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Supreme court allows set off of extinguished counterclaim in arbitration following CIRP
The Supreme Court of India, in, examined the interplay between the clean slate principle under the Insolvency and Bankruptcy Code, 2016 (IBC) and the right to raise a counterclaim in arbitration after approval of a resolution plan. The Court upheld the continuation of arbitration proceedings while permitting the appellant to use its extinguished claim solely for set off, without allowing independent monetary recovery.
Background of the Dispute
The dispute arose from a construction contract dated 9 July 2018 between Modern Asset and KNK Construction Pvt. Ltd., valued at ₹133.68 crore. Clause 19.13 of the agreement provided for arbitration. KNK Construction claimed that approximately 95% of the work had been completed, while disagreements over the performance of the contract eventually led to its termination in February 2020.
Meanwhile, insolvency proceedings against KNK Construction had commenced on 11 December 2019. During the Corporate Insolvency Resolution Process (CIRP), Modern Asset submitted a claim of ₹12,26,30,840 before the Resolution Professional. Under the resolution plan approved by the National Company Law Tribunal (NCLT) on 5 April 2022, ₹8,82,942, together with interest, was allowed for payment, representing approximately 0.72% of the claim.
Subsequently, KNK Construction invoked arbitration against Modern Asset, seeking amounts allegedly payable under the same construction contract. Modern Asset objected, arguing that its claim had been substantially reduced under the resolution plan and that allowing KNK Construction to pursue its claim without considering a corresponding counterclaim would result in an inequitable outcome.
The Karnataka High Court permitted arbitration to proceed, leaving the substantive disputes for the arbitral tribunal. Modern Asset challenged this decision before the Supreme Court.
Supreme Court's Observations
The principal question was whether the Successful Resolution Applicant (SRA) could pursue claims belonging to the corporate debtor after approval of the resolution plan, while the opposing party's claim had been extinguished under the insolvency process.
The Supreme Court reaffirmed the clean slate principle under Section 31 of the IBC. Once a resolution plan is approved, claims against the corporate debtor that stand extinguished under the plan cannot ordinarily be revived. However, the SRA retains the right to pursue subsisting claims of the corporate debtor against its debtors.
The Court also upheld the appointment of the arbitral tribunal under Section 11 of the Arbitration and Conciliation Act, 1996. Nevertheless, it considered the circumstances of the case significant. Both parties' claims arose from the same contract, and Modern Asset had suffered a substantial reduction in its claim. The Court also noted that the former promoters of KNK Construction had returned to management as the SRA and had submitted the resolution plan providing for the limited payment.
In reaching its decision, the Court relied on Ujaas Energy Ltd. v. West Bengal Power Development Corporation Ltd. (2026), which recognised that a counterclaim barred from independent recovery may, in appropriate circumstances, be considered for set off in arbitration.
Final Decision
The Supreme Court upheld the High Court's order appointing an arbitral tribunal but modified it to permit Modern Asset to raise its counterclaim solely for set off.
The tribunal must consider the entire claim raised by Modern Asset before the Resolution Professional for this limited purpose, rather than restricting the set off to the amount admitted for payment under the resolution plan. If the tribunal finds that Modern Asset owes money to KNK Construction, the set off shall be allowed to the extent of that counterclaim.
However, Modern Asset cannot obtain an independent monetary award through its extinguished claim. Even if KNK Construction's claim is rejected entirely, Modern Asset cannot recover money on the basis of its counterclaim. The tribunal must also consider the dispute concerning the encashment of the bank guarantee.
Legal Significance
The judgment highlights the need to balance the clean slate principle under the IBC with equitable considerations where competing claims arise from the same contractual transaction. It distinguishes between reviving an extinguished claim for independent recovery and permitting its limited use as a defence through set off.
The decision does not establish a general right to revive extinguished claims in arbitration. Instead, the Court granted limited relief in the specific circumstances of the case, without disturbing the finality of the approved resolution plan.
For insolvency and arbitration practice, the ruling clarifies that an extinguished counterclaim may, in exceptional circumstances, be considered for set off without permitting independent monetary recovery or undermining the clean slate principle.
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