Arbitrability Of Fraud In India

Indian Consciousness Of Arbitration

ADR as a practice dates back to the most primeval of our times tracing its genesis to the Vedic literature of the Brihadaranyaka Upanishad and religious textbook of Mahabharata.

The historical references from the Brihadaranyaka Upanishad and the Mahabharata offer intriguing parallels and insights into the arbitrability of important disputes in ancient India. In the Brihadaranyaka Upanishad, the establishment of arbitral bodies, collectively known as Panchayats, encompassed 'Puga' for local groups, 'Srenis' for trade-related matters, and 'Kulas' for community affairs. The Panchas, who were members of these bodies, were entrusted with the resolution of issues that closely mirror the purview of modern-day Arbitration. This historical context, acknowledged in the case of "Vytla Sitanna vs Marivada Viranna" (1934) 36 BOMLR 563 by the Privy Council, highlights a long-standing tradition of alternative dispute resolution mechanisms.

Drawing an analogy from the Mahabharata, we witness a pivotal moment when Lord Krishna's arbitration attempts were unsuccessful, leading to the Kurukshetra war. This narrative underscores the preference for arbitration as the primary means of dispute resolution in ancient India. The Mahabharata's lesson, where the parties resorted to war only after exhausting arbitration, resonates with the contemporary understanding of resolving complex disputes.

When examining the arbitrability of fraud in modern India, these historical references underscore the importance of alternative dispute resolution mechanisms like arbitration. They emphasize that even in ancient times, society recognized the value of resolving disputes through peaceful means, echoing the modern principle that arbitration should be explored as the preferred recourse. This traditional historical perspective underscores the enduring relevance of arbitration as an opted method for dispute resolution, including also for cases involving complex issues like the division of royal estates, which aligns with the evolving jurisprudential legal landscape in modern India.

Statutory Framework For Fraud Induced Arbitration in India

Sections 34(2)(b) and 48(2) of the Arbitration Act stipulate that an award can be annulled if the dispute's nature makes it unsuitable for settlement by arbitration.

Even though the Arbitration Act does not in express and exclusionary terms debar the entry of criminal adjudication anywhere in the Act, however, one needs to be mindful that the Act is primarily concerned with the independence of party autonomy in dealing with the contractual civil disputes arising between the parties and therefore, much explicitly eliminates from within its purview all those matters incapable of settlement by Arbitration and against the fundamental policy of Indian law. Various tests have been propounded by the higher constitutional courts of the country to determine subject matters that can be submitted to the process of adjudication by Arbitration.

Indian Supreme Court on Arbitrability of Fraud

The issue of determining the arbitrability of fraud gained prominence after the Abdul Kadir judgment in 1962. However, it was the period between 2009 and 2022 that witnessed a significant number of landmark judgments delivered by the Supreme Court of India. These rulings clarified and established the legal principles surrounding the arbitrability of (non-serious) fraud in a manner as follows:

• In the case of Abdul Kadir Shamsuddin Bubere v Madhav Prabhakar Oak (AIR 1962 SC 406) the Supreme Court while dealing with Section 20 of the Indian Arbitration Act, 1940 provided expansive discretionary powers to the Court to decide whether a matter should be referred to arbitration, held that when serious allegations of fraud were made against a party, and the party, which was charged with fraud, desired the matter to be tried in open court, this would be sufficient cause for the court not to order an arbitration agreement to be filed. It is important to highlight that the decision of Russel Vs assisted the application of this principle. Russel [1880] 14 Ch.D. but on the other principle of “only serious allegations of fraud exempting the Arbitration” propounded therein, the matter was referred to arbitration as the allegations of fraud based upon some kind of dishonesty/misconduct were held not qualifying the standard of seriousness and like in Russell, were only held to have been based on suspicion.

Standard Of Serious Fraud

• Later, while dealing with the statutory framework of the Arbitration & Conciliation Act, 1996, the Supreme Court in N Radhakrishnan v Maestro Engineers (2010) 1 SCC 72 held those matters of fraud necessitating a detailed investigation and elaborate evidentiary examination. It further stated that such a case involving substantial allegations of fraud would not be subject to Arbitration and should be tried in a court of law which would be more competent and have the means to decide such a complicated matter involving various questions and issues raised therein. Importantly, in the instant matter, the Appellant had leveled multiple allegations of fraud against the Respondent and had himself moved the court under Section 8 of the Act for reference of a dispute to the Arbitration.

Evolving Jurisprudence

• The restructuring of jurisprudence on the issue of the ever-expanding scope of arbitrability of fraud resurfaced again in the Supreme Court’s judgment in Booz Allen and Hamilton Inc v SBI Home Finance Ltd (2011) 5 SCC 532 laying down the foundation to determine whether a dispute would be amenable to arbitration or not. It was decided that if a dispute concerned a right in rem, then it would not be arbitrable, and if the dispute pertained to a right in personam it would be arbitrable. It was also held that disputes relating to subordinate rights in personam arising from rights in rem have always been considered to be arbitrable.
• However, in the case of Swiss Timing v Organising Committee, Commonwealth Games 2010 (2014) 6 SCC 677, the N Radhakrishnan case was critiqued and was neglected for being per incuriam for its failure take into account the ratio of earlier judgments of the Court in Hindustan Petroleum Corp case and Anand Gajapathi Raju case, wherein it has been held that a civil court is obligated to direct parties before it to arbitration where there exists an arbitration agreement between such parties.

Interestingly, the Court rejected the contention of the Respondent that the arbitration should not be commenced pending the adjudication of the criminal proceedings against the officials by observing that the possibility of conflicting decisions is not a bar against proceeding simultaneously with arbitration and criminal proceedings.

Current Laws That Are Settled

• Remarkably, the criterion for assessing the gravity of fraud was established in the A Ayyasamy v A Paramasivam & Ors (2016) 10 SCC 386 case. In this case, the Supreme Court, without explicitly overturning the N Narayan precedent, clarified the distinction between simple fraud and serious fraud. It emphasized that a mere allegation of fraud between parties is insufficient to render a matter non-arbitrable. The ruling specified that not all types of fraud fall outside the scope of arbitration; only allegations of fraud that are both serious and have the potential to undermine the fundamental validity of the contract and arbitration clause can be considered non-arbitrable. In essence, unless the fraud in question is of a significant and complex nature, the arbitrator's jurisdiction remains intact.

The Apex Court further differentiated between cases where fraud allegations were serious and intricate, constituting not only a criminal offense but also requiring extensive evidence, and cases where one party simply accused the other of fraud. Only in instances where the court, while dealing with Section 8 of the Arbitration Act, determines that the allegations of fraud are exceptionally serious, amounting to clear criminal conduct, or are so intricate that only a civil court, with its ability to assess voluminous evidence, can adequately address them, should the court reject the arbitration agreement by dismissing a Section 8 application and proceed with a trial on the merits.

• The precedent set by the Ayyasamy (supra) found application in the Rashid Raza v. Sadaf Akhtar case (2019) 8 SCC 710. In Rashid Raza, the Supreme Court adhered to the dual criteria articulated in paragraph 25 of Ayyasamy, as follows: (i) Does the fraud allegation fundamentally taint the entire contract, including the arbitration agreement, rendering it null and void? (ii) Do the fraud allegations pertain to the private internal matters between the parties, without broader public implications?
• In the subsequent decision of Ameet Lalchand Shah & Ors. v. Rishabh Enterprises & Anr. (2018) 15 SCC 678, the dispute involved allegations of fraud related to criminal breach of trust and misrepresentation concerning equipment procured and leased for a Photovoltaic solar plant. A civil suit was instituted, seeking a declaration that all agreements were tainted by fraud and misrepresentation. An application was also filed under Section 8 of the Arbitration Act, requesting the disputes to be referred to arbitration under all four agreements. The Apex court ruled that it is only when the court is convinced that the fraud allegations are both serious and complex that it would be more appropriate for the court to handle the disputes instead of directing the parties to arbitration. The court emphasized its duty to ensure the effectiveness of commercial transactions and underscored that mere allegations of fraud do not suffice to deny the referral of disputes to arbitration.
• Finally, in the case of Avitel Post Studioz Ltd v HSBC PI Holdings (Mauritius) Ltd 2020 SCC OnLine SC 656, the Supreme Court sitting in the bench of Justice Nariman and Justice Sinha, JJ in untangling varied strings of judgments rendered by the Courts in India on the subject and provisions of Indian Contract Act, 1872 formulated the tests to determine "serious allegations of fraud" for exemption against the Arbitrability of disputes. Their Lordships in their ultimate analysis further confined the precedential ambit of the above-mentioned N Radhakrishnan case by holding that it was no longer a good precedent. Moreover, the court clarified that merely because some facts involve civil and criminal proceedings, it would not necessarily lead to a conclusion that the disputes are not arbitrable. Pertinently, the case involved the allegations of impersonation, false representations, and diversion of funds which were held by the Apex court to be all inter parties, having no "public flavor" to attract the "fraud exception".

“16. In the light of the aforesaid judgments, paragraph 27(vi) of Afcons (supra) and paragraph 36(i) of Booz Allen (supra), must now be read subject to the rider that the same set of facts may lead to civil and criminal proceedings and if it is clear that a civil dispute involves questions of fraud, misrepresentation, etc. which can be the subject matter of such proceeding under section 17 of the Contract Act, and/or the tort of deceit, the mere fact that criminal proceedings can or have been instituted in respect of the same subject matter would not lead to the conclusion that a dispute which is otherwise arbitrable, ceases to be so.”

14. “…It is clear that "serious allegations of fraud" arise only if either of the two tests laid down are satisfied, and not otherwise. The first test is satisfied only when it can be said that the arbitration clause or agreement itself cannot be said to exist in a clear case in which the court finds that the party against whom the breach is alleged cannot be said to have entered into the agreement relating to arbitration at all. The second test can be said to have been met in cases in which allegations are made against the State or its instrumentalities of arbitrary, fraudulent, or malafide conduct, thus necessitating the hearing of the case by a writ court in which questions are raised which are not predominantly questions arising from the contract itself or breach thereof, but questions arising in the public law domain.”

The court, upon a combined reading of the provisions of Sections 10, 14, 17, and 19 of the Indian Contract Act, of 1872 cautioned that a contract would then be void, should it have been affected by fraud or cheating i.e. at the time of entering into the contract, thereby creating a distinction between a contract founded upon or materialized by fraud and fraud being an offshoot from the underlying contract or in other words, being practiced in the performance of the contract.

• Following up with the expansion of ambit for an arbitrable fraud, the Supreme Court on a reference by a division bench presided over, interestingly once again, by R.F Nariman J while doubting the ratio in Himangni Enterprise referred the matter to a full bench which settled the law in Vidya Drolia v Durga Trading Corporation (2021) 2 SCC
  1. The Court extensively dealt with the competency of an arbitral tribunal to deal with public policy matters, and this time, expressly overruled N Radhakrishnan and Himangni Enterprises. The bench then laid down a fourfold test for determining when the subject matter of a dispute in an arbitration agreement is not arbitrable:

1. when the cause of action and subject matter of the dispute relates to actions in rem, that do not pertain to subordinate rights in personam that arise from rights in rem.
2. when the cause of action and subject matter of the dispute affects third party rights; have erga omnes effect; require centralized adjudication, and mutual adjudication would not be appropriate and enforceable;
3. when the cause of action and subject matter of the dispute relates to inalienable sovereign and public interest functions of the State and hence mutual adjudication would be unenforceable; and
4. when the subject matter of the dispute is expressly or by necessary implication non-arbitrable as per mandatory statute(s).

Notably, the court made it clear that these tests are not rigidly separate categories; they overlap, interconnect, and intersect one another. However, when applied comprehensively and practically, they contribute significantly to the determination and confirmation, in accordance with Indian law, of whether a dispute or subject matter is ineligible for arbitration. The conclusion that a dispute is non-arbitrable is reached only when the answer is affirmative. Additionally, it was clarified that claims involving fraud can be subjected to arbitration only when they pertain to civil disputes rather than criminal ones.

• In the subsequent NN Global Mercantile Pvt Ltd v Indo Unique Flame Ltd. 2021 SCC OnLine SC 13 (NN Global – I) judgment, building substantially up upon the Vidya Drolia (supra), the Supreme Court affirmed the arbitrability of civil dimensions of fraud. However, it clarified that this holds true unless the contracts in question have fraudulent origins that undermine the validity of the arbitration clause.
• Quite recently, in September 2023, the High Court of Delhi JRA Infratech V. Engineering Projects (India) Limited 2023:DHC:6541 has emphasized that determining whether an arbitration agreement is affected by fraud should be within the arbitrator's discretion, who can assess it based on the evidence. The Court, when exercising authority under Section 11 of the A&C Act, should refrain from making such a determination.

Justice Rekha Palli's bench clarified that the mere existence of a criminal complaint against the petitioner for alleged fraud should not be used as a reason to divert the parties from arbitration, especially when the dispute falls under the scope of the arbitration clause and is not in controversy.

Analysis

Based on the decisions cited supra, the position qua arbitrability of fraud cases in India can be summarized as under:

1. cases involving simpliciter non-serious fraud allegations can be referred to Arbitration whereas those involving serious and complex allegations of fraud would require adjudication only by the courts.
2. complex allegations requiring the adducing of voluminous evidence is a factor indicative of the serious character of the fraud allegations.
3. in a given case, upon ascertaining the nature and gravity of fraud

simpliciter, still, if the cause of action and subject matter is found to

have been involved or arisen out of rights in rem, the same should not be referred to Arbitration.

4. parties affected by or involved in such allegations i.e. allegations affecting parties inter se or public at large.
5. consequence test - the public implication or effect thereof, if any, with society has to be seen.
6. if a statute expressly or by necessary implication excludes the applicability of Arbitration as a mechanism for dispute resolution.

While these parameters discussed above provide valuable guidance, they are not exhaustive. They serve as indicators to help reach a specific conclusion regarding the arbitrability of fraud cases. The ultimate determination often involves a comprehensive assessment of the unique circumstances and complexities surrounding each case, ensuring that justice and sanctity of adjudication are served equally, effectively, and expeditiously.

Conclusion

The jurisprudence of arbitrability of fraud in India emphasizes the importance of a sophisticated strategy that strikes a balance between the ideals of party autonomy and public policy. While Indian courts normally accept arbitration agreements, they reserve the authority to interfere in circumstances of flagrant fraud that jeopardize the arbitral process's integrity. This difficult balance between encouraging alternative dispute resolution and protecting the public interest is critical in defining the arbitration environment in India.

1. The Supreme Court in its noble pursuit of an (autonomous) objective not only has found a way to redressal a dispute involving allegations of arbitrable fraud but has also inevitably dissected it into two sub-parts i.e Serious fraud allegations and Non-serious simpliciter fraud allegations for Arbitrability thereof, which, respectfully, has failed to find its roots nowhere in neither Criminal, Civil or Contractual law all providing for fraud as one single indivisble genus. Ironically, even the Arbitration Act also lacks any such cleavage.
2. What will be the threshold in a given case to push an allegation beyond the judicial realm of non-seriousness is left to the acquired wisdom and judicial discretion of the learned judge presiding over such a case subject of course to the considerations of facts and circumstances obtaining therein.
3. If voluminousness of evidence, the complexity of allegations, public or private nature of the dispute, parties affected, implication on the public domain or right in rem or right in personam arising out of right in rem, as the case may be, are some of the threshold parameters applicable in law to determine if the leveled allegations transcend the boundary of non-seriousness to attract judicial knocking, then it is difficult to understand as to why an Arbitrator who has been bestowed trust by the parties and nowadays, in most cases, by the Courts alike is less competent to perform civil adjudication with the similar set of wherewithal and more particularly when the same has already been recommended by the 246^th Report of the Law Commission of India.

In conclusion, the analysis of relevant case law and the discussions presented supra shed some light on the intricate nuances of the legal landscape governing the domain of arbitrability of fraud in India leaving us desirous for more. In attempting to find that “more”, it is imperative to honor the dynamic nature of the law while also ensuring that minimization of delays and party autonomy remains the steadfast beacons in our crusade to make India Arbitration and ADR friendly.

Author: Adv. Abhay Chitravanshi

About The Author: 

Abhay is a passionate law practitioner specializing in Criminal and commercial/Corporate litigation, White-Collar crimes, Arbitration, Economic Offenses, Start-up Advisory, Consumer laws, and Dispute Resolution. He has provided effective legal solutions and advocated for clients in complex legal matters before various judicial fora.