Explained | Supreme Court decision on scope & ambit of Section 11 of the SARFAESI Act

Supreme Court: While considering a matter involving a dispute between two nationalised banks which touched upon the technicalities of Section 11 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), the Division Bench of J.B. Pardiwala* and Pankaj Mithal, JJ., had to consider the following issues:

• What is the meaning of the expression “any dispute relating to securitisation or reconstruction or non-payment of any amount due including interest” occurring in Section 11 of the SARFAESI Act?

• 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? What is the underlying object behind prescribing arbitration for the adjudication of disputes between a bank, financial institution, asset reconstruction company or qualified buyer, in Section 11 of the SARFAESI Act?

• Whether the existence of a written arbitration agreement between the parties is required for the purpose of resolution of disputes under Section 11 of the SARFAESI Act, 2002? Is there any conflict between the decisions of Oriental Bank of Commerce (supra) and Federal Bank (supra)?

• Whether Section 11 of the SARFAESI Act, 2002 should be construed as mandatory or directory in its nature?

The Bench held that 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.

Background and Legal Trajectory:

Sri Nangli Rice Mills Pvt. Ltd (the borrower) had availed credit facility from Bank of India (BoI) by hypothecating stocks of paddy and other assets. Pursuant thereto, a Credit Facility Agreement (the agreement) was executed between the borrower company and the BoI. As per clause 4.6 of the agreement it was stipulated that the borrower shall not avail any credit facility or loan from any other bank or financier until the borrower amount in respect of the credit facility sanctioned by the BoI herein is repaid.

While the loan amount under the aforesaid credit facility sanctioned by the BoI was still outstanding and yet to be discharged; the borrower, on 22-11-2013 by way of a loan application, proceeded to simultaneously avail one another credit facility from Punjab National Bank (PNB). Pursuant thereto, an Agreement of Advance/Pledge Agreement dated 06-12-2013 was executed between the borrower and the PNB, by which the warehouse receipts of certain goods including stocks of paddy and rice, were pledged in favour of the PNB as security.

Sometime in 2015, the borrower herein defaulted in repayment of the loan amount sanctioned by BoI, whereupon an inspection was undertaken by the BoI of the stocks of paddy and rice that were hypothecated to it with a view to realize the outstanding dues. It was the case of BoI that during the course of this inspection, it discovered for the first time that pledge tags of the PNB had been affixed on the said security.

Subsequently the matter reached the Debts Recovery Tribunal (DRT) wherein the BoI filed a securitization application. The DRT in its final order held that charge created in the favour of BoI by way of hypothecation over the stocks of paddy and rice was prior in time and, consequently, would take precedence over any subsequent charge that may have been created in favour of PNB by way of pledge. DRT allowed the BoI to sell the stocks of rice and paddy hypothecated in its favour for the purpose realizing the outstanding dues from the sale proceeds thereof.

Aggrieved by the aforesaid, PNB preferred an appeal before the Debt Recovery Appellate Tribunal (DRAT). The DRAT held that the DRT failed to take into consideration the preliminary objection that was raised by the PNB herein to the effect that the application filed by the BoI under Section 17 of the SARFAESI Act was not maintainable.

On remand, the DRT-I, Chandigarh vide its order dated 12-02-2020, held that it has no jurisdiction to adjudicate the dispute since the controversy pertained to competing claims between two banks over the same secured asset. it held that where the dispute in respect of the secured asset is inter-se between two banks or creditors, the same must be adjudicated by way of arbitration in terms of Section 11 of the SARFAESI Act by approaching the competent authority for seeking appointment of arbitrator by way of an application under Section 11 of the Arbitration and Conciliation Act, 1996.

The BoI eventually approached the Punjab & Haryana High Court, wherein by way of the impugned order, the Court upheld the upheld the afore-said decision of the DRT and thereby dismissed the writ petition filed by the BoI.

Court’s Assessment vis-a-vis scope of Section 11 of SARFAESI Act:

Perusing the dispute, the Court firstly delved into the Legislative History and Scheme of the SARFAESI Act. It was noted that despite the enactment of the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, there was a continuing rise in number of Non-Performing Assets (NPA) at banks and other financial institutions in India, further accentuated by the poor rate of loan recovery and the failure of the existing legislation in redressing the difficulties of recovery by banks. Therefore, On the recommendations of the Narasimham Committee and Andyarujina Committee, the SARFAESI Act was enacted to empower the banks and financial institutions to take possession of the securities and to sell them without intervention of the court.

Vis-a-vis scope and ambit of Section 11 of the SARFAESI Act, the Court pointed out that Section 11 deals with resolution of disputes relating to securitisation or reconstruction or non-payment of any amount due including where such dispute is between the bank or financial institution or asset reconstruction company or qualified buyer and stipulates that such disputes i.e., those pertaining to the subject-matter provided therein and involves the parties stipulated thereto, shall be resolved by arbitration, as if such parties to the dispute had consented to resolve it by arbitration in terms of the A&C Act, 1996. The Court further noted that from the plain language of Section 11 of the SARFAESI Act, it is manifest that the scope and ambit of the said provision have been limited or confined by the twin conditions- firstly, the dispute must be between any bank or financial institution or asset reconstruction company or qualified buyer and secondly, the dispute must relate to securitisation or reconstruction or non-payment of any amount due including interest.

It was therefore held that where the aforesaid twin conditions are found to be prima-facie satisfied, there the DRT will have no jurisdiction and the proper recourse would only be through Section 11 of the SARFAESI Act read with the A&C Act, 1996.

It was pointed out that 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 of facilitating recoveries of dues from the borrowers expeditiously by enforcement of secured assets or other means provided thereunder.

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. The entire scheme of the SARFAESI Act is premised on the liability of the borrower being crystallized by virtue of its classification as a non-performing asset by the secured creditor.

The Court further pointed out that the word “dispute” used in Section 11 of the SARFAESI Act does not consider “any dispute” that arises out of “any reason whatsoever”. The scope and meaning of the said term has been qualified and limited by the provision itself, more particularly, the expression “relating to securitisation or reconstruction or non-payment of any amount due including interest”. Hence, Section 11 would be attracted only where the dispute arises in relation to (i) securitisation, or (ii) reconstruction, or (iii) non-payment of any amount due (including interest).

The Court pointed out that the instant case, more particularly dispute between BoI and PNB does not pertain to either securitisation or reconstruction. It does not involve any acquisition of financial assets or rights by an asset reconstruction company (ARC). Rather, the crux of the issue is whether the controversy involving the competing claims of rights over the stocks of goods by hypothecation or pledge and the dispute therein falls within the scope of Section 11 of the SARFAESI Act, more particularly the third category of disputes delineated thereunder pertaining to “non-payment of any amount due including interest”. Furthermore, the Court held that the expression “non-payment of any amount due including interest” used in Section 11 of the SARFAESI Act is of wide import.

The Court further stated that any dispute between two banks, financial institutions, asset reconstruction companies or qualified buyers etc., where the jural relation between the two is of a lender and borrower, then Section 11 of the SARFAESI Act will have no application whatsoever. The use of the phrase “any person” in the definition of ‘borrower’ in Section 2(f) of the SARFAESI Act, makes it abundantly clear that even a bank, financial institution or asset reconstruction company or qualified buyer can be considered a borrower, if they receive financial assistance from a bank or financial institution etc by providing or creating a security interest. Thus, a lender-turned-borrower would also fall within the scope of a “borrower” under the SARFAESI Act and shall be governed by the same statutory framework as any ordinary borrower.

Vis-a-vis the requirement of written arbitration agreement under Section 11 of the SARFAESI Act, the Court held that 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 arbitration agreement in order to attract Section 11 of the SARFAESI Act. The said provision creates a legal fiction as regards the existence of an arbitration agreement notwithstanding whether such agreement exists or not in actuality.

Finally, considering the nature of Section 11 of the SARFAESI Act, the Court held that Section 11 of the SARFAESI Act is mandatory in nature. Due to the use of the word “shall” therein, the mandate of the provision cannot be bypassed or subverted by the parties by seeking recourse elsewhere.