or not. The party can approach the National Company Law Tribunal when the receiver rejects to adopt the contract. Therefore, the existence of a dispute before or after insolvency proceedings commenced is considered and evaluated for an application for the Corporate Insolvency Resolution Process under the Insolvency and Bankruptcy Code, 2016.


After an award is passed concerning an insolvent party and challenged under Section 34 of the Arbitration and Conciliation Act, 1996 will constitute an existence of the dispute. In the recent Supreme Court decision of K Kishan v. M/S Nirman Company Pvt Ltd. Civil Appeal No. 21825 of 2017, pending Section 34 application is considered as the existence of disputes. Hence, a Corporate Insolvency Resolution Process cannot be initiated awaiting the decision of a setting aside process. 


An existing arbitral proceeding shall stop an insolvency proceeding initiated by operational creditors. In the occurrence of a default, an operational creditor delivers a notice to the corporate debtor. In the next ten days, the corporate debtor shall reply to the notice proving the existence of a dispute. Under section 5(6) of the Insolvency and Bankruptcy Code, 2016, disputes have been defined as a suit or arbitration proceedings related to the existence of the amount of debt, the quality of good or service or the breach of a representation or warranty. 


In cases where the National Company Law Tribunal or National Company Law Appellate Tribunal directs an order to not consider an arbitration agreement because of the circumstances of the insolvent company, then the party can file a civil suit against the receiver. Therefore, an existing arbitration agreement affects the adjudication of insolvency proceedings. 


In India, insolvency is a non-arbitrable dispute because rights exercisable are in rem involving a third party. Arbitration and Insolvency are two different proceedings which cannot take place simultaneously. The timing of the constitution of the arbitration agreement, the decision of the receiver appointed by the court and National Company Law Tribunal orders play a significant role in deciding the proceedings and laws applicable to a dispute with an insolvent party.