Arbitrability of Fraud – What Does the Supreme Court of India Say?

ARBITRABILITY OF FRAUD – WHAT DOES THE SUPREME COURT OF INDIA SAY?

Introduction:-

The arbitrability of fraud has been a matter of long discussion in the field of arbitration law with various courts in the country holding differing views on the subject matter. The Supreme Court’s recent judgments of Avitel & Rashid Raza have attempted to bring a certain clarity to the issue and can be seen by one as a positive step towards resolving the knot of arbitrability of allegations complex/serious fraud. This blog will discuss in short, the takeaways from some important cases revolving around this issue and the law laid down therein by courts.

- Abdul Kadir Shamsuddin Bubere vs Madhav Prabhakar Oak:

The

landmark judgment of Abdul Kadir Shamsuddin Bubere vs Madhav Prabhakar Oak was the first ever judgment by the Hon’ble Supreme Court of India on the issue of arbitrability of fraud. It was held that a dispute containing fraud of any nature cannot be decided upon by an arbitral tribunal (even where the party accused of committing a fraud does not wish to pursue the case in an open court), since questions of fraud involve complicated factual questions that should be decided in an open court. In such a situation, the jurisdiction of an arbitrator would have to be presumed to be ousted. This decision having been rendered under the 1940 Act, it was subsequently followed by the legislature by incorporating the principle in the 1996 act.

Subsequently, a division bench of the Supreme Court in the N. Radhakrishnan vs M/S. Mastero Engieers & Ors decision declared that all disputes involving ‘allegations’ of fraud would be not arbitrable. Hence, these decisions in the 1996 Act regime were in line with the decision in Abdul Kadir (supra).

- A.Ayyasamy v. A. Paramasivam:

The case of A. Ayyasamy v. A. Paramasivam can be said to be one of the most important cases wherein the Supreme Court tried to set this issue of arbitrability of fraud to rest by holding that the mere allegations of fraud simplicitor are arbitrable whereas serious allegations of fraud are not.

Interpretation of “serious allegations of fraud”:

A plain reading of the same would suggest to a prudent man that the court in talking about “serious allegations of fraud” is probably referring to frauds wherein gargantuan amounts of money is involved or such allegations which are of such a nature so as to deserve a full-fledged criminal trial. As a matter of policy, this could be a cogent interpretation since such accusations having criminal colour and most probably involving public money are best suited for adjudication by a public institution viz. our courts of law. However, when one puts a closer look at the judgment, he/she will realize that this interpretation is only partially correct.

The court in this case found that serious allegations of fraud are non-arbitrable because they involve complicated issues of fact and require adducing of elaborate evidence. Thus, when the court refers to “serious allegations of fraud” it is independent of the gravity of the alleged fraud but is dependent on the amount of evidence required to prove the allegation.

The problem with this interpretation is that allegation of fraud involving huge sums on money might be referred to arbitration since they may not require voluminous amounts of evidence or allegations of fraud involving small amounts of money will not be referred to arbitration as they might require voluminous amount of evidence to be adduced, depending upon the nature of fraud varying from case to case. This problem opens up a Pandora’s Box of uncertainty and unnecessary judicial intervention in the process of arbitration leading to wastage of time due to long drawn court procedures. This approach defies the very purpose of parties opting for arbitration as it bids adieu to the principle of Kompetenz-Kompetenz i.e. minimal interference.

- Rashid Raza vs. Sadaf Akhtar:

The Hon’ble Supreme Court in the case of Rashid Raza (supra) further clarified the scope of arbitrability of disputes involving allegations of fraud. Justice R. F. Nariman relying upon the landmark judgment of Supreme Court in Ayyasamy (supra) set out the tests to determine whether or not an allegation of fraud is arbitrable.
The fraud in the present case was in a partnership firm wherein one party had utilized the assets of the partnership firm in another firm run by his father; created proprietorship firm with a same name, S. R. Coating, and introduced it to one of the firm's existing business partners, Reliance Industries Ltd.; opened a new bank account on the basis of a fake agreement; and transferred money into the Petitioner's personal bank account and his father's bank account.

In this case, the Supreme Court held that serious allegations of fraud would involve:

• Allegations which constitute a clear cut case of a criminal offence;

• Complex allegations of fraud to the extent that it becomes necessary for the fraud to be tried by a Civil Court on account of voluminous evidence to be adduced;

• Serious allegations of forgery/fabrication of documents being the way of committing fraud;

• Case where the fraud goes to the validity of the contract thereby alleging fraud against the arbitration clause itself.

Twin Tests:

While applying the relevant principles from Ayyasamy to the instant allegations, the apex court held that a distinction has to be drawn between 'serious allegations' of forgery or fabrication supporting the plea of fraud, and 'simple allegations' - to determine arbitrability. Accordingly, it culled out two working tests to determine this distinction as follows:

(1) does this plea permeate the entire contract and above all, the agreement of arbitration, rendering it void?

Or

(2) whether the allegations of fraud touch upon the internal affairs of the parties inter se having no implication in the public domain?

Applying the aforementioned tests to the facts of the present case, the Supreme Court held that:

(i) There is no allegation of fraud which vitiates the Partnership Deed as a whole, including the arbitration clause:

(ii) The allegations pertain to the affairs of partnership and siphoning of funds, which do not pertain to matters in the public domain.

The Supreme Court held that the allegations are arbitrable as they fall within the ambit of 'simple allegations'. It set aside the judgment of the High Court and proceeded to appoint an arbitrator under Section 11 of the Act to resolve the disputes between the parties.

It is also noteworthy to mention that in the instance case, court has observed that allegations of fraud would be serious if a clear cut criminal offence could be made out in the ordinary course. The court has also cautioned that in such a case, the burden of proving that the dispute is not amenable to arbitration will lie heavily on the party opposing arbitration or the party who claims that the dispute should not be referred to arbitration.

- Avitel Post vs HSBC PI Holdings:

The Hon’ble Supreme court, in its latest judgment on this issue has further clarified the serious allegations of fraud by providing an air of clarity around the remaining ambiguities. The court in Avitel Post Studioz Ltd. & Ors. v/s HSBC PI Holdings (Mauritius) Ltd. held that only a serious allegation of fraud would take a dispute outside the ambit of an arbitration clause. The court also brought in a much needed clarity by observing same set of facts giving rise to concurrent civil and criminal liability would not render an otherwise arbitrable dispute, non-arbitrable. This is one of very arbitration friendly decisions as it clarifies the true construct of ‘serious allegations of fraud’ and takes away from the respondent an opportunity to thwart the arbitration agreement by merely raising fraud as an issue.

In this case as well, the apex court, after analysis of the precedents till date, clarified that the meeting of serious allegation of fraud threshold will be determined by satisfying one of the two tests laid down and not otherwise. The 2 tests are as follows:

• Where it can be said that the arbitration clause or agreement itself cannot exist, due to inability of the party to enter into the arbitration agreement – either due to fraud or other specified reasons in the Contract Act, 1872.

• Where allegations of fraud are made against the State or its instrumentalities, thus necessitating the hearing of the case by a writ court. In such cases the questions raised are not predominantly questions arising from the contract itself or breach thereof, but rather questions arising in the domain of public law and policy.

Further, the court observed that the fact that a criminal proceeding can, or has been, instituted in respect of the same (civil) subject matter would not itself vitiate a party's ability to follow arbitration as a commercial or civil remedy. Thus, this also makes it clear that criminal liability form the same set of facts & criminal litigation thereof will run concurrently with arbitration.

The court also re-iterated that the allegations o fraud will be arbitrable unless they were not inter-se parties and had a public flavour so as to attract the exception of fraud. The court further, observed that arbitration will be conducted if the act of fraud (in this case, siphoning of money inter-se parties) is a tort for which damages would be available.

Concluding Analysis:

Simple allegations of fraud which do not go to the root of the dispute and vitiate the underlying contract as well as the arbitration clause will not attract the fraud exception. For a fraud to be non-arbitrable, it is necessary that it vitiates the underlying contract rendering the arbitration clause itself as void by alleging fraud against the arbitration clause itself.

Accusations of fraud which have no bearing on the rights in public domain will be held as arbitrable. Hence it is necessary for the allegations of fraud to have an implication in the public domain so as to attract the fraud exception to arbitration. Accusations of fraud which have affects rights which are inter-se parties and touches upon their internal affairs in their private domain alone, will be arbitrable how may ever serious in nature they may seem. From a practical perspective, the above mentioned decisions also limits the extent to which an award can be challenged on the basis of arbitrability and public policy (i.e. the allegation of fraud must go beyond fraud simpliciter, and must be "serious" enough that one of the two tests above is satisfied). With the ever shrinking remit of public policy defense in India - international parties can certainly build more confidence around enforcement of their foreign awards in India.

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AUTHOR: Chirag M. Bhatia

Copyright CMB Legal



Disclaimer: Every effort has been made to ensure the accuracy of this publication at the time it was written. It is not intended to provide legal advice or suggest a guaranteed outcome as individual situations will differ and the law may have changed since publication. Readers considering legal action should consult with an experienced lawyer to understand current laws and.how they may affect a case. For specific technical or legal advice on the information provided and related topics, please contact the author.