Arbitration mandatory for inter-bank disputes under SARFAESI Act: Supreme Court

The Supreme Court on Friday ruled that disputes between banks and financial institutions over competing claims on secured assets must be resolved through mandatory arbitration under Section 11 of the SARFAESI Act [Bank of India v. Nangli Rice Mills]..A Bench comprising Justices JB Pardiwala and Pankaj Mithal categorically held that debt recovery tribunals (DRT) lack jurisdiction to adjudicate such inter-bank disputes."The object underlying Section 11 of the SARFAESI Act insofar as it mandates arbitration or conciliation as the only mechanism for resolution of disputes between a bank, financial institution, ARC etc. and ousts the jurisdiction of the DRTs under Section 17 for adjudicating such disputes is to ensure that ancillary or collateral disputes that may arise between competing secured creditors do not hinder the larger purpose of the SARFAESI Act," the Court stated.The Court further held that no written arbitration agreement is required between the parties for arbitration under Section 11."Section 11 of the SARFAESI Act, provides for a statutory arbitration for any dispute mentioned therein between any of the parties enumerated thereunder. There is no need for an explicit written agreement to arbitrate between such parties," the judgment said. .The case arose out of overlapping claims over pledged stocks of rice and paddy belonging to Sri Nangli Rice Mills Pvt Ltd, a borrower that had taken credit facilities from both Bank of India and Punjab National Bank (PNB). While Bank of India had hypothecated the borrower’s stock in 2006, PNB subsequently extended loans in 2013 against warehouse receipts, treating the same stock as pledged security.After the borrower defaulted, Bank of India discovered that stocks earlier hypothecated to it bore PNB’s pledge tags. This led to a dispute between the two banks over their competing claims. Both banks initiated proceedings under the SARFAESI Act and took steps to enforce their respective security interests. The matter eventually reached the DRT, which initially ruled in favour of Bank of India after recognising its prior hypothecation.However, on appeal, the Debt Recovery Appellate Tribunal (DRAT) remanded the matter to the DRT to consider whether such inter-bank disputes were even maintainable under Section 17 of the SARFAESI Act.The DRT then held that it lacked jurisdiction and directed the parties to resort to arbitration in terms of Section 11 of the Act. The High Court upheld this decision, prompting Bank of India to approach the Supreme Court..The Supreme Court unequivocally held that Section 11 of the SARFAESI Act is mandatory in nature and rejected the suggestion that arbitration is merely an alternative dispute resolution mechanism in such cases. The Court emphasized that the use of "shall" in the provision creates a binding obligation that cannot be circumvented."The usage of 'shall' in the provision mandates the parties to adhere to the mentioned mechanism and restricts them from approaching any other forums," the Court stated, adding that "the parties cannot bypass or subvert it by seeking recourse elsewhere," the Court ruled. .The Supreme Court ruled that arbitration under Section 11 of the SARFAESI Act is not optional but compulsory for resolving disputes between banks, financial institutions, asset reconstruction companies (ARCs) and qualified buyers. "Section 11 of the SARFAESI Act is mandatory in nature. The use of the word ‘shall’ therein, the mandate of the said provision cannot be bypassed or subverted by the parties by seeking recourse elsewhere," the Court underscored. .On the scope of disputes covered by Section 11, the Court interpreted the phrase “non-payment of any amount due, including interest” broadly. It ruled that this provision includes not just direct defaults by a financial entity but also indirect or third-party defaults (such as those by a common borrower), where multiple creditors assert claims against the same asset..The court ruled that under Section 11, banks do not need a formal arbitration agreement. The provision itself incorporates a legal fiction that treats the parties as if they have consented in writing to arbitration.This legal fiction—created by the phrase “as if the parties to the dispute have consented in writing”—ensures that arbitration remains a compulsory and automatic recourse for eligible financial entities, even in the absence of a contractual clause..The Court also drew a clear line between disputes among secured creditors and those involving borrowers. While Section 11 governs disputes inter se banks, ARCs, financial institutions and qualified buyers, it does not apply where the dispute is between a bank and a borrower even if the borrower is a financial institution in another context:"A borrower that happens to be a financial institution would still, for the purposes of the SARFAESI Act, be considered a borrower and thus would be disentitled to claim the benefit of Section 11," the Bench made it clear. .The petitioner was represented by Senior Advocate Dhruv Mehta with advocate Pranab Kumar Mullick, Soma Mullick and Sebat Kumar Deuria..The respondents were represented by advocates Ekta Choudhary, Divyank Dutt Dwivedi, Siddhartha Chowdhury, Snehasish Mukherjee and Shaffi Mather. .[Read Judgment]