Monday, May 9, 2011

SC rules that mortgage suits are non-arbitrable

In a landmark judgment last month, Booz Allen and Hamilton Inc. v. SBI Home Finance Ltd. & Ors. (judgment dt. April 15, 2011) a two-judge bench of the Supreme Court ruled in an appeal by special leave that a suit for enforcement of a mortgage by sale is non-arbitrable.
The scope of section 8 of the Arbitration and Conciliation Act, 1996 was under consideration in this SLP.

Capstone Investment and Real Value Investment, both Respondents in this case and owners of flats, had borrowed loans from SBI Home Finance, another Respondent, under two loan agreements by securing the two flats in favour of SBI. The Appellant was permitted to use the above two flats under leave and license agreements signed by Appellant, the respective flat owners as well as SBI as confirming parties.
A tripartite deposit agreement was also entered into by Capstone and Real Value as one party, Appellant as second party and SBI as third party. As per this agreement, Appellant was to pay the flat owners a certain sum of money as refundable security deposit according to the terms and conditions of the leave and license agreement and deposit agreement, and the three agreements formed a single integral transaction. A part of the security deposit was paid directly to SBI towards payment of loan taken by Capstone and Real Value. As a result, the loan due by Capstone was cleared but the loan due by Real Value was outstanding. Capstone however became guarantor for repayment of the amount due by Real Value and its flat was used as security.
Clause 16 of the deposit agreement provided for arbitration.
In about July 1997, Real Value applied to the Board of Industrial and Financial Reconstruction (BIFR) under the Sick Industrial Companies Act, pursuant to which the official liquidator took over the flat owned by Real Value.
As the loan amount due by Real Value had not been paid, SBI filed a mortgage suit about two years later before the Bombay High Court against Capstone, Real Value and the Appellant, in regard to the mortgaged property, which was the flat owned by Capstone. SBI sought a declaration that Capstone as mortgagor owed a certain amount of money to SBI and if the same is not paid by the date fixed by the Court for redemption, SBI had the right to redeem the amount due from proceeds of sale of the suit property. It also sought a declaration that Appellant would vacate the property at the earliest.

High Court
Among other arguments by various parties, Appellant prayed that the parties to the suit be referred to arbitration, as per clause 16 of the deposit agreement. SBI resisted this application.
The High Court (single judge) rejected the application on three grounds:
(a) Clause 16 of the deposit agreement did not cover the dispute, subject matter of the claim by SBI against its borrowers (Capstone and Real Value) and thus it was not open to Appellant to request the court to refer the parties to arbitration;
(b) The counter-affidavit filed by Appellant, in regard to the notice of motion for temporary injunction, amounted to submission of the first statement on the substance of the dispute, before filing the application under section 8 of the Act and therefore Appellant lost the right to seek reference to arbitration; and
(c) The suit was filed on 28.10.1999. Appellant filed the counter affidavit opposing the application for temporary injunction on 15.12.1999. The application under section 8 of the Act was filed in October 2001 nearly 20 months thereafter, during which period Appellant had subjected itself to the jurisdiction of the High Court. In view of the inordinate delay, Appellant was not entitled to the relief under section 8 of the Act.

Supreme Court
Appellant preferred appeal by special leave from this decision. Appellant contended that parties to the suit were all parties to the deposit agreement containing the arbitration agreement. SBI's claim was for enforcement of the charge over Capstone's flat and realisation of sale proceeds from it, which was specifically mentioned as an arbitrable dispute. Under section 8 of the Arbitration and Conciliation Act, the Court should have thus referred the dispute to arbitration.
The Court was required to decide on four questions:
(i) Whether the subject matter of the suit fell within the scope of the arbitration agreement contained in clause 16 of the deposit agreement;
(ii) Whether the appellant had submitted his first statement on the substance of the dispute before filing the application under section 8 of the Act;
(iii) Whether the application under section 8 was liable to be rejected as it was filed nearly 20 months after entering appearance in the suit;
(iv) Whether the subject matter of the suit is 'arbitrable', that is capable of being adjudicated by a private forum (arbitral tribunal); and whether the High Court ought to have referred the parties to the suit to arbitration under section 8 of the Act.

On the first question, the Court held that the subject matter of the suit fell within the scope of the arbitration agreement.
With regard to the second question, the Supreme Court was of the opinion that filing a detailed objection to an application for interim relief cannot be considered to be submission of a statement on the substance of the dispute resulting in submitting oneself to the jurisdiction of the court. Moreover, in this case, the counter-affidavit contained a disclaimer that the reply was being filed for the limited purpose of opposing the interim relief.
Regarding question number three, facts in this case demonstrated that the plaintiff in the suit had filed an application for temporary injunction and appointment of Receiver that was pending. Thereafter, talks were in progress for arriving at a settlement out of court. On failure of such talks, Appellant filed an application under section 8 of the Act before filing the written statement or filing any other statement which could be considered to be a submission of a statement on the substance of the dispute. The High Court was therefore not justified in rejecting the application on the ground of delay.

On the final issue, the Court first stated that the nature and scope of issues arising in a section 11 application for appointment of arbitrators is far narrower than of those arising in a section 8 application. In a section 11 application, the issue of 'arbitrability' is left for decision by the tribunal, whereas the Court must decide the same in a section 8 application.
'Arbitrability' covers three contexts - whether the disputes, having regard to their nature, are capable of being resolved by a private forum, or fall exclusively within the domain of public fora; whether the disputes, by agreement of parties, are covered by the arbitration agreement; and whether the disputes fall within the scope of submission to the arbitral tribunal, that is, whether parties have referred the dispute to arbitration.
Elaborating on the first category of 'arbitrability' the Court first went on to state that certain categories of proceedings were reserved for public fora for public policy reasons either expressly or by necessary implication.
Examples given by the Court of non-arbitrable disputes are: (i) disputes relating to rights and liabilities which give rise to or arise out of criminal offences; (ii) matrimonial disputes relating to divorce, judicial separation, restitution of conjugal rights, child custody; (iii) guardianship matters; (iv) insolvency and winding up matters; (v) testamentary matters (grant of probate, letters of administration and succession certificate); and (vi) eviction or tenancy matters governed by special statutes where the tenant enjoys statutory protection against eviction and only the specified courts are conferred jurisdiction to grant eviction or decide the disputes.
All of the above examples are of rights in rem, exercisable against the world at large, as opposed to rights in personam, interests protected against specific individuals. A judgment in rem refers to a judgment that determines the status of property which operates directly on the property itself. Disputes relating to rights in rem are thus generally considered to be unsuitable for private arbitration, although this is not a rigid rule.

The only indication regarding arbitrability in the Arbitration and Conciliation Act, 1996 are sections 34(2)(b) and 48(2) of the Act which provide that an arbitral award would be set aside if the court found that the subject matter is incapable of settlement by arbitration (in other words, inarbitrable).

The Court also relied on Mustill and Boyd on Law and Practice of Commercial Arbitration in England where they have stated by way of example that an arbitrator cannot render and award which might bind third parties.

In Haryana Telecom Ltd. v. Sterlite Industries India Ltd., (1999) 5 SCC 688, the Apex Court held that notwithstanding agreement of parties, an arbitral tribunal has no authority to order winding up of a company.
In Olympus Superstructures v. Meena Vijay Khetan, (1999) 5 SCC 651, it was held that an arbitrator had the power and jurisdiction to grant specific performance of contracts relating to immovable property.
In Chiranjilal S. Goenka v. Jasjit Singh and Ors., (1993) 2 SCC 507, a grant of probate, being a judgment in rem, was held to be inarbitrable, even if the parties had agreed otherwise.

An agreement to mortgage does not involve transfer of a right in rem but create only a personal obligation. Therefore if specific performance is sought in regard to an agreement to mortgage, the claim for specific performance will be arbitrable. On the other hand, a mortgage is a transfer of a right in rem. A mortgage suit for sale of the mortgaged property is an action in rem, for enforcement of a right in rem. A suit on mortgage is not a mere money suit. Being enforcement of a right in rem, it will have to be decided by courts of law and not by arbitral tribunals.

The Court was also of the opinion that Order 34 of the Civil Procedure Code (CPC), read with provisions of the Transfer of Property Act relating to mortgages, made it abundantly clear that mortgage suits were intended to be decided by public fora. Order 34 Rule 1, for example, provides that all persons having interest in the mortgage security or in right of redemption are required to be joined as parties, whether or not they were parties to the mortgage. This is not possible in case of an arbitration. The court can direct that an account be taken of what is due to the mortgagee and declare the amounts due and direct that the mortgagor pays into court, the amount so found due, on or before such date as the court may fix. Where in a suit for sale subsequent mortgagees or persons deriving title from, or subrogated to the rights of any such mortgagees are joined as parties, the court while making the preliminary decree for sale could provide for adjudication of respective rights and liabilities of parties to the suit in a manner and form set out in an appendix to the CPC. The court has the power under Rule 4(2), on good cause being shown and upon terms to be fixed by it, from time to time, at any time before a final decree is passed, extend the time fixed for payment of the amount found or declared due or the amount adjudged due in respect of subsequent costs, changes, expenses and interest, upon such terms as it deems fit.
Most importantly, a decree for sale of a mortgaged property as in the case of a decree for order of winding up, requires the court to protect the interests of persons other than the parties to the suit and empowers the court to entertain and adjudicate upon rights and liabilities of third parties. None of the above, according to the Court, are possible in an arbitration. Therefore, a suit for sale, foreclosure or redemption of mortgaged property cannot be submitted to arbitration.
Finally, although the issues referred to arbitration by Appellant could separately be submitted to arbitration, the issues in a mortgage suit cannot be divided. As held in Sukanya Holdings v. Jayesh Pandya, (2003) 5 SCC 531, and relied upon by the Court, section 8 of the Arbitration and Conciliation Act does not provide for bifurcation of a suit and partly referring a dispute to arbitration.

In light of all these, the Court held that a suit for enforcement of a mortgage by sale was not capable of being settled by arbitration or 'arbitrable'.

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