Institutional arbitration: A turning point for NBFCs and banks in resolution of NPAs?

Banks and Non-Banking Financial Companies (NBFCs) play a major role in propelling the nation’s economic growth. Since they deal with public money, it is essential that they recover money from defaulted loan accounts quickly so that funds can be redeployed for productive purposes.

Though they have legal recovery tools that can be enforced through debt recovery tribunals, arbitration is the primary legal tool for recovery of dues in small-ticket loans, since approaching civil courts is time-consuming. Traditionally, banks and NBFCs appointed their own officials or advocates as arbitrators, as this was convenient. These cases were generally uncontested, given the small size of the loans. Similar practices were seen in other industries, such as large procurement or construction contracts involving public sector authorities.

Before the 2015 amendments to the Arbitration and Conciliation Act, 1996, a lingering question always remained - can a party interested in the outcome of a dispute appoint the arbitrator? This issue was addressed the through the introduction of Section 12(5) in the 2015 Amendment Act, which says,

“Notwithstanding any prior agreement to the contrary, any person whose relationship with the parties or counsel or the subject-matter of the dispute falls under any of the categories specified in the Seventh Schedule shall be ineligible to be appointed as an arbitrator: Provided that parties may, subsequent to disputes having arisen between them, waive the applicability of this sub-section by an express agreement in writing."

This outlines that certain persons such as employees, consultants and those having financial/business dealings with a party are automatically disqualified from being arbitrators. The Supreme Court in TRF Ltd v. Energo Engineering Projects Ltd (2017) and Perkins Eastman Architects DPC v. HSCC (India) Ltd (2019) categorically invalidated unilateral appointment of sole arbitrators. Following these developments, lenders began switching to cost-effective institutional arbitration mechanisms, enlisting the services of arbitration institutions/platforms that appoint arbitrators independently, without involvement of the lending institutions. These platforms are fast and efficient, often delivering awards within 90–100 days of invocation. Since costs and expenses are charged to the borrower’s account, the efficiency benefits both lenders and borrowers.

The real test for lenders arises when filing execution petitions before civil courts after expiry of the mandatory cooling-off period of 90 days from receipt of the award. Many civil courts refused to accept such awards, citing conflict with the 2015 amendments and the TRF and Perkins rulings.

Lenders struggled to explain the distinction between sole arbitrators appointed directly by them and arbitrators appointed by independent institutions. This led to mixed results across courts - some were convinced, others not, often due to inadequate advocacy, resulting in delays or mass dismissal of execution petitions in certain locations. Lenders, especially small NBFCS, were stuck without effective remedy as they don’t have the SARFAESI Act benefit for loans of ₹20 lakh and below. However, a few recent case laws have clarified this issue.

The Delhi High Court in Balaji Enterprises v. Sundaram Finance Ltd upheld institutional arbitration clauses in NBFC loan agreements and rejected borrower objections of unilateral appointment. The Court held that execution courts cannot invalidate awards on appointment grounds and that such objections must be raised under Section 34 of the Arbitration Act.

The Madras High Court in Thomas Varghese v. Sundaram Finance Ltd echoed this view, holding that objections to arbitrator eligibility must be raised under Sections 12, 14, or 34 and not at the enforcement stage.

Despite these developments, many local courts, particularly in Rajasthan, continued to dismiss execution petitions based on awards passed by arbitrators appointed through arbitration platforms. NBFCs struggled to enforce such awards for years.

The Rajasthan High Court’s recent decision in Sundaram Finance Ltd v. Hanuman Prasad & Anr, decided on April 24, 2026, marks a turning point. In this case, after a borrower defaulted on a loan, the lender invoked the arbitration clause, which referred disputes to the Madras Chamber of Commerce & Industry (MCCI). The MCCI appointed a sole arbitrator, who passed an ex-parte award in April 2023. Sundaram Finance filed an execution petition before the Ajmer commercial court, which dismissed it on grounds of unilateral appointment and questioned the Chennai jurisdiction.

The High Court held that Section 20 of the Arbitration Act enshrines party autonomy. Once parties agreed to Chennai as the seat, the execution court could not invalidate proceedings merely because borrowers were based in Rajasthan. The Court further held that the appointment by MCCI is institutional, not unilateral, and that execution courts cannot revisit arbitrator eligibility; objections must be raised under Sections 12, 14, or 34. It thus overturned the lower court’s orders, restoring enforceability of the award.

This judgment is a major relief for lenders, especially NBFCs, who do not have the benefit of the SARFAESI Act for outstanding dues below ₹20 lakh.

While the Rajasthan High Court judgment is welcome and will help speed up enforcement, execution courts in other states may still raise similar objections. The long-term solution lies in adopting the 2024 Arbitration Amendment Bill, which explicitly recognises institutional arbitration. The Bill provides that the Supreme Court and High Courts will designate arbitral institutions. This ensures neutrality and independence in appointments, preventing any perception of bias or unilateral control by lenders.

Institutional arbitration has now emerged as a credible and enforceable mechanism for lenders, especially NBFCs, to recover small-ticket loans efficiently. The Rajasthan High Court’s ruling provides clarity and relief, ensuring that institutional arbitrator appointments are not equated with unilateral ones. Going forward, the adoption of the 2024 Amendment Bill will be critical to cementing this jurisprudence into statutory law, thereby reducing litigation hurdles, strengthening credit discipline and enhancing confidence in India’s arbitration framework.

K Selvaraj is a Chief Compliance Officer and General Counsel at APAC Financial Services Private Limited.

Views expressed are personal.