Judicial Interpretation of the Arbitrability of Fraud Disputes in India

Reading time : 8 minutes

Introduction

The Arbitration and Conciliation Act, 1996 (hereinafter referred to as “Act of 1996”) was enacted to consolidate and amend the laws relating to domestic arbitration, international commercial arbitration and enforcement of foreign arbitral awards. The purpose of the Act was to bring the existing law on arbitration in conformity with the UNCITRAL Model Law on Commercial Arbitration, 1985, thereby striving to fulfil India’s quest for economic prosperity.

Although the Act of 1996 expressly does not exclude any category of disputes from the scope of arbitration, by implication it does exclude those cases which require the determination of a right in rem, as against those requiring determination of a right in personam, which means that except criminal proceedings, all disputes of a civil nature and/or arising out of contractual relationship between parties are arbitrable.[1] However, courts in India have many a times overlooked these fundamental principles and have held certain class of private disputes to be un-arbitrable or incapable of being settled by arbitration. One of those subjects of private/civil dispute is arbitrability of fraud which although is not excluded from applicability of the Act either expressly or by implication, but it has been held to be un-arbitrable in various judgements.

The N. Radhakrishnan Judgement

The question of arbitrability of fraud came up before the Supreme Court in N. Radhkrishnan v Maestro Engineers[2]. In this case, the appellant and respondents were partners in a partnership firm. A dispute arose among them on the issue of contribution made by each partner to the firm, and the appellant alleged that malpractices were happening in the firm and the respondents were colluding amongst themselves to drive out the appellants’ clients and forge the accounts of the firm. After a series of allegations and counter-allegations on each other by the appellants and respondents, the respondents approached the Court of the District Munsif at Coimbatore and filed an application seeking an injunction against the appellant restraining him from disturbing the business of the firm and prayed that the appellant be declared retired from the firm. In response, the appellant filed another application before the same court under Section 8 of the Act of 1996, and prayed that the dispute be referred to an arbitral tribunal since their partnership deed contained an arbitration clause. The appellant’s plea was rejected by both the lower court and the High Court of Madras. The case came up before the division bench of the Supreme Court, and the issue was whether matters involving serious allegations of fraud and misappropriation can be referred to arbitration. The Court held that such a matter cannot be decided by an arbitrator and therefore, it has to be referred to a court of law. The Court relied on the decision of Madras High Court in the case of H.G. Oomor Sait v. O. Asiam Sait[3],wherein it was held that the power of civil courts to refuse to refer certain disputes to arbitration on certain grounds under the Arbitration Act, 1940 (hereinafter referred to as “Act of 1940”) continues to be available to the courts under the Act of 1996 and their refusal to refer the matter to arbitration would be justified if the dispute involves complicated questions of law and requires “detailed oral and documentary evidence”.

Thus, the court said in N. Radhakrishnan case that since very “detailed oral or documentary evidence” is required to prove or disprove an allegation of fraud, the courts, and not the arbitral tribunal, are the appropriate forum to decide the same.

The judgement of the Supreme Court in N Radhakrishnan was contradictory to its earlier decision given in P Gajapati Raju v PVG Raju[4] and reiterated in HPCL v Pinkcity Midway Petroleum[5], where it was held that if a valid arbitration agreement exists, then, under section 8 of the Act of 1996, it is mandatory for the courts to refer the matter to arbitration.

A Period of prevailing confusion

Section 8 of the Act of 1996 says that if an action is brought before a judicial authority in a matter which is subject to a valid arbitration agreement, then the judicial authority has to refer the parties to arbitration. Despite the clear words of this provision, the Hon’ble Supreme Court pronounced contradictory decisions in P Gajapati Raju case and HPCL case on the one hand and N. Radhakrishnan case on the other hand, thereby creating confusion regarding the true position of arbitrability of fraud in India. This unclear position of the law resulted into divergent opinions being rendered by various Courts in subsequent cases.

For instance, the Bombay High Court in the case of Goldstar Metal Solutions Pvt. Ltd. v. Dattaram Gajanan Kavtankar[6] held that in cases where serious allegations of fraud are prima facie demonstrable or if the party against whom fraud is alleged desires to have a public trial, then the dispute cannot be referred to arbitration. However, the Punjab & Haryana High Court in Hughes Communications India Ltd. v. East West Traders[7] refused to accept the view that a dispute would be rendered un-arbitrable by mere appearances of expressions of fraud or undue influence. On a similar line, the Bombay High Court held in the case of Rekha Agarwal v. Anil Agarwal[8] that though courts still have the discretion to deny a reference to arbitration, there is no restriction on a reference to arbitration on account of allegations of fraud.

The Judgement in the Swiss Timing case

The legal position regarding the arbitrability of fraud disputes saw an upside-down shift after the decision of the Supreme Court in the case of Swiss Timing Ltd. v. Common Wealth Games 2010 Organising Committee[9] in which it was held that the N. Radhakrishnan judgement was per incuriam as it was contrary to the well-established principle laid down by the Apex Court in HPCL and Gajapati Raju case and Section 16 of the Act of 1996.

In the case, the applicant, Swiss Timing entered into a contract with the respondent, Common Wealth Games Organising Committee, for providing timing, score etc. during the Commonwealth Games, 2010. Later a dispute arose between them where the applicant alleged that the respondent has defaulted in making payment and invoked the arbitration agreement for settling the matter. When the respondent failed to appoint an arbitrator on its behalf, the applicant approached the Supreme Court for the appointment of arbitrator under Section 11(6) of the Act of 1996. The respondent opposed the appointment of arbitrator and claimed that as the applicant has resorted to corrupt practices, therefore, as per the terms of the contract, the contract stands void ab initio. The respondent also contended that since the dispute involves serious allegations of fraud, it cannot be referred to arbitration.

The court rejected the first claim of the respondent and held that since an arbitration agreement can be severed from the main contract, the invalidity of the main contract does not render it ineffective. It was held that for the purpose of appointment of arbitrator, the courts are not required to undertake a detailed scrutiny of the merits and demerits of the case and it would suffice if they only decide preliminary issues such as jurisdiction to entertain the application, the existence of a valid arbitration agreement, whether a live claim existed or not.

It was further observed by the court that once the parties have agreed to settle their disputes through arbitration, they cannot be permitted to avoid arbitration without satisfying the Court that it will be just and in the interest of all the parties to do so.[10] The court held that on a conjoint reading of Section 5 and Section 16 of the Act of 1996, it becomes clear that all matters including the issue of the validity of main contract can be referred to arbitration.

The court, rejecting the respondent’s contention that since dispute involves serious allegations of fraud, it should be decided by the court itself, held that since N. Radhakrishnan was decided in ignorance of the express provisions of Section 16 of the Act of 1996 and the previous decisions given in HPCL and Gajapati Raju, it is per incuriam and does not law down correct position of law.

The Current Position

The inconsistency between N Radhakrishnan and Swiss Timing was sought to be settled by the Supreme Court in A. Ayyasamy v A. Paramasivam[11], where the court made a distinction between “mere allegations of fraud” and “serious allegations of fraud”, holding the former to be arbitrable and the latter to be non-arbitrable. But this further led to the problems of inconsistent and hazy interpretations of “serious allegations of fraud” by many courts, thereby complicating the matter. In particular, the decision of A. Ayyasamy held that “a strict and meticulous enquiry into the allegations of fraud” would be conducted in order to determine whether an allegation of fraud is serious or not. This was bound to result in unnecessary judicial intervention and delay, in the absence of a clear-cut formula to distinguish the two categories of fraud.

The Supreme Court clarified the phrase “serious allegations of fraud” in the 2016 decision of Avitel Post Studioz Ltd. v HSBC PI Holdings[12], where it laid down the test to determine “serious allegations of fraud”. The court said that serious allegations of fraud would arise only in either of the two scenarios:

First, when arbitration agreement cannot be said to exist. This would involve cases in which a party cannot be said to have entered into an agreement to arbitrate at all or where a party claims that the arbitration agreement was fraudulently induced. Therefore, as per this scenario, this test would apply only in cases where the allegations of fraud are directed towards the ‘agreement to arbitrate’ or are such that if proved, it would vitiate the arbitration clause itself, along with the agreement.

Section 16(1) of the Act of 1996 provides for a wide interpretation of the arbitration clause in the contract between the parties. It provides that the arbitration clause shall be treated as an agreement in itself and the invalidity of the main contract shall not ipso jure render invalid the arbitration clause. Therefore, through Section 16(1), even in a case where the contract is claimed to be fraudulently induced, the substantive validity of the arbitration clause is not compromised. When the first test is applied together with Section 16(1), the scope of judicial intervention on grounds of fraud would be considerably reduced.

Secondly, when allegations of arbitrariness, fraud or mala fide conduct are made against the “state or its instrumentalities”. Such cases would not come under the purview of arbitration because the questions raised would concern matters of public law, which would thereby attract implications not only on the parties but concerning the public domain as well. Mostly, these cases would be settled in a writ court as issues related to fundamental rights of the people would arise.

The Avitel Post Studioz decision is certainly a positive development after many inconsistencies were found in the interpretations of “serious allegations of fraud”. However, there are some concerns with the test laid down in this case too. The second scenario that it presents, where “allegations of frauds are made against the state or its instrumentalities”, can create problems as parties to an arbitration agreement can now conveniently raise an allegation of fraud to avoid recourse to arbitration. This test can be misused to avoid arbitration proceedings in those cases which involve government sectors, authorities or instrumentalities.  

Conclusion

The position regarding arbitrability of fraud in India has seen many twists and turns. The position taken by the Supreme Court on this issue ranged from N Radhakrishnan on one hand to Swiss Timing on the other. Many High Courts have also given contradictory rulings on this issue. The recent decision of the Supreme Court in Avitel Post Studioz has laid down the test for determining which allegations amount to “serious allegations of fraud”. This test, though clarifies the issue to some extent, it also has the potential of leading to bogus allegations of fraud by parties whenever they are dealing with a government entity, in order to avoid recourse to arbitration. Thus, a foolproof solution to the issue has not yet been found. An improved and loophole-free test of “serious allegation of fraud” is needed so as to provide complete clarity on the issue of arbitrability of fraud disputes in India.   


[1] Booz-Allen and Hamilton Inc. v. SBI Home Finance Ltd., (2011) 5 SCC 532

[2] (2010) 1 SCC 72

[3] (2001) 3 CTC 269

[4] (2000) 4 SCC 539

[5] (2003) 6 SCC 503

[6] (2013) 3 AIR Bom R 529

[7] 2013 SCC Online P&H 11163

[8] 2014 SCC Online Bom 4954

[9] (2014) 6 SCC 677

[10] Ibid.

[11] (2016) 10 SCC 386

[12] Civil Appeal No. 5145 of 2016

Author: Rohit Ranjan, NUSRL, Ranchi

Editor: Kanishka VaishSenior Editor, LexLife India.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s