An application under Section 8 of the Arbitration and Conciliation Act, 1996 is not maintainable after admission of Section 7 IBC petition as the dispute becomes non-arbitrable

In the matter of Indus Biotech Private Limited vs. Kotak India Venture (Offshore) Fund & Ors. in Civil Appeal No. 1070/ 2021 and Arbitration petition (Civil) No. 48/2019 decided on 26.03.2021 by the Supreme Court.

Facts: The judgment arises out of two connected matters – one, petition filed by Indus Biotech for appointment of arbitrator and second, appeal preferred by Respondent no. 2 against order of NCLT dismissing its application under Section 7 of IBC. It is pertinent to note that the Respondent no. 2 had preferred an application under Section 7 of IBC claiming that Indus Biotech had defaulted in payment of debt. Indus Biotech had moved an application under Section 8 of Arbitration and Conciliation Act, 1996 citing existence of arbitration clause between the parties. The NCLT allowed the application of Indus Biotech and consequently dismissed the application under Section 7 of IBC.

Issues: Whether a dispute becomes non-arbitrable after insolvency proceedings have commenced.
Whether the NCLT was correct in entertaining n application under Section 8 of Arbitration and Conciliation Act, 1996 in the backdrop of a Section 7 petition under IBC.

Held: The Court referred to the test of arbitrability as laid down in the judgment of Vidya Drolia & Ors. Vs. Durga Trading Corporation (2021 2 SCC 1) where it was stated that if the subject matter of dispute relates to actions in rem or affect third party rights requiring centralized adjudication, such dispute shall be non-arbitrable.
The Supreme court observed that to decide the present issue, the stage of the proceedings at which the impugned NCLT judgment was passed will be relevant. The Court held that to consider a proceeding under Section 7 of the IB Code as a proceeding in rem, it is necessary that the Adjudicating Authority ought to have applied its mind, recorded a finding of default and admitted the petition. On admission, third party right is created in all the creditors of the corporate debtors and will have erga omnes effect. The mere filing of the petition and its pendency before admission, therefore, cannot be construed as the triggering of a proceeding in rem. Therefore, an application under Section 8 of the Arbitration and Conciliation Act, 1996 is not maintainable after admission of Section 7 IBC petition as the dispute becomes non-arbitrable.
The Court next dealt with the question- whether in a petition filed under Section 7 of IB Code, before it is admitted, whether an application under Section 8 of the Arbitration Act 1996 can be entertained. The Court held that even if an application under Section 8 of the Act, 1996 is filed, the Adjudicating Authority has to first decide the Section 7 IBC proceedings and record a satisfaction as to whether there is default or not.
If the Adjudicating Authority concludes that there is default and the debt is payable, the Adjudicating Authority shall consequently proceed to pass an order admitting the application which would make convert the proceeding into a proceeding in rem. In such a case no question of arbitration shall arise.
On the other hand, if the Adjudicating Authority concludes that there is no default committed by the company, leading to rejection of Section 7 of IBC petition, it will be open for the parties to secure appointment of the Arbitral Tribunal in an appropriate proceeding as contemplated in law and the need for the NCLT to pass any orders on such application under Section 8 of Act, 1996 would not arise.