The Supreme Court’s recent take on statutory arbitration under the SARAFESI Act

In a significant pronouncement, the Supreme Court of India (“Supreme Court”) in Bank of India v. M/s Sri Nangli Rice Mills Pvt. Ltd. & Ors. clarified that under Section 11 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARAFESI Act”), disputes between creditors must mandatorily be arbitrated under the Arbitration & Conciliation Act, 1996 (“Arbitration Act”). In doing so, the Supreme Court eliminated the need for any written agreement referring the dispute to arbitration and effectively ousted the jurisdiction of the Debt Recovery Tribunal (“DRT”) in a dispute between two financial institutions.

The dispute arose owing to conflicting claims on the same secured assets of Sri Nangli Rice Mills Pvt. Ltd (“the Borrower”) by Bank of India (“Appellant Bank”) and Punjab National Bank (“Respondent Bank”). 

The Borrower and Appellant Bank executed a Credit Facility Agreement by hypothecating stocks of paddy and other assets. While such loan was still outstanding, the Borrower executed an Advance/Pledge Agreement with the Respondent Bank by pledging warehouse receipts stocks of paddy and rice. On default, the Appellant Bank and Respondent Bank both filed applications before the District Magistrate seeking assistance with taking possession of the Borrower’s secured assets. The District Magistrate partly allowed the application of the Appellant Bank but directed it to not interfere with the assets pledged with the Respondent Bank. Aggrieved by the same, the Appellant Bank approached the High Court of Punjab and Haryana at Chandigarh (“High Court”) which directed it to approach the DRT.

Following this, in 2017, the Appellant Bank filed a securitization application before the DRT, which ruled in its favour and stated that the charge created in favour of the Appellant Bank was prior in time and would thus take precedence over any subsequent charge. However, in 2019, the matter was remanded back to the DRT by the Debt Recovery Appellate Tribunal (“DRAT”). On remand, the DRT in 2020 held that it has no jurisdiction to adjudicate the dispute as the same must be adjudicated by way of arbitration in terms of Section 11 of the SARFAESI Act.

This view was upheld by the Punjab and Haryana High Court which rejected the writ petition filed by the Appellant Bank, and stated that in view of Section 11 of the SARAFESI Act, the dispute ought to be settled via arbitration. Aggrieved by this, the Appellant Bank filed a special leave petition before the Supreme Court.

The Supreme Court affirmed the High Court’s ruling that the dispute fell within the ambit of Section 11 of the SARAFESI Act and ought to be arbitrated. With respect to Section 11, the Supreme Court observed that:

• The twin conditions to be prima facie satisfied for the DRT’s jurisdiction to be ousted and Section 11 to be applicable are (i) the dispute must be between any bank or financial institution or asset reconstruction company or qualified buyer and (ii) the dispute must relate to securitisation or reconstruction or non-payment of any amount due including interest.
• As also held in Transcore v. Union of India & Anr, Section 11 is not applicable where one of the parties is a bank or financial institution etc., but its jural relation to another such entity is that of a borrower and lender.
• Section 11 creates a legal fiction whereby, an arbitration agreement is presumed to exist between the parties falling under the said provision for the resolution of any dispute between them, notwithstanding whether such agreement exists or not.
• As highlighted in Union Bank of India v. Satyawati Tondon & Ors, the primary object of the SARAFESI Act is to bring about “special machinery for speedy recovery of the dues of banks and financial institutions. Ergo, if disputes that fall specifically under the ambit of Section 11 of the SARFAESI Act are permitted to get through DRT proceedings, it would create unnecessary litigation, frustrate the avowed object of the SARFAESI Act and undermine the efficiency of the prescribed process of resolution by arbitration or conciliation.  
• The usage of “shall” mandates the parties to adhere to the mentioned mechanism and restricts them from approaching any other forums. The parties cannot bypass or subvert it by seeking recourse elsewhere.

The rationale adopted by the Supreme Court in interpreting Section 11 of the SARFAESI Act is to ensure speed, efficiency, and subject-matter expertise in resolving sectoral disputes, avoid clogging of courts, and uphold the legislative intent for expedited dispute resolution in public interest.

This is in line with the rationale adopted by Indian Courts in their interpretation of similar provisions in other statutes such as the Micro, Small and Medium Enterprises Development Act, 2006 and Indian Telegraph Act, 1885

Section 18 of the Micro, Small and Medium Enterprises Development Act, 2006, provides that upon failure of conciliation, the dispute ought to be mandatorily referred to arbitration under the provisions of the Arbitration Act. Similar to Section 11 of the SARAFESI Act, Section 18(3) uses the term “as if” to create a legal fiction that dispenses with the requirement of a consensual arbitration agreement and overrides certain contractual provisions  which mandate statutory arbitration.

Similarly Section 7B of the Indian Telegraph Act, 1885 states that any dispute concerning any telegraph line, appliance or apparatus arises, the dispute shall be determined by arbitration and shall be referred to an arbitrator appointed by the Central Government. This mirrors the SARAFESI logic arbitrating technical disputes for efficient and expert determination.

Thus, the Supreme Court’s pronouncement cementing the mandatory nature of statutory arbitration under Section 11 of the SARFAESI Act prioritizes commercial certainty and expediency. This decision also aids faster resolution of SARFAESI disputes for the financial institutions and borrowers alike and will unclog the already heavily burdened dockets of various DRTs in the country.  This echoes the broader legislative trend across multiple statutes to channel certain categories of disputes away from the court system into expert, time-bound arbitral processes- promoting the overall efficiency and stability of these regulated sectors. 

We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com  or write to our authors: 

Ashishchandra Rao, Partner – Email – ashishchandrarao@elp-in.com 

Urja Thakkar, Associate – Email – urjathakkar@elp-in.com