A Marriage Of Convenience: Arbitrability Under The SARFAESI Act, 2002

On 20^th December 2023, the Bombay High Court decided Tata Motors Finance Solutions Limited vs Naushad Khan (“Tata Motors Finance”) on the question of arbitrability in cases involving a financial institution under the Securitization and Reconstruction of Financial Asset and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”). In the present matter, the parties entered into a loan agreement which contained an arbitration clause. Upon dispute regarding the mortgaged property, the Petitioner sought to invoke the said clause. However, such invocation was challenged by the Respondent on the grounds of arbitrability. It was contended that owing to Petitioner being a financial institution under the SARFAESI Act, the Debt Recovery Tribunal (“DRT”) had exclusive jurisdiction over such a dispute. Thereby, the question arose whether a dispute that has an alternative remedy under the SARFAESI Act is arbitrable.

Arbitrability under the RDB Act

Another issue that arose in the present matter was regarding the application of the Recovery of Debts and Bankruptcy Act, 1993 (“RDB Act”) and whether the present claim becomes non-arbitrable. The Apex Court in Vidya Drolia had held RDB Act disputes are non-arbitrable, and therefore, even if there is an arbitration clause, the same would be rendered ineffective. Such adjudication would only take place in consonance with the RDB Act before the special forum, i.e., the DRT. It is to be noted that the SARFAESI Act also makes reference to the DRT for enforcement of the debt due to the financial institution. Thus, in the present proceedings, the respondent prayed the Court to hold SARFAESI Act disputes as non-arbitrable similar to RDB Act disputes.

However, the Bombay High Court noted that the RDB Act encompasses a different mechanism as compared to the SARFAESI Act. It noted that the RDB Act dictates the mechanism and machinery for adjudication and determination of the debt due to a “financial institution” as under the SARFAESI Act. The petitioner, not being a financial institution notified under the RDB Act, cannot effectuate the mechanism under it.

In exploring the arbitrability of disputes under the RDB Act, reference was made to Mantras Green Resources Limited and others vs CanaraBank, where the bank in question was a notified financial institution under the RBD Act and was made a party to the proceedings. Further, the Court examined the decision in Bank of Rajasthan Ltd. vs VCK Shares and Stock BrokingServices Ltd. where the bank had the remedy and mechanism under the RDB Act available to them. In sum, the Court clarified that claims governed by the RDB Act cannot be subject to arbitration proceedings. However, the Court reprimanded the misplaced reliance on the aforesaid decisions and noted that while the RDB Act and the SARFAESI Act are complementary statutes, they are not identical. The purpose for which the DRT is approached under the RDB Act is for adjudication of the debt due. It is this adjudicatory mechanism that bars the use of any other means of adjudication, such as arbitration.

Arbitrability under the SARFAESI Act

At the outset, it is noteworthy that the decision in Tata Motors Finance has crystalized a two-step test for the determination of debt due and its enforcement under the SARFAESI Act. The appreciation of the facts in the present case highlight that the test is based on the classification of a 'financial institution' under Section 2(1)(m) of the SARFAESI Act.

Firstly, the definition under Section 2(1)(m) of the SARFAESI Act is distinct from the 'financial institution' under Section 2(h) of the RDB Act. More pertinently, Section 2(1)(m)(iv) of the SARFAESI Act is different from the preceding provisions of Section 2(1)(m). The language of Section 2(1)(m)(iv) expressly states that the notification of any institution or non-banking financial company as a financial institution is “for the purpose of this Act”. Therefore, the words used in the aforesaid provision make it clear that such a financial institution is only for the purpose of the SARFAESI Act.

Secondly, the decision of Tata Motors Finance reinforced the position of law regarding the Arbitration Act and the SARFAESI Act operatingin tandem. The Single Judge relied on the Supreme Court decision in M.D. Frozen Foods ExportsPrivate Limited vs Hero Fincorp Limited that laid down that the provisions of the SARFAESI Act are a remedy in addition to the provisions under the Arbitration Act. The compatibility of the two legislations is drawn from the fact that in the event the secured assets are insufficient to satisfy the debt, the secured creditor may initiate proceedings under the Arbitration Act for crystallization of the debt due, after which the secured creditor can proceed for enforcement under the SARFAESI Act. Therefore, the Arbitration Act and the SARFAESI Act can go hand in hand, unlike arbitrability under the RDB Act.

To contextualize the aforesaid principles to the present matter, the petitioner was notified as a 'financial institution' only under Section 2(1)(m)(iv) of the SARFAESI Act, and arbitration as an adjudicatory process leadsto determination and crystallization of the debt due to the petitioner, that the petitioner would be able to resort to the enforcement process under the SARFAESI Act. In light of the peculiarity and nature of the facts in the present case, the matter is outside the scope of the RDB Act, and in the absence of a mechanism to determine the crystallization of debt under the SARFAESI Act, it allows for the application of the Arbitration Act through a purposive interpretation and as a cumulative remedy.

Implications

The decision in Tata Motors Finance highlights that the law contains a bifold mechanism for the determination of debt due and for enforcement of a debt. However, the caveat for the application of the Arbitration Act to determine a debt due is that it is fact-specific and on a case-by-case basis. Furthermore, the critical analysis of the decision demonstrates a logical conclusion that addresses the practical implications faced by secured creditors. SARFAESI Act envisages an expeditious procedure for liquidation of secured interest while the RDB Act provides for adjudicationof the grievance made by any aggrieved person qua the procedure adopted by the banks, financial institutions, and other secured creditors. The SARFAESI Act is solely concerned with the enforcement process, and thus, arbitration as an adjudicatory process facilitates the enforcement process pursuant to the determination of a debt due. The Court, in the absence of a debt crystallization mechanism, resorted to arbitration as a forum to determine the debt due. Therefore, reference to the SARFAESI Act in the agreements cannotbe a bar for the petitioner to invoke arbitration.

Another key takeaway from the case is that it gears towards a pro-arbitration stance on account of greater clarity regarding such loan facility transactions being arbitrable. The ambiguity regarding the arbitrability of SARFAESI Act claims was muddied in Vidya Drolia, and the position clarified herein. Additionally, it upholds the principle of party autonomy, the cornerstone of arbitration, by allowing the petitioner to resort to the arbitration clause contained in the agreement executed by the parties. In brokering a conclusion, the decision not only clarifies the obiter dictum in Vidya Drolia but also provides beneficial insulation for secured creditors and charters a welcome measure for India's pro-arbitration regime.

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