Supreme Court decides that disputes between Banks, FIs and ARCs Must Go to Arbitration as per Section 11 of SARFAESI Act: Insights from Bank of India vs Sri Nangli Rice Mills Pvt. Ltd

Factual Matrix

At the core of the dispute is a complex inter-creditor conflict between two public sector banks- namely, the Appellant – Bank of India (“BOI”) and the Respondent No. 2 – Punjab National Bank (“PNB”), arising from competing claims over the same secured assets of Sri Nangli Rice Mills Pvt. Ltd (the “Borrower”). The Borrower had first availed of a credit facility from BOI in 2006, secured by hypothecation of rice and paddy stocks, and subsequently obtained another facility from PNB in 2013, backed by a pledge over the same secured asset. Upon the Borrower’s default, BOI discovered that the stock had been hypothecated twice. The competing claims led to several rounds of litigation before various courts, including the Debt Recovery Tribunal (“DRT”).

Procedural History

In particular, BOI filed Securitisation Application No. 285 of 2017 before the DRT-I, Chandigarh, which initially ruled in BOI’s favour, recognising its prior hypothecation charge. On appeal, however, the DRAT remanded the matter back to the DRT, observing that the DRT had failed to consider whether it had jurisdiction over a dispute between two banks. Upon remand, the DRT-I (Chandigarh), placing reliance on the order of the DRAT in Oriental Bank of Commerce & Anr. v Canara Bank and Ors.[iii], refused to entertain the matter observing that it had no jurisdiction as the dispute was between two banks and ought to be adjudicated by arbitration as prescribed under Section 11 of the SARFAESI Act. Accordingly, the DRT-I ordered the parties to approach the High Court for the appointment of an arbitrator (“DRT Order”).  Aggrieved by the DRT Order, the BOI approached the Punjab and Haryana High Court by way of a writ petition, which ultimately dismissed the same finding no fault with the decision of the DRT, which led to the instant appeal before the Supreme Court.

Issues Raised

• What is the scope of Section 11 of the SARFAESI Act?

• Is Section 11 of the SARFAESI Act mandatory or directory in its nature?

• What is the significance of the expression “arises amongst any of the parties, namely, the bank or financial institution or asset reconstruction company or qualified buyer” used in Section 11 read with Section 2 of the SARFAESI Act?

• Is a written arbitration agreement a precondition for referring disputes under Section 11?

Court’s Decision

The Court made the following observations:

1.  Section 11 is mandatory in nature. It is a stand-alone dispute resolution mechanism carved out specifically for inter se disputes between banks, financial institutions, ARCs, and qualified buyers.

2. The category of disputes contemplated under Section 11 of the SARFAESI Act are those which pertain to the rights and entitlements of secured creditors inter se, in relation to the enforcement of security interest, independent of the borrower’s liability. Accordingly, the Court observed that the scope and ambit of Section 11 of the SARFAESI Act have been confined by the twin conditions, that must be satisfied in order to attract the said provision, which are:

(i) Where the dispute arises between:

• any bank;
• any financial institution;
• any asset reconstruction company

(ii) Where the dispute relates to:

• securitization of financial assets;
• reconstruction of assets;
• non-payment of any amount due and /or interest

3. It observed that Section 11 will not apply to disputes between Banks, Financial Institutions, ARCs or Qualified Buyers, who are otherwise a borrower.

4. The Court emphasized that the legislative intent was to keep such disputes out of the DRT’s domain, which is otherwise focused on facilitating recoveries from borrowers. The Court noted that without such a mandate, disputes between secured creditors over the same asset would inevitably stall recovery proceedings against the borrower, undermining efforts to meaningfully recover bad debts. By directing these inter-creditor disputes to arbitration, the legislature aimed to prevent internal wrangling among creditors from impeding or delaying the enforcement of security interests.

5. The expression “non-payment of any amount due, including interest” used in Section 11 of the SARFAESI Act is of wide import and would include a various range of scenarios of ‘disputes’ connected to unpaid amounts including those arising due to third-party defaults, such as indirect defaults of the borrowers. In the case at hand, the issue pertaining to the priority of charge is inherently linked to the borrower’s “non-payment of any amount due” as contemplated under Section 11 of the SARFAESI Act. Therefore, such a dispute shall fall within the ambit of the said section even though the manner in which the charge was created was through a pledge which as per Section 31(b) of the SARFAESI Act falls outside the ambit of the Act.One of the most consequential findings was that disputes under Section 11 do not require a pre-existing arbitration agreement.

6. The Court clarified that Section 11 creates a statutory obligation to refer disputes to arbitration or conciliation, independent of party consent or contractual stipulation. The Court held that Section 11 of the SARFAESI Act creates a legal fiction as regards the existence of an arbitration agreement and therefore no written agreement is necessary.

Conclusion

This decision is particularly significant for disputes involving Banks, Financial Institutions including NBFCs (those which qualify as financial institutions under the SARFAESI ACT) and ARCs, who may not share arbitration agreements but are nonetheless swept within Section 11’s ambit. Arbitration of such disputes may expedite the resolution of similar inter-creditor disputes and ease the burden of DRTs, thereby reinforcing the legislative intent behind the SARFAESI Act to enable swift and efficient enforcement of security interests. The legal strategy must therefore shift from litigation before the DRT to invocation of arbitration and appointment of an arbitrator where necessary.