Modern Asset v. KNK Construction Private Limited.

What happened

The parties entered a contract on 9 July 2018 for civil and structural work on an office building, total value ₹133.68 crores, with an arbitration clause (clause 19.13) and a bank guarantee of ₹1,56,13,250. KNK was admitted to CIRP on 11 December 2019, the appellant terminated the contract in February 2020, and the appellant submitted an operational creditor's claim of ₹12,26,30,840 to the resolution professional, which the plan submitted by the erstwhile promoter (as MSME resolution applicant under section 240A) accepted to the extent of ₹8,82,942, about 0.72%. The NCLT approved the plan on 5 April 2022, the promoters came back as management, and the plan payments started on 15 June 2023. KNK invoked arbitration by notice of 13 March 2023 and filed a section 11 application on 20 June 2023. The High Court of Karnataka held that the arbitration clause survived by separability, that the effect of the plan was for the Tribunal under section 16, and appointed an arbitrator after mediation. The appellant argued that its claim and the contract were extinguished and the reference was a one-way street. KNK argued that the SRA may pursue the corporate debtor's claims and that section 31(6), inserted from 26 May 2026, clarified the clean slate rule.

Questions before the court

• Can the SRA pursue arbitration against an operational creditor whose claim was cut in the plan, and can the creditor raise its claim by way of set-off?

Why the court ruled this way

Section 11 enquiry is limited to the prima facie existence of an arbitration agreement, and the arbitration clause survives, so the High Court was right to appoint an arbitrator (paragraph 19). The clean slate principle of section 31(1) is well entrenched, the SRA is subject to it, and nothing remains for the arbitrator to decide on that point, but the SRA may proceed on the dues of the corporate debtor, even if the erstwhile promoters returned as SRA (paragraphs 12 to 14 and 19). The limitation was within time as the moratorium period is excluded (paragraph 13). Because the promoters had notice of the claim through the information memorandum, offered 0.72% in their plan, and thus deemed to have accepted the entire claim, and the counterclaim from the same contract was never brought up by the resolution professional, equity required allowing set-off, as in Ujaas Energy Ltd. v. West Bengal Power Development Corporation, where the Court allowed counterclaim for set-off alone (paragraphs 18 to 24). The set-off is to the extent of the entire claim raised before the resolution professional, but the appellant cannot receive any payment on it (paragraphs 24 and 25).

Controlling point

Arbitration may proceed, with a set-off for the creditor to the extent of its entire admitted claim.

Order and next steps

The impugned order was sustained with the modification that the appellant may raise the counterclaim only for set-off, to the extent of the entire counterclaim it put forward; even if the respondent's claim fails completely, the appellant cannot claim any payment since its claim stands extinguished. The question of encashment of the bank guarantee will also be considered by the Arbitral Tribunal. The appeal was disposed of and pending applications rejected.

Practical implications

A creditor who accepted a plan haircut and then faces the debtor's arbitration claim on the same contract can seek to plead its own claim as a set-off, but cannot expect a money award.

Limits of this ruling

• The Court said that the equities arose from the facts, including return of the promoters as SRA and the claim on the same contract, and the set-off right does not give any positive relief; it did not alter the clean slate principle.