Algorithm-Based Arbitrator Selection Cannot Cure Unilateral Appointment Illegality: Bombay High Court

Recently, the Bombay High Court came down heavily on banks and non-banking finance companies for attempting to legitimise unilateral arbitrator appointments through institution-backed and algorithm-based selection mechanisms, holding that such practices are manipulative devices to circumvent Supreme Court rulings on arbitrator independence and neutrality.

Justice Somasekhar Sundaresan set aside arbitral orders passed in proceedings initiated by IIFL Finance and issued directions for compliance with Supreme Court law on arbitrator neutrality. He observed:

“...the attempt by finance companies and banks to pretend to have cleansed the arbitrator-appointment process by getting an “institution” of their choice to make a purportedly “independent” appointment is wholly untenable and completely illegal, and indeed a colourable and manipulative device to circumvent the law declared by the Supreme Court.”

The dispute arose from loan recovery arbitrations initiated by IIFL Finance against D S Textiles, Madhuram Fabrics Pvt Ltd and P R Packing Service where arbitrators appointed through institutional or algorithm-based mechanisms passed interim orders under Section 17 of the Arbitration and Conciliation Act, including attachment of bank accounts.

The borrowers challenged the legality of the appointment process, contending that it violated settled Supreme Court law on arbitral neutrality and independence.

The High Court clarified that the position may have been different had both parties expressly agreed to appointment through a particular institution. However, where one party alone selects the institution the process cannot cure what is fundamentally a tainted and one-sided appointment mechanism.

Explaining the prevalent market practice, the Bench said that finance companies often withdrew arbitration proceedings once borrowers challenged unilateral appointments before courts thereby avoiding judicial scrutiny, while similar proceedings continued against parties lacking resources to litigate. It held:

“The market practice that is evident to any judge with the arbitration roster, is that the manipulative device being resorted to is to simply surrender to the Court in those cases where the counterparty has the strength to approach the Court. By having the arbitration withdrawn, there would be no need to have a ruling on the resort to illegality. In all other cases where the parties do not have the wherewithal to come to Court, resort to such illegal means could still lead to recoveries of funds. This is precisely the approach that lends arbitration a bad name and inflicts long-term damage to alternate dispute resolution as a mechanism.”

Accordingly, the Court quashed the impugned arbitral orders and directed that the judgment be placed before the Audit Committee and Board of Directors of IIFL Finance to ensure framing of arbitration policies compliant with Supreme Court law.