Securing Unsecured Creditors in Arbitrations – An IBC Perspective

Can an award holder receive payments against the Section 9 Security despite an order of moratorium against the award debtor/ corporate debtor?
Securing Unsecured Creditors in Arbitrations – An IBC Perspective
Ashish Bhan, Ketan Gaur, Aayush Mitruka

It is not uncommon for parties to an arbitration to secure (or at least attempt to secure) amounts involved in arbitration from a “Court” under Section 9 of the Arbitration and Conciliation Act, 1996 (Arbitration Act).This can be done by way of deposits in an interest-bearing account maintained by such Court or by furnishing bank guarantees and/or similar instruments (Section 9 Security).

The Section 9 Security is intended to smoothen the process of enforcement of awards in India which process is otherwise fraught with difficulties and is often seen as an arduous battle in the recovery of proceeds.While these protective orders are obtained in the usual course to secure a party against all future contingencies, the effectiveness of such orders in a situation where the award debtor is roped into insolvency before the award is enforced against such security is debatable.

It is a settled position that an arbitral award (or for that matter, a court decree) passed against the corporate debtor would be rendered incapable of execution once a moratorium order comes into effect under Section 14 of the Insolvency and Bankruptcy Code, 2016 (IBC). However, the question that begs to be answered is whether the moratorium would also extend to Section 9 Security? That is, whether an award holder would be able to receive payments against the Section 9 Security despite an order of moratorium against the award debtor/ corporate debtor?

Some indicative precedents

Nahar Builders Case

The Bombay High Court’s decision in Nahar Builders Ltd. v. Housing Development and Infrastructure Ltd (HDIL) sheds some light on this. Nahar Builders was able to secure an amount of INR 80 million from HDIL by way of a Court deposit in proceedings under Section 9 of the Arbitration Act. This order was made subject to the outcome of the arbitration. Ultimately, a money award was passed in favor of Nahar Builders. However, after the award was pronounced, an insolvency application came to be admitted against HDIL and a moratorium order was in effect. When Nahar Builders moved an application for withdrawing the secured amount, it met with opposition from HDIL that the Section 9 Security cannot be enforced against Nahar Builders in view of the moratorium. HDIL argued that the security amount is the “property” of the corporate debtor within the meaning of Section 14 of the IBC and would be beyond the reach of the award holder given the moratorium. However, the Bombay High Court rejected this argument and held that:

“7. [..] Once an amount is deposited in this Court, it is placed beyond the reach of either party without permission of the Court. It is, therefore, not 'the property' of either party pending an adjudication as to entitlement by the Court. Once the Arbitrator held that it was Nahar Builders that was entitled to this amount, and that award became enforceable as a decree of this court, then no question remained of the amount being claimed by HDIL. In another manner of speaking, from the time the deposit was made until the time withdrawal is ordered, that amount is not the property of either party to the dispute.

The Bombay High Court was also of the view that an application for withdrawal/ disbursement of money would not amount to a suit, proceeding or execution within the meaning of Section 14(1)(a) of the IBC. It, therefore, allowed the application filed by Nahar Builders and passed an order for disbursement of the deposited money.

Morgan Securities Case

However, the Delhi High Court has taken a somewhat different position in Morgan Securities and Credits Pvt. Ltd. (Morgan Securities) v. Videocon Industries Ltd. (Videocon). In that, a money award came to be passed in favour of Morgan Securities. Videocon challenged the award under Section 34 of the Arbitration Act. During the pendency of the challenge proceedings, Morgan Securities had also obtained an order under Section 9 of the Arbitration Act directing Videocon to deposit a bank guarantee of INR 200 million in favour of the Delhi High Court’s Registrar. This bank guarantee was subsequently directed to be encashed and the amount was to be deposited in the bank account maintained by the Delhi High Court. However, before the challenge to the arbitral award came to be rejected, insolvency proceedings came to be admitted against Videocon and a moratorium order was also in play.

Following the rejection of the challenge mounted against the arbitral award under Section 34 of the Arbitration Act, Morgan Securities requested for withdrawal of the deposited money on the ground that the deposited money is an “asset” of Morgan Securities (and not Videocon). However, the Delhi High Court rejected this argument on the ground that at the time of encashment of the bank guarantee, the Section 9 Security remained the asset of Videocon (i.e. the corporate debtor)“for only then it could be offered as a security to protect the interests of the present Appellant [i.e. Morgan Securities]” and given that the outcome of the challenge was not known at that point in time. As the rejection of Videocon’s challenge was only after the moratorium was in effect, the Delhi High Court was of the view that the deposited money should be retained in the account of the Delhi High Court Registrar subject to further orders in the insolvency proceedings. This order was subsequently upheld by the Division Bench and thereafter, by the Supreme Court.

Morgan Securities’ request for the disbursement of the deposited amount was disallowed primarily on the ground that the insolvency proceedings commenced before the award attained finality. This decision could have turned in a situation where the insolvency proceedings commenced against the corporate debtor after the award attained finality.

Morgan Securities also approached the NCLT for withdrawal of the deposited amount. However, this request was turned down by the NCLT on the ground that the deposited amount of INR 200 million was the asset of the corporate debtor (in this case, Videocon). This order was upheld by the NCLAT and thereafter, by the Supreme Court.

Bharat Aluminium Case

Recently, the NCLAT in Bharat Aluminium Co. Ltd. v. M/s J.P. Engineers Pvt. Ltd. &Anr. has allowed the invocation of a bank guarantee issued by the corporate debtor during the existence of a moratorium order. Despite resistance from the corporate debtor, the NCLAT allowed the invocation of the bank guarantee in view of the amended provisions of Section 14 (3)(b) of IBC. In that, it is now a settled position that order of moratorium is no longer applicable to a surety in relation to a contract of guarantee to a corporate debtor. The NCLAT, therefore, observed that “the assets of the surety are separate from those of the corporate debtor, and proceedings against the corporate debtor may not be seriously impacted by the actions against assets of third party like surety.” It is the authors’ view that this decision would significantly enhance the ability of award holders to realise the award proceeds against a Section 9 Security should a bank guarantee be issued as such security.

Concluding remarks

The position in law continues to be unsettled and a reasoned decision from the Supreme Court is currently awaited. In arriving at a decision, it is the authors’ view that a balancing act would have to be performed by Courts with respect to two competing principles. First, when the execution of a money award/ decree itself cannot proceed against a corporate debtor after an order of moratorium is in effect, permitting withdrawal/ disbursement of the amount secured in Section 9 proceedings may be viewed as bypassing the legislative intent behind Section 14 of the IBC. This could also be seen as a “preferential payment” as an award holder would in effect be treated as a secured creditor while other creditors would have to wait in line for payments.However, at the same time, the interests of an award holder who has been secured for the decretal amount by a court of competent jurisdiction must also be protected.

The authors are Ashish Bhan, Ketan Gaur and Aayush Mitruka are lawyers working at Trilegal. Ashish Bhan is a partner, Ketan Gaur is a senior associate and Aayush Mitruka is an associate at the firm.

Related Stories

No stories found.
Bar and Bench - Indian Legal news
www.barandbench.com