Arbitration and IBC: Section 7, Section 9 and Moratorium

Most commercial contracts contain an arbitration clause, so debtors often try to use it to keep creditors out of the NCLT. The answer depends on the route and the stage. A section 7 application turns on default, not on a dispute about it. A section 9 application fails if arbitration or a real dispute existed before the notice. Once a CIRP begins, the moratorium freezes arbitrations against the debtor. And insolvency itself can never be sent to arbitration.

1. The Law in Brief

• Non-arbitrability. Insolvency proceedings are actions in rem affecting third parties and are not arbitrable (Vidya Drolia v Durga Trading Corporation, 2020)
• Section 7 and section 8. Proceedings become in rem only on admission; where both are pending, the NCLT first decides whether there is a default (Indus Biotech, 2021)
• Section 9. A pending suit or arbitration filed before the demand notice, or a plausible dispute, defeats the application (section 8(2)(a); Mobilox, 2017)
• Moratorium. Section 14(1)(a) bars the institution or continuation of proceedings, including arbitration and execution of awards, against the corporate debtor.

Figure 1: Section 7 application and an arbitration reference

2. Can a Section 7 Application Be Referred to Arbitration?

• Issue. How the NCLT should deal with a section 8 application filed while a section 7 application is pending.
• Law. In Indus Biotech v Kotak India Venture Fund (2021), a three-judge bench held that a section 7 application becomes a proceeding in rem only on admission. Where a section 8 application is filed before that, the NCLT must first decide the section 7 application by examining whether there is a financial debt in default. If it finds default and admits, the section 8 application fails; if it finds none, it rejects the section 7 application and the parties may arbitrate.
• Application. Whether an amount is due depends on the disputed conversion formula. The NCLT must examine whether a financial debt has fallen due and is in default on the record.
• Conclusion. The NCLT should decide default first. If, as in Indus Biotech itself, the amount depends on an unresolved conversion dispute and no default is shown, it should reject the section 7 application, and the dispute goes to arbitration. If default is clearly shown, it must admit, and the arbitration clause cannot prevent that.

3. Does a Pending Arbitration Defeat a Section 9 Application?

• Issue. Whether an arbitration commenced before the demand notice is a pre-existing dispute under section 8(2)(a)
• Law. Section 8(2)(a) refers to the existence of a dispute or a record of a pending suit or arbitration filed before receipt of the notice. Mobilox (2017) held that the NCLT must reject the application if the dispute is plausible and pre-existing, without deciding its merits.
• Application. HI Ltd invoked arbitration two months before the notice, on grounds of defective work that relate directly to the amount claimed. That is not a spurious or patently feeble defence.
• Conclusion. The section 9 application must be rejected, and FG Ltd must pursue its claim in the arbitration, where it may counterclaim for the price.

Figure 2: Arbitration and awards during and after a CIRP

4. What Happens to Arbitrations during the Moratorium?

• Issue. The effect of the section 14 moratorium on arbitrations by and against the corporate debtor, and on execution of an award.
• Law. Section 14(1)(a) prohibits the institution or continuation of suits or proceedings against the corporate debtor, including arbitration, and the execution of any award. The moratorium protects the debtor and its estate and does not stop the debtor from pursuing its own claims, which the resolution professional may continue in the interest of the estate.
• Application. LM Ltd's arbitration is a proceeding against JK Ltd and must stop. JK Ltd's claim against NO Ltd would increase the estate. PQ Ltd's execution is enforcement against JK Ltd's assets.
• Conclusion. LM Ltd's arbitration is stayed, and LM Ltd must file its claim with the resolution professional. JK Ltd's arbitration against NO Ltd may continue through the resolution professional. PQ Ltd cannot execute its award and must file a claim based on it, ranking as a financial or operational creditor according to the nature of the debt.

5. Can an Arbitration Clause Oust the NCLT's Jurisdiction?

• Issue. Whether parties may contract out of the NCLT's jurisdiction under the Code by an arbitration clause.
• Law. In Vidya Drolia v Durga Trading Corporation (2020), the Supreme Court held that disputes relating to actions in rem, which affect third parties and need centralised adjudication, are not arbitrable, and gave insolvency and winding up as examples. Section 238 gives the Code overriding effect, and section 63 bars civil courts from matters within the NCLT's jurisdiction.
• Application. A CIRP affects all creditors of TU Ltd, not only RS Bank, and only the NCLT can admit a company into insolvency, approve a plan or order liquidation. A private tribunal cannot exercise those powers.
• Conclusion. The clause cannot oust the NCLT's jurisdiction, and the stay must be refused. The clause may still govern purely contractual disputes between the parties outside the insolvency process.

6. Frequently Asked Questions

Is an arbitral award under challenge enough for a section 9 application?

No. A pending section 34 challenge keeps the operational debt disputed (K. Kishan, 2018; Topic 100).

What happens to an award holder's claim that is not included in the approved plan?

It is extinguished, and no proceedings can be continued on it for the period before approval (Ghanashyam Mishra, 2021).

Can a financial creditor with an unpaid award use section 7?

Where the award relates to a financial debt, yes. Dena Bank (2021) held that an unsatisfied decree, award or recovery certificate for money gives a fresh cause of action for a section 7 application.

7. Related Topics

• Topic 79: IBC and Arbitration. Arbitrability, moratorium and awards.
• Topic 100: Section 9 IBC. Demand notice and dispute.
• Topic 106: Section 14 IBC Moratorium. What section 14 bars.