top of page
  • Rajnandan Gadhi and Joshua Joseph Jose

Arbitration Under Hypothecation Agreements: A Faustian Bargain


Rajnandan Gadhi and Joshua Joseph Jose*


 

I. INTRODUCTION


The proposition that this piece contends originates from a conversation the authors had with an autorickshaw driver who woefully expressed that his vehicle was on the verge of repossession and cast doubts on the partisan nature of the procedure adopted to resolve the dispute. Upon further inquiry, the authors discovered a pattern of illegality that is commonly seen in vehicle loan cum hypothecation contracts (‘hypothecation agreements’). Hypothecation agreements are contracts where a borrower agrees to pledge their vehicle's ownership to the lender at the time of purchase until the vehicle loan is fully paid.


The dispute resolution clauses embedded within these contracts are, generally, boilerplate arbitration clauses that empower the financial institution with the right to appoint an arbitrator without the consent of the hypothecator. A myriad of case laws involving hypothecation agreements, such as Shriram Transport Finance Co. Ltd. v. Shri Narender Singh, display a trend, which involves unilateral appointment by the lender, insufficient disclosure by the arbitrator, and a failure to issue proper notice by the lender.


In a significant number of cases, hypothecators can be seen challenging the arbitral award issued, seeking relief from the courts, which can sometimes fail in addressing the wrongdoing. A corollary to the many judgments evidencing illegal conduct is that such illegal operations are rife outside of the instances brought before the courts. Often, the hypothecator, unaware of the partly uncodified law, falls victim to the actions of the financial institutions in their debt recovery process. Because of their ignorance, hypothecators often fail to seek relief from the courts for the improper conduct faced.


The authors argue that the dispute resolution process is improper due to poor arbitration clauses that result in unilateral appointments. This unilateral appointment is often accompanied by improper notice and inadequate disclosure of previous appointments, which culminate in the passing of an unjust ex-parte arbitral award. Thus, this post intends to explore the above-mentioned improper arbitration procedures engaged in by financial institutions such as banks and Non-Banking Financial Companies (‘NBFCs’), when offering credit through hypothecation agreements to unsuspecting customers.


Part II of this post probes into the unilateral appointments made in hypothecation disputes and the arbitration clauses that enable such appointments. Part III critically examines the failure of unilateral arbitrators to disclose their previous entanglements with the appointing party. Part IV discusses the mandatory service of notices or the lack thereof, commonly witnessed in such arbitrations. Part V puts forth remedies such as mediation or litigation as possible alternatives, legislative amendments, and record maintenance. Part VI concludes by emphasising the need to implement these solutions to uphold the spirit of arbitration law.

 

II. UNDUE INFLUENCE IN HYPOTHECATION DISPUTES

 

Unilateral appointment in hypothecation agreements is the one-sided appointment of an arbitrator by the financial institution seeking repossession upon default on repayment, for the adjudication of a dispute it has with the hypothecator. It has been held to be non-est and void ab initio by the Supreme Court of India in Perkins Eastman Architects DPC v. HSCC (India) Ltd (‘Perkins’). This decision, followed by a catena of judgments, affirmed the invalidity of unilateral appointments unless waived off by the other party through an express written agreement after the dispute had arisen between the parties. Unilateral appointment is the crux of the problem in the dispute resolution process of hypothecation agreements, as it is an act that is attempted at the beginning of the relationship between the hypothecator and the financial institution.

 

This issue stems from most of these hypothecation agreements containing clauses that suffer from defects that go against the tenets of arbitration law. In other words, the loan cum hypothecation agreements generally possess pathological arbitration clauses that are phrased along the lines of ‘any dispute or disagreement arising out of or in connection with this Agreement (“Dispute”), shall be submitted to arbitration and shall be finally resolved by arbitration in accordance with the Arbitration and Conciliation Act, 1996 (‘the Act’) with a sole arbitrator to be appointed by the Lender.’ Such unilateral appointment clauses where only the financial institution has the right to appoint an arbitrator have been explicitly declared to be violative of the arbitral principle of party autonomy.


These pathological clauses are a particularly pervasive issue in hypothecation agreements, as these are usually standard-form contracts, thereby putting the hypothecator in a weaker bargaining position. This weaker position is taken advantage of by lenders in various ways; one of them being the slipping in of a unilateral appointment clause. Specimen agreements issued by financial institutions like Axis Bank, Volkswagen Finance, Reliance Commercial Finance, HDFC Bank, and Tata Financial Services Ltd, to name a few, contain the supra-mentioned pathological clause. These clauses, while discussing the appointment of the arbitrator, generally end by empowering the lender with the sole right to appoint the arbitrator.


Cholamandalam Investment and Finance Co. Ltd. v. Amrapali Enterprises and Anr. is a case of unilateral appointment in hypothecation disputes. Here, the Calcutta High Court likened the appointment of arbitrators by financial institutions to a virus that had emerged and set aside the unilateral arbitral award given in the case. Again, in Hina Suneet Sharma v. M/s Nissan Renault Financial Services India Private Limited, the arbitral award passed by a unilaterally appointed arbitrator was successfully challenged in the Madras High Court. Additionally, the Kerala High Court in Hedge Finance Private Limited v. Bijish Joseph held an award to be unsustainable in law due to the coram non judice nature of the unilateral appointment in the absence of a waiver. In these cases, the courts have established that the deliberate inclusion of unilateral arbitral clauses in hypothecation agreements by financial institutions is wrong and unsustainable in law and as a consequence, the very appointment of, and other subsequent actions taken by, the arbitrator are unlawful.

 

Notwithstanding all the jurisprudence against unilaterally appointed arbitrators, such appointments made under hypothecation agreements are still the norm. However, a fluke solution presents itself. As pointed out by Justice Shekar B. Saraf in Srei Equipment Finance Limited v. Sadhan Mandal, Perkins judicially expanded the Seventh Schedule of the Act to include the unilateral appointment of arbitrators by one of the parties as a category that would render one ineligible to be an arbitrator. This inclusion creates an apparent solution to the issue: a challenge to the appointment under Section 13. Unfortunately, this solution is rendered futile by Kompetenz-Kompetenz, the power of an arbitral tribunal to determine its own jurisdiction. An ironic circumstance is created where the weaker party has to submit a challenge of appointment on the grounds that it was unilateral, to the unilaterally appointed arbitrator themselves.

 

If the challenge is not successful, that is, the arbitrator determines themself to be competent and continues the proceedings, there is no recourse available until the award is passed; at which point an application to set aside the award may be filed under Section 34.

 

 

III. UNDERNEATH THE TIP OF THE ICEBERG

 

Upon deeper dissection of hypothecation arbitration cases, there are various instances of repeat appointments of the same unilateral arbitrator by financial institutions. In a multitude of disputes, the same arbitrator has been appointed without disclosing their previous services, as they are required to do under Section 12(1)(a) in the format of the Sixth Schedule of the Act. In Ram Kumar v. Shriram Transport Finance Co. Ltd. (‘Ram Kumar’), a unilateral arbitrator was impanelled with the NBFC in question. The arbitrator acted in numerous arbitrations for them and still failed to disclose their previous services. Here, it was held that the award was null due to the omission of disclosure where there was a mandate to do so.

 

Analogously, the Bombay High Court, in Shawarma Gadodia v. Tata Capital Finance Services Ltd., observed that:

 

...most of the companies, who are in the business of lending finance, are, whilst appointing Arbitrators not following the provisions of the Act, but without disclosing this fact in the disclosure mandatorily required to be made under the Act, are appointing the same Arbitrator in hundreds of matters; sometimes in more than 1000 (one thousand) matters…”.

 

On some occasions, this troubling situation devolves into something downright dire. In V.K. Senthilkumaran v. Shriram Transport Finance, a brazen occurrence of the unilateral arbitrator working out of the lender’s address, the Madras High Court specifically raised concern over “[the] multitude of arbitration proceedings had been concluded in favour of the first respondent-Company, mechanically or without any pretension of impartial adjudication.” and emphasised that “The arbitrator has gone about discharging his duties dutifully as a paid employee and servant of the first respondent-Company.

 

While it is true that Sixth Schedule disclosure is a positive obligation and directory in nature, it would be prudent if it were given in the current context, considering that the appointment is unilateral. In the immortal words of Sir Michael J. Mustill and Stewart C. Boyd,

 

A person who is approached with a request to act, and knows that he has some kind of relationship with one of the parties, should remember that there is no keener sense of injustice than is felt by someone who has doubts about whether the arbitrator is doing his honest best

 

This is the bare minimum that needs to be performed by the arbitrator, given that the Sixth Schedule disclosure has no means of being verified. Notwithstanding a disclosure actually being given by the arbitrator, the non-appointing party has no means of knowing if the disclosure is true and complete. Hence, in such a system based solely on trust and good faith, it would best serve the interests of the parties if the burden of disclosure is greater when the unilaterally appointed repeat arbitrator is approached with a potential appointment. This follows the precedent set by the Delhi High Court in Ram Kumar, wherein it held that it is “mandatory for the person who is approached in connection with his possible appointment as an arbitrator, to disclose all circumstances that may give rise to justifiable doubts as to his independence and impartiality.

 

 IV. NOTICE(D) THE DISOBEDIENCE


Notices in arbitration proceedings are a vital procedural component to ensure equity and maintain public policy. Section 9 mandatorily requires a notice to be sent “especially when coercive orders are being passed”, as per New Morning Star Travels v. Volkswagen Finance Private, a case involving a hypothecation agreement. Section 11(13) of the Act also mandates that service of notice ought to be given to the opposite party. This requirement of notice is affirmed in Manish Engineering Enterprises v. Indian Farmers Fertilizer Coop. Ltd. and Ors. Similarly, Section 21 of the Act mandates the issuance of a notice as per the decisions of courts in Alupro Buildings v. Ozone, Rahul Jain v. Atul Jain, and Globe Detective v. Gammon. Section 25 is also no exception to the notice norm, as it requires a notice per Ms Mittal Pigments Pvt Ltd v. Ms Gail Gas Limited. In this case, an arbitral award was set aside on account of “improper communication to the petitioner, before proceeding ex-parte”.


Thus, financial institutions in such vehicle hypothecation arbitration cases are obliged to send notice to comply with the procedure when a dispute arises. However, antithetical to the laws above, these financial institutions in various hypothecation arbitration cases have not complied with the procedure by issuing appropriate notices. This non-compliance with the procedure from the financial institutions results in improper communication, which catalyses the unilateral appointment clause. This causes a unilaterally appointed arbitrator, thereby yielding an unjust ex-parte arbitral award.

 

The Calcutta High Court, in 2019, noted one such case where Shriram Transport Finance failed to issue notice to the hypothecator under Section 11(13) and Section 21 of the Act. As a result, it set aside the arbitral award which was passed in favour of a “fresh hearing in accordance with law”. K. Suresh v. Shriram Transport Finance (2021) is a Madras High Court case where improper communication resulted in the passing of an ex-parte award. The Court, with respect to notice under Section 21 of the Act, held that “there was no indication in the award to show that notice has been served on the … [hypothecator] before passing the award.” In 2022, one can observe yet another case with Shriram Transport Finance where the lender had not issued a notice under Section 21 of the Act. As in the earlier case, the Delhi High Court, too, came to the finding that “no notice as contemplated under the provisions of Section 21 of the Act was ever received by the Respondent”.


A similar situation can be observed in Sibi C.B. v. Muthoot Vehicle and Asset Finance Ltd., a Kerala High Court case. Here, the hypothecator did not appear to even possess a copy of the hypothecation agreement, let alone receive notice for the commencement of arbitral proceedings. The cases above, concerning non-issuance of notice, illustrate that improper conduct with respect to issuance of notice is an issue across jurisdictions throughout the country. They indicate that, despite decisions reprimanding the improper issuance of notice, the practice remains rife.

 

 

V. ROADMAP TO COMPLIANCE

 

The above-mentioned issues paint a bleak picture of the scenario in terms of compliance with the Act and other arbitral procedures. However, one must not interpret this solely as a result of malicious action by these financial institutions. The procedural requirements such as the disallowance of unilateral appointment, and proper notice under Sections 9, 21, and 25, are not all codified and easily accessible, as many exist only through judicial precedent.

 

The authors propose a twofold approach to this problem to alleviate it in the short term and resolve it in the long term: A) resolving such disputes using existing alternatives and B) amending the law to make the relevant arbitration infrastructure more holistic, respectively.

 

A. Existing Alternatives

 

Arbitration in India, although purported to be a speedy and cost-effective process, is still another layer of litigation, especially in such small-scale disputes. On the contrary, as seen in R.L. Jayalal v. Sundaram Finance Limited, mutually agreed mediation has been tried and tested in hypothecation disputes and enjoys a considerable success rate. Furthermore, the parties can always avail the debt recovery mechanisms provided under the Recovery of Debts and Bankruptcy (RDB) Act, 1993, and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, if the claim falls above the prescribed threshold. Suppose the claim does not meet the threshold. In that case, the aggrieved party can always prefer a summary suit for money recovery as prescribed under Order 37 of the Code of Civil Procedure, 1908, or a civil suit under Order 4.

 

B. Necessary Legislative Amendments

 

Over the long haul, if arbitration continues being the modus operandi, we recommend that a sub-provision be inserted in Section 36 of the Act whereby concerned courts maintain a record of every arbitrator’s past activity and supply them upon request by parties doubting the exhaustiveness of the disclosure made.


This record should include the names of the parties involved, preferably by keeping track of Section 36 applications and the subsequent enforced awards. It would act as a means of verifying the arbitrators’ disclosure. The Act, in its current form, does not mandate the issuance of notice under Sections 9, 21, and 25. The authors recommend the addition of sub-provisions in these sections that make sending notices compulsory. If the notices are unable to be delivered, the relevant notice may be published in newspapers.

 

Additionally, the Act needs to adopt a practice from the UNCITRAL Model Law on Arbitration (‘Model Law’). The Model Law allows for the challenging party to request, after the challenge to appointment fails, the court or other authority specified to decide on the challenge. This appeal, following a failed challenge, would aid the hypothecator in bringing this predicament to the attention of the courts sooner.

 

Perkins went a long way in cutting down on unilateral appointments but it did not eliminate the issue entirely. We argue that unilateral appointment without the waiver must be made illegal de jure by statutorily inserting it as a category under the Seventh Schedule for ineligibility of appointment under the Act.  Following this, we assert that the NBFCs, instead of offering mere lip service, must actually comply with the Act by ensuring that the appointment of the arbitrator is by mutual consent. The parties may also approach the appropriate courts seeking appointment, to ensure the independence of the arbitral tribunal.


When approached, the courts must also exercise a sense of sensitivity and caution while appointing arbitrators in these vehicle financing arbitration matters, to ensure that repeat appointments are not made for the nth time. An arbitrator can only be appointed in two ways, for the resolution of any disputes or differences between the parties, either by approaching the appropriate court under Section 11 of the Act, or by mutually agreeing on the name of the arbitrator and appointing the same.

 

VI. CONCLUSION

 

There exist various discrepancies in the conduct of arbitral procedure by various lenders in hypothecation agreements. These inconsistencies bear significant hurt to the hypothecator due to their weaker position in the transaction. This activity is laid bare by the various disputes before the courts and specimen hypothecation agreements. From unilateral appointment of arbitrators to inadequate disclosure, to the improper issuance of notice, these problems culminate in unjust ex-parte arbitral awards.

 

In conclusion, arbitral clauses, in ample hypothecation agreements, are whitewashed tombs that on the outside, look like amicable settlement means, but really are a dispute resolution process practiced unfairly. These issues, however, could be mitigated at the instant by way of mediation or traditional debt recovery mechanisms under existing legislative structures. If arbitration is still preferred, the issues could be remedied in the long term by maintaining records of arbitrators and making the law clearer through codification.


Rajnandan Gadhi and Joshua Joseph Jose are second-year students at the National University of Advanced Legal Studies, Kochi. They would like to thank Adv. Haaris Moosa for planting the seed that became this piece. They are also grateful to Ms. Fathima Rena Abdulla and the blog editors of NLSBLR for their comments on previous drafts of this post.

Recent Posts

See All

Commentaires


bottom of page