Effectiveness of arbitration in financing document disputes

By Nishtha Arora and Sounak Chakraborty, SNG & Partners

Globally, litigation and arbitration are the most commonly used methods for resolving commercial and transactional disputes. However, in India, in case of a dispute arising from financing transactions, the most preferred mechanism opted by banks and financial institutions is litigation. The statutory remedies available against a borrower in breach or default of any financing agreement are:

  1. Filing of debt recovery application before the Debt Recovery Tribunal under the Recovery of Debts and Bankruptcy Act, 1993.
  2. Taking action under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, for enforcement of security interest without the intervention of the court.
  3. Initiating an insolvency application before the National Companies Law Tribunal under the Insolvency and Bankruptcy Code, 2016.
  4. Filing of ordinary recovery suit or summary suit under the provisions of Code of Civil Procedure, 1908.
Nishtha Arora
SNG & Partners

Arbitration has become a mainstay in resolving commercial disputes as it gives parties the freedom to customize the procedural aspects of the dispute resolution process. This route offers the choice of governing law, neutral territory, speedy disposition, confidentiality of proceedings and awards, cost-effectiveness, specialized competence of arbitrators and the binding nature of arbitral awards, which makes it a popular dispute resolution alternative.

However, arbitration has not been embraced by banks and financial institutions. While parties to the arbitration exercise control over the manner of conduct of proceedings, it often becomes a costly and time-consuming affair, especially in cases of ad hoc arbitrations.

Delays result from the lack of summary judgment procedure available in litigation for straightforward claims of breach of any finance document. Further, courts have the power to grant ex parte reliefs and to join additional parties to litigation and consolidate related proceedings to avoid inconsistent judgments. Arbitrators lack authority to grant relief on an ex parte basis or to order joinder of third parties, which can result in multiple proceedings, adding to the cost of arbitration.

Sounak Chakraborty
SNG & Partners

It is also argued that arbitration offers finality as it precludes an appeal on its merits. This is, however, subject to mandatory provisions including the right of appeal that the law governing the arbitration proceedings may prescribe. For example, the Indian Arbitration and Conciliation Act, 1996, allows the parties to challenge an arbitral award on grounds such as the composition of the arbitral authority or the arbitral procedure not being in accordance with the agreement, non-arbitrability of dispute and conflict with public policy, etc. These rights are mandatory and cannot be waived by an agreement between the parties. Although such appeal may not involve a reconsideration of the merits, it still detracts from the finality of awards as it delays enforcement.

Financial institutions prefer judgments from courts that can be used as precedents for future disputes over arbitral awards that do not have precedential value. Further, arbitration clauses in the financing documents that give them the sole right to appoint an arbitrator lack legal certainty in terms of enforcement as an arbitral award passed by such arbitrator can be challenged on the ground of lack of independence or impartiality of the arbitrator, which breaches the principles of natural justice.

The primary reason for litigation being preferred among banks and financial institutions is the ability to take action selectively against the defaulting borrower. The availability of different statutory remedies against the borrower enables them to strategize their recourse in a cost-effective and timely way.

The Indian Arbitration and Conciliation (Amendment) Act, 2015, introduced several significant changes such as restricting judicial intervention in arbitral proceedings, limiting the scope of challenge to an arbitral award, ensuring time-bound completion, and regulating costs to make it a preferred mode for dispute settlement. However, parties and arbitrators still face practical difficulties in terms of judicial intervention, enforcement of awards, timely completion, and so on.

While India has an effective law of arbitration, there is a need to inculcate the culture of arbitration and create a robust ecosystem to make arbitration an efficient and effective alternative dispute resolution method for Indian banks and financial institutions.

SNG & Partners has offices in New Delhi, Mumbai and Singapore. Nishtha Arora and Sounak Chakraborty are associates.


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