Arbitration Mandatory for Inter-Creditor Disputes Involving Secured Assets

In a significant ruling, the Hon’ble Supreme Court of India, in the case of Bank of India vs M/S Sri Nangli Rice Mills Pvt. Ltd. & Ors., (2025 INSC 765), dated May 23, 2025, held that disputes between secured inter-creditors must be resolved through arbitration or conciliation under Section 11 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI ACT). The Court clarified that a formal written arbitration agreement is not required, as Section 11 creates a statutory legal fiction deeming such consent to arbitration to exist, thereby mandating resolution of such disputes through arbitration and ousting the jurisdiction of the Debt Recovery Tribunal (DRT).

The case involved competing claims over the same secured asset, being stocks of rice and paddy, by Bank of India and Punjab National Bank, both of whom had extended credit facilities to the borrower, M/s Sri Nangli Rice Mills Private Limited. Bank of India had granted a loan to the borrower on July 31, 2003, formalised through a credit facility agreement that expressly prohibited the borrower from creating third-party rights or borrowing from other lenders without the prior written consent of Bank of India. In breach of these terms, the borrower obtained a second loan from Punjab National Bank on November 22, 2013, secured by a pledge agreement. Bank of India, having neither been informed of nor consented to this second facility, discovered the pledge during a stock inspection in 2015 after the borrower defaulted. Bank of India issued a demand notice under Section 13(2) of the SARFAESI Act, sought assistance under Section 14, and filed a securitisation application before the DRT to restrain Punjab National Bank and assert priority over the secured assets. Although the DRT initially ruled in favour of the Bank of India, recognising its prior hypothecation, the Debt Recovery Appellate Tribunal remanded the matter for reconsideration of the DRT’s jurisdiction. Upon rehearing, the DRT held that it lacked jurisdiction to decide a dispute between two banks and directed the parties to resolve the matter through arbitration under Section 11 of the SARFAESI Act.

The Court held unequivocally that Section 11 of the SARFAESI Act envisions a statutory mechanism for resolving disputes relating to securitisation, reconstruction, or non-payment of any amount due, including interest, as between banks, financial institutions, asset reconstruction companies (ARCs), or qualified buyers. In such cases, the provision mandates resolution through conciliation or arbitration, governed by the Arbitration and Conciliation Act, 1996, and does so ‘as if the parties have consented in writing’ to such process. This phrase, ‘as if,’ was interpreted by the Court as creating a legal fiction, thereby dispensing with the need for an actual arbitration agreement between the parties.

The Court observed that the statutory intent behind Section 11 was to preclude delays in recovery proceedings caused by inter-creditor disputes and to prevent such disputes from frustrating the realisation of bad debts. The nature of DRT proceedings being largely summary, the legislature consciously excluded such inter-creditor disputes from its purview by omitting the term ‘borrower’ in Section 11. Thus, where the dispute is between secured creditors and satisfies the dual conditions that the parties fall within the class specified under Section 11 and the subject matter relates to securitisation, reconstruction, or non-payment of dues, the DRT loses jurisdiction, and arbitration becomes the mandated route.

The Court further clarified that the dispute in the present case, though not involving direct securitisation or reconstruction, arose fundamentally from the borrower’s non-payment and gave rise to conflicting claims over the borrower’s assets. Therefore, it fell within the third category of disputes recognised under Section 11, namely disputes relating to ‘non-payment of any amount due, including interest’.

Importantly, the judgment also delineated the limits of Section 11, stating that it would not apply where the dispute is between a lender and another entity who has assumed the role of borrower. In such instances, the relationship between the parties alters fundamentally into one of lender and borrower, thereby rendering Section 11 inapplicable.

Reinforcing the mandatory character of Section 11, the Court highlighted that the provision uses the word ‘shall’, thereby making it impermissible for the parties to bypass or avoid the statutory requirement by resorting to other fora. It held that the legal presumption of consent created by Section 11 must be accorded full meaning and effect, as the legislative fiction operates independently of a formal arbitration agreement.

The judgment thus reinforces the role of arbitration as a statutorily mandated recourse under Section 11 of the SARFAESI Act in inter-creditor disputes involving secured assets and non-payment of dues.