Explicating Arbitrability of Fraud in India

By Alay Ninad Raje and Jaysinh Kela, Students at Institute of Law, Nirma University

Introduction

From time to time, the issue of arbitrability of fraud arises in order to ascertain whether the disputes involving allegations of fraud are capable of being resolved through arbitration instead of courts. The Supreme Court of India (SC) recently through the  judgment of Vidya Drolia & Ors. v. Durga Trading Corp., (“Vidya Drolia”) explicitly overruled N. Radhakrishnan v. Maestro Engineers (“Radhakrishnan”) judgment, and providing a pro-arbitration approach towards arbitrability of fraud, thereby bringing clarity on the subject matter.

The arbitrability of the dispute based on subject matter was primarily first dealt by the SC in the Booze Allen Hamilton v. SBI Home Financecase, wherein the arbitrability of disputes was subjected to the nature of rights involved. Thus, it was held that while disputes pertaining to rights in personam (private right) are arbitrable, those concerning rights in rem (public right) are not.

Understanding The Radhakrishnan view

Prior to Vidya Drolia, the position stood in context of the judgment of Radhakrishnan. In Abdul Kadir v. Madhav Prabhakar Oak the issue of arbitrability of fraud was discussed for the first time and held that, fraud of any nature is strictly non-arbitrable because of the complexity involved in such issues. The court relying and extending the same principle in the case of Radhakrishnan, held that, serious allegations of fraud were non-arbitrable, and while determining arbitrability the complexity of subject-matter of dispute must be considered. The allegations included malpractice, collusion, forging of the firm’s accounts, and siphoning of money for personal gain. Mere allegations of fraud can be adjudicated by arbitration, however, it was opined that  courts should look into the facts and preliminary evidences to decide whether the issue involves fraud of serious nature. Thus, the effect of the judgment was that generally all disputes pertaining to fraud are non-arbitrable.

Anti-Radhakrishnan Development

In Swiss Timing v. Organising Committee(“Swiss Timing”) the SC held that arbitral tribunals have the power and competence to adjudicate upon disputes concerning fraud. Allegations were made pertaining to default in making the due payments under the parties’ contract and that the defaulting party had defrauded. However, this judgment did not expressly overrule Radhakrishnan, as it was the decision of a smaller bench. Later, in the landmark case of A. Ayyasamy v. A. Paramasivam(“Ayyasamy”),. the court propounded that a dispute becomes non-arbitrable only when; the fraud allegations virtually amounts to a criminal offence, or are so complicated that it requires producing and/or analysing huge amounts of evidences, or where the allegations are against the very validity of the arbitration agreement itself, or it vitiates the entire contract i.e., fraud alleged in the very core of the contract. Allegations were made regarding default in making deposits and siphoning of funds in a fraudulent manner, The Court gave an example that if complex allegation of forgery or fabrication of documents are raised for supporting the allegation of fraud, then such a case can be non-arbitrable.  

The decision of Ayyaswamy was further assented to in the case of  Rashid Raza v. Sadaf Akhtar (“Rashid Raza”), where business improprieties including siphoning of funds was alleged,the Court highlighted the distinction between ‘fraud simpliciter’ and ‘complex fraud’. It laid down the following twin-test for determining the same:

(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.

Thus, in cases where there are simple allegations of fraud concerning and limited to the internal affairs of the parties without any effect on public at large, the arbitral tribunal can arbitrate upon it, as that is ‘fraud simpliciter’.

Recently, the court in Avitel Post Studios v. HSBC PI Holdings (Mauritius) (“Avitel”) affirmed and clarified the view taken by the Court in Rashid Raza. Avitel through misrepresentation and fraud induced HSBC to invest 60-million dollars in it. It held that, the plea permeating the arbitration agreement is not arbitrable because once the arbitration agreement is itself vitiated by fraud, it cannot be said to exist. Secondly, where allegations are made against the State or its instrumentalities, relating to arbitrary, fraudulent, or mala-fide conduct, then that is a matter of public law rather than a issue of contractual arrangement between the parties, hence cannot be arbitrated upon.

Vidya Drolia: The Latest Angle

The SC in its recent  judgment in Vidya Drolia, held that while the allegations of fraud pertaining to civil suit are arbitrable in nature, fraud that would completely vitiate and render the arbitration clause invalid, is non-arbitrable. Even-though the facts were not expressly related to allegations of fraud, and arose of out a tenancy dispute, the Court had the opportunity to deliberate on ‘subject-matter arbitrability’ at length and specifically on fraud allegations., The Court dwelled into the issue of arbitrability and public policy and observed that non-arbitrability of the subject matter cannot be considered with regards to public policy. In such circumstances, public policy means applicability of an existing statute i.e., only because the subject matter of the dispute is governed by an existing law the dispute cannot be termed non-arbitrable. Unless the governing statute itself expressly or impliedly demands exclusion of the dispute from arbitration, mere probability that arbitration would not be able to uphold the public policy envisaged under the said legislation, does not invalidate the arbitration agreement or affirm non-arbitrability of the dispute. 

The denial of arbitrability of subject matter with such ease would tantamount to defeat of the ADR mechanism. The purpose of arbitration was to provide a speedy redressal of disputes accompanied by benefits of informal process, more accessibility, etc. and yet have a binding decision on the parties. The fundamental judicial principles are also an important part of arbitration and provides for fair proceedings, natural justice, etc. 

The court categorically pointed out the flawed reasoning of Radhakrishnan with respect to the capability of arbitration to deal and decide on complex issues involving public interest. Arbitrators are generally selected from a pool of well qualified and knowledgeable experts on the subject-matter of the dispute and give an award keeping in mind the relevant judicial precedents, legislation, customary practices, facts, evidences etc. Thus, considering the specialisation of the arbitral tribunal in general, the subject matter before them can easily be decided through arbitration.

The Court propounded the following fourfold test for determining non-arbitrability of the subject matter of a dispute:

(1) when 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 cause of action and subject matter of the dispute affects third party rights and/or affects people at large.

(3) when cause of action and subject matter of the dispute relates to inalienable sovereign and public interest functions of the State. and

(4) when the subject-matter of the dispute is expressly or by necessary implication non-arbitrable as per mandatory statute(s).

Analysis of the Judgments

While numerous judgments have come up to decide the arbitrability of disputes involving fraud, not always the court has been able to provide a clear point of view. In Radhakrishnan, the Court had erroneously extended the ‘serious allegations’ standard laid down in Booze Allen to disputes inter partes as well. Even-though in that case, the dispute was solely of a civil nature, it was declared non-arbitrable. Then after, through cases such as Ayyasamy & Rashid Raza, the court tried and succeeded to some extent in clearing the clouds around the arbitrability of fraud, however, these judgments gave rise to confusion in interpretation of ‘serious/complex allegations of fraud’. Moreover, they made the same mistake as in Radhakrishnan of, requiring “a strict and meticulous enquiry into the allegations of fraud” to be conducted. As a result, these precedents went against the core principle of minimizing judicial intervention, because courts would have to determine whether the allegation pertains to ‘serious’ fraud.

Through the Vidya Drolia, the Court has affirmed to abide by the ‘public flavour’ test propounded in Avitelwhich looks into whether the alleged fraud is a matter between parties under civil law and that it has no public ramifications. Thus, the current settled law for arbitrability of fraud in India, can be explicated as those disputes which involve criminal elements, and which would not simply affect inter partes, instead relate to ‘public wrongs’, and have an effect in public domain are non-arbitrable.

Impact of Ordinance on Position of Fraud

Recently, through the Arbitration and Conciliation (Amendment) Ordinance, 2020 (“Ordinance”),  made amendments to section 36 & 43J of the Arbitration and Conciliation Act, 1996. Under Section 36 which deals with enforcement of awards, a proviso has been added which enables parties to seek unconditional stay on the award if prima facie case of fraud or corruption is proved.

Due to the insertion of proviso in section 36 now courts must provide an unconditional stay on enforcement of the award of domestic arbitration, given a prima facie case of fraud or corruption is made out. The earlier amendment of  2015 was in contradiction of the legislative intent manifested in this ordinance which restricted  unconditional stay (on awards) of any manner. Thus, the legislative position has been somewhat unsettled with respect to the unconditional stay on awards.

Conclusion

After so much legal deliberation upon this matter, and pro-arbitration judgments widening the scope of arbitrability in terms of fraud, the legislature has impliedly made fraud non-arbitrable. This is because, if allegations of fraud are made by any party, and they are arbitrated upon, after the passing of award the same gets challenged on grounds of fraud and corruption which again has to be determined by the Courts, during which an unconditional stay on award will be ordered by the courts, making the entire arbitration proceedings futile. As with the ruling of Vidya Drolia making disputes of fraud arbitrable, it seems that the tussle between courts and legislature would long continue till both reach to a common ground.