July 13, 2021

The efficacy of arbitral proceedings to resolve the issue of fraud as the subject matter of dispute has drawn the attention of courts from time to time. As observed by the Supreme Court, every civil or commercial dispute which is capable of being decided by a civil court is in principle capable of being resolved through arbitration unless it is excluded either expressly by statute, or by necessary implication. Moreover, the Courts, on the basis of public policy and common law practices, have, generally treated certain categories of subject matters to be incapable of resolution through arbitration.

In the present article, I will briefly examine the following aspects relating to arbitrability of fraud as the subject matter of dispute:

  1. The position of law on the above subject under the Arbitration Act, 1940 (hereinafter referred to as the “1940 Act”) vis-à-vis the Arbitration and Conciliation Act, 1996 (hereinafter referred to as the “1996 Act”);
  2. The scope and extent of arbitrability of fraud under Part I of the 1996 Act and the nuances with respect to overlapping civil and criminal aspect of fraud;
  3. The position of law in the above regard with respect to International Commercial Arbitration held outside the territory of India.

Position of law relating to arbitrability of fraud under the 1940 Act:

The leading case on the issue of arbitrability of fraud under the 1940 Act is the case of Abdul Kadir Shamsuddin Bubere v. Madhav Prabhakar Oak [1].

Before dealing with the said case, it may be relevant to note the relevant provisions under the 1940 Act dealing with the subject issue.

Section 20 of the 1940 Act reads as follows: –

20. Application to file in Court arbitration agreement.— (1) Where any persons have entered into an arbitration agreement before the institution of any suit with respect to the subject-matter of the agreement or any part of it, and where a difference has arisen to which the agreement applies, they or any of them, instead of proceeding under Chapter II, may apply to a Court having jurisdiction in the matter to which the agreement relates, that the agreement be filed in Court.

….

(4) Where no sufficient cause is shown, the Court shall order the agreement to be filed, and shall make an order of reference to the arbitrator appointed by the parties, whether in the agreement or otherwise or, where the parties cannot agree upon an arbitrator, to an arbitrator appointed by the Court.…”

As is evident from a bare perusal of Section 20 of the 1940 Act, which was also noted by the Supreme Court in Abdul Kadir (supra), a wide discretion was vested in the court to refuse to refer the parties to arbitration if “sufficient cause” is made out in terms of sub-section (4) of Section 20 of the 1940 Act even if the subject matter of dispute is covered by the arbitration agreement.

Further, under Section 35 of the 1940 Act, even where arbitral proceedings are on-going, all further proceedings in the pending reference shall become invalid the moment legal proceedings upon the whole of the subject matter of reference have been commenced between all the parties to the reference and a notice thereof has been given to the arbitrators or umpire unless a stay of proceedings is granted under Section 34 thereof.

Section 35 of the 1940 Act, thus, indicates that the scheme of the 1940 Act appears to have been tilted in favor of an adjudication by the civil court rather than recourse to arbitration.

Coming back to Abdul Kadir (supra), while dealing with the issue of fraud in an application under Section 20 of the 1940 Act, the Three Judge Bench of the Supreme Court referred to various English judgments including the leading case of Russel v. Russel[2] where the Court, as noticed by the Supreme Court in paragraph 9, held as follows:

“in a case where fraud is charged, the court will in general refuse to send the dispute to arbitration if the party charged with the fraud desires a public inquiry. But where the objection to arbitration is by the party charging the fraud, the court will not necessarily accede to it, and will never do so unless a prima facie case of fraud is proved”.

Another relevant English judgment, namely, Charles Osenton & Co. v. Johnston[3] was also referred to in Abdul Kadir (supra), and thereafter, the Supreme Court laid down the law as follows:

“13. There is no doubt that where serious allegations of fraud are made against a party and the party who is charged with fraud desires that the matter should be tried in open court, that would be a sufficient cause for the court not to order an arbitration agreement to be filed and not to make the reference. But it is not every allegation imputing some kind of dishonesty, particularly in matters of accounts, which would be enough to dispose a court to take the matter out of the forum which the parties themselves have chosen. This to our mind is clear even from the decision in Russel case [1880 14 Ch D 471] . In that case there were allegations of constructive and actual fraud by one brother against the other and it was in those circumstances that the court made the observations to which we have referred above. Even so, the learned Master of the Rolls also observed in the course of the judgment at p. 476 as follows:

“Why should it be necessarily beyond the purview of this contract to refer to an arbitrator questions of account, even when those questions do involve misconduct amounting even to dishonesty on the part of some partner? I do not see it. I do not say that in many cases which I will come to in the second branch of the case before the Court, the Court may not, in the exercise of its discretion, refuse to interfere; but it does not appear to me to follow of necessity that this clause was not intended to apply to all questions, even including questions either imputing moral dishonesty or moral misconduct to one or other of the parties.”

We are clearly of opinion that merely because some allegations have been made that accounts are not correct or that certain items are exaggerated and so on that is not enough to induce the court to refuse to make a reference to arbitration. It is only in cases of allegations of fraud of a serious nature that the court will refuse as decided in Russels case [1880 14 Ch D 471] to order an arbitration agreement to be filed and will not make a reference.………It is only when serious allegations of fraud are made which it is desirable should be tried in open court that a court would be justified in refusing to order the arbitration agreement to be filed and in refusing to make a reference.

While turning to the facts of the case before it and holding that the allegations made in the said case do not amount to serious allegation of fraud, it significantly added as follows:

“14…It seems to us that every allegation tending to suggest or imply moral dishonesty or moral misconduct in the matter of keeping accounts would not amount to such serious allegation of fraud as would impel a court to refuse to order the arbitration agreement to be filed and refuse to make a reference. ………”

Thus, the Three Judge Bench of the Supreme Court opined as follows –

(i) It will constitute a sufficient cause for the court to refuse reference to arbitration whereserious allegations of fraud are made against a party and the party who is charged with fraud desires that the matter should be tried in open court. However, where the objection to arbitration is made by the party charging the fraud, the court will not necessarily accede to it, and will never do so unless a prima facie case of fraud is proved.

(ii) It is not every allegation imputing some kind of dishonesty, particularly in matters of accounts, which would be enough for the court to refuse reference to arbitration.

(iii) Every allegation tending to suggest or imply moral dishonesty or moral misconduct in the matter of keeping accounts would not amount to such serious allegation of fraud as would impel a court to refuse to order the arbitration agreement to be filed and refuse to make a reference.

Before travelling to the scheme under the Arbitration and Conciliation Act, 1996 (hereinafter referred to as “1996 Act”), it is relevant to mention that the aforesaid judgment in Abdul Kadir (supra) has to be read and understood in the context of the scheme under the 1940 Act.

Policy and Scheme under the 1996 Act

The 1996 Act marks a significant departure from the scheme of the 1940 Act and the whole policy of the 1996 Act was designed towards encouraging resolution of disputes expeditiously and economically through the process of arbitration with minimal intervention by courts. The 1996 Act has not made any specific provision excluding any category of disputes from the ambit of arbitration. However, the scheme of the 1996 Act indicates and recognizes that certain disputes or subject matters are not capable of being resolved through arbitration. Section 2(3), Section 34(2)(b)(i) and Section 48(2)(a) of the 1996 Act, inter-alia, are some of the provisions which indicate the above position.

That apart, the Supreme Court, based on ‘public policy’ and ‘common law practices’, has, inter-alia, carved out certain categories of dispute or subject matters which are generally considered to be falling outside the ambit of arbitration.

In the case of Afcons Infrastructure Ltd. v. Cherian Varkey Construction Co. (P) Ltd [4], the Supreme Court, in paragraph 27, while dealing with Section 89 of the Code of Civil Procedure, 1908, delineated six categories of subject matters which are normally considered not to be suited for Alternative Dispute Resolution process. For the purpose of this article, category (iv) and (vi) are relevant and are reproduced hereinbelow:

27. The following categories of cases are normally considered to be not suitable for ADR process having regard to their nature:

(iv) Cases involving serious and specific allegations of fraud, fabrication of documents, forgery, impersonation, coercion, etc.

(vi) Cases involving prosecution for criminal offences.”

Further, the Two Judge Bench of the Supreme Court in Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd.,[5] dealt with the issue of the term “arbitrability” and its facets and further laid down the law regarding arbitrability and non-arbitrability. The Supreme Court, in paragraph 36, again delineated certain categories of subject matters which are well recognized examples of non-arbitrable disputes. The relevant paragraphs are extracted hereinbelow:

34. The term “arbitrability” has different meanings in different contexts. The three facets of arbitrability, relating to the jurisdiction of the Arbitral Tribunal, are as under:

(i) Whether the disputes are capable of adjudication and settlement by arbitration? That is, whether the disputes, having regard to their nature, could be resolved by a private forum chosen by the parties (the Arbitral Tribunal) or whether they would exclusively fall within the domain of public fora (courts).

(ii) Whether the disputes are covered by the arbitration agreement?…

(iii) Whether the parties have referred the disputes to arbitration?…

……

36. The well-recognised examples of non-arbitrable disputes are: (i) disputes relating to rights and liabilities which give rise to or arise out of criminal offences;

….

38. Generally and traditionally all disputes relating to rights in personam are considered to be amenable to arbitration; and all disputes relating to rights in rem are required to be adjudicated by courts and public tribunals, being unsuited for private arbitration. This is not however a rigid or inflexible rule. Disputes relating to subordinate rights in personam arising from rights in rem have always been considered to be arbitrable.”.

The aforesaid aspect of the matter has also been discussed in paragraph 105-109 of a recent Three Judge Bench judgment of the Supreme Court in the case of N.N. Global Mercantile Pvt. Ltd. v. Indo Unique Flame Ltd. & Ors.[6].

Further, it may also be mentioned that the Three Judge Bench of the Supreme Court in the case of Vidya Drolia v. Durga Trading Corporation [7] * in paragraph 76 to 76.6, has laid down a fourfold test for determining when the subject matter of dispute in an arbitration agreement is not arbitrable.

The stage at which a judicial authority or a court is confronted with an objection that the subject matter though covered by an arbitration agreement is not arbitrable can be at the reference stage under Section 8 or Section 11 or it can be raised before the arbitral tribunal under Section 16 or it can be post the award as a ground of challenge to the award under Section 34(2)(b)(i) of the 1996 Act. It can also be at the Section 9 stage. The nature and scope of the adjudicatory process when such an objection is raised has been discussed threadbare in the recent case of Vidya Drolia v. Durga Trading Corporation (supra)by a Three Judge Bench.

The aforesaid provisions of law under the 1996 Act, particularly Sections 5, 8 & 16, signify the shift in the approach and policy towards resolution of disputes through arbitration with minimal intervention of the courts in cases where the subject matter of dispute is covered by the arbitration agreement.

Case laws dealing with arbitrability of fraud under Part – I of the 1996 Act:

The Two Judge Bench of the Supreme Court in the case of N. Radhakrishnan v. Maestro Engineers [8] while dealing with the issue of non-arbitrability of the subject matter on account of serious allegation pertaining to fraud and malpractices held as follows:

“21. In our opinion, the contention of the respondents relating to the jurisdiction of the arbitrator to decide a dispute pertaining to a matter of this proportion should be upheld, in view of the facts and circumstances of the case. The High Court in its impugned judgment has rightly held that since the case relates to allegations of fraud and serious malpractices on the part of the respondents, such a situation can only be settled in court through furtherance of detailed evidence by either parties and such a situation cannot be properly gone into by the arbitrator.

23.  …..In this connection, reliance was placed on a decision of this Court in Abdul Kadir Shamsuddin Bubere v. Madhav Prabhakar Oakin which this Court under para 17 held as under: (AIR p. 411)

“17. There is no doubt that where serious allegations of fraud are made against a party and the party who is charged with fraud desires that the matter should be tried in open court, that would be a sufficient cause for the court not to order an arbitration agreement to be filed and not to make the reference.”

In our view and relying on the aforesaid observations of this Court in the aforesaid decision and going by the ratio of the abovementioned case, the facts of the present case do not warrant the matter to be tried and decided by the arbitrator, rather for the furtherance of justice, it 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 in the present dispute.

25. The learned counsel for the respondents further elaborated his contention citing the decision of the High Court of Judicature at Madras in H.G. Oomor Sait v. O. Aslam Sait [(2001) 3 CTC 269 (Mad)] wherein it was held: (CTC pp. 269-70)

‘..The civil court can refuse to refer matter to arbitration if complicated question of fact or law is involved or where allegation of fraud is made…’

We are in consonance with the above referred decision made by the High Court in the matter concerned.

It is relevant to mention that while following the law in Abdul Kadir (supra), the Two Judge Bench of the Supreme Court quoted only part of the law as laid down by the Three Judge Bench of the Supreme Court in Abdul Kadir (supra), leaving out certain relevant aspects of the law which have been paraphrased by me hereinabove under sub-paras (ii) & (iii)[9]. Significantly, as noted in a subsequent Three Judge bench in Avitel Post Studioz Limited v. HSBC PI Holdings (Mauritius) Limited [10] , the Supreme Court in N. Radhakrishnan (supra) failed to appreciate that Abdul Kadir (supra) was a decision rendered under the 1940 Act and that the scheme of the 1996 Act, more particularly, Section 5, 8 & 16 thereof, marked a sea change in approach and policy in contrast to the scheme under the 1940 Act. I shall deal with this case in more detail when I discuss Avitel(supra), wherein, the Three Judge Bench of the Supreme Court has declared the said decision of the Two Judge Bench in N. Radhakrishnan (supra) to be lacking in precedential value.

In a proceeding under Section 11 (4) read with Section 11 (6) of the 1996 Act, the Ld. Single Judge of the Supreme Court in the case of Swiss Timings Ltd. V. Commonwealth Games 2010 Organising Committee [11] held that the law laid down in N. Radhakrishnan (supra) was per-incurium on two grounds. Firstly, the judgment of the Supreme Court in Hindustan Petroleum Corpn. Ltd. v. Pinkcity Midway Petroleums [12] which casts a mandatory obligation upon the judicial authority to refer the subject matter pending before it to arbitration if it is covered by the arbitration agreement, though noted, was not followed and a similar view of the Supreme Court in P. Anand Gajapathi Raju & Ors. v. P.V.G. Raju & Ors.[13] was not even brought to the notice of the Court. Secondly, Section 16 of the Arbitration Act was not brought to the notice of the Court in that case.

The next significant judgment on the issue of arbitrability of fraud is the case of A. Ayyasamy v. A. Paramasivam [14] wherein two learned Judges of the Supreme Court by way of separate concurring judgments analysed and laid down the law in detail. After analyzing Abdul Kadir (supra) and N. Radhakrishnan (supra), the Supreme Court speaking through Justice A.K. Sikri explained the law as follows:     

“18. When the case involves serious allegations of fraud, the dicta contained in the aforesaid judgments would be understandable. However, at the same time, mere allegation of fraud in the pleadings by one party against the other cannot be a ground to hold that the matter is incapable of settlement by arbitration and should be decided by the civil court. The allegations of fraud should be such that not only these allegations are serious that in normal course these may even constitute criminal offence, they are also complex in nature and the decision on these issues demands extensive evidence for which the civil court should appear to be more appropriate forum than the Arbitral Tribunal. Otherwise, it may become a convenient mode of avoiding the process of arbitration by simply using the device of making allegations of fraud and pleading that issue of fraud needs to be decided by the civil court. The judgment in N. Radhakrishnan [N. Radhakrishnan v. Maestro Engineers, (2010) 1 SCC 72 : (2010) 1 SCC (Civ) 12] does not touch upon this aspect and the said decision is rendered after finding that allegations of fraud were of serious nature.

The observation of Law Commission as contained in paragraph 50 and 51 of the 246th Law Commission Report dealing with the issue of arbitrability of fraud was noted in paragraph 22 and based on a perusal of the same, the Supreme Court held as follows:

“23.It, thus, follows that those cases where there are serious allegations of fraud, they are to be treated as non-arbitrable and it is only the civil court which should decide such matters. However, where there are allegations of fraud simpliciter and such allegations are merely alleged, we are of the opinion that it may not be necessary to nullify the effect of the arbitration agreement between the parties as such issues can be determined by the Arbitral Tribunal.”

In paragraph 24, the Supreme Court, based on its decision in the case of State of West Bengal v. Associated Contractors [15] clarified that decision of the Ld. Single Judge in the Swiss Timings (supra) does not have any precedential value and therefore, it cannot be deemed to have overruled the proposition of law laid down in N. Radhakrishnan (supra). Ultimately, the Supreme Court speaking through Justice A.K. Sikri crystalized the law in paragraph 25 and held as follows:

25. In view of our aforesaid discussions, we are of the opinion that mere allegation of fraud simpliciter may not be a ground to nullify the effect of arbitration agreement between the parties. It is only in those cases where the court, while dealing with Section 8 of the Act, finds that there are very serious allegations of fraud which make a virtual case of criminal offence or where allegations of fraud are so complicated that it becomes absolutely essential that such complex issues can be decided only by the civil court on the appreciation of the voluminous evidence that needs to be produced, the court can sidetrack the agreement by dismissing the application under Section 8 and proceed with the suit on merits. It can be so done also in those cases where there are serious allegations of forgery/fabrication of documents in support of the plea of fraud or where fraud is alleged against the arbitration provision itself or is of such a nature that permeates the entire contract, including the agreement to arbitrate, meaning thereby in those cases where fraud goes to the validity of the contract itself of the entire contract which contains the arbitration clause or the validity of the arbitration clause itself. Reverse position thereof would be that where there are simple allegations of fraud touching upon the internal affairs of the party inter se and it has no implication in the public domain, the arbitration clause need not be avoided and the parties can be relegated to arbitration. While dealing with such an issue in an application under Section 8 of the Act, the focus of the court has to be on the question as to whether jurisdiction of the court has been ousted instead of focusing on the issue as to whether the court has jurisdiction or not. It has to be kept in mind that insofar as the statutory scheme of the Act is concerned, it does not specifically exclude any category of cases as non-arbitrable. Such categories of non-arbitrable subjects are carved out by the courts, keeping in mind the principle of common law that certain disputes which are of public nature, etc. are not capable of adjudication and settlement by arbitration and for resolution of such disputes, courts i.e. public fora, are better suited than a private forum of arbitration. Therefore, the inquiry of the Court, while dealing with an application under Section 8 of the Act, should be on the aforesaid aspect viz. whether the nature of dispute is such that it cannot be referred to arbitration, even if there is an arbitration agreement between the parties. When the case of fraud is set up by one of the parties and on that basis that party wants to wriggle out of that arbitration agreement, a strict and meticulous inquiry into the allegations of fraud is needed and only when the Court is satisfied that the allegations are of serious and complicated nature that it would be more appropriate for the Court to deal with the subject-matter rather than relegating the parties to arbitration, then alone such an application under Section 8 should be rejected.

Justice D.Y. Chandrachud in his separate concurrent judgment elaborately dealt with the law relating to arbitrability of fraud. While dealing with N. Radhakrishnan(supra), the Supreme Court speaking through Justice D.Y. Chandrachud in paragraph 40 observed that the decision in Abdul Kadir (supra) arose under 1940 Act and was in the context of Section 20 thereof. It further noted that wide discretion was available to a Court under sub-section (4) of Section 20 of the 1940 Act and in contrast the scheme of 1996 Act made a radical departure from the position under the erstwhile enactment. A marked distinction is made in Section 8 where no option has been left to the judicial authority but to refer parties to the arbitration. The Court in paragraph 43 held the allegations of criminal wrongdoing or of statutory violation would not detract from the jurisdiction of the Arbitral Tribunal to resolve a dispute arising out of a civil or contractual relationship on the basis of the jurisdiction conferred by the arbitration agreement.

The Supreme Court speaking through Justice Chandrachud placed a word of caution qua the decision in N. Radhakrishnan (supra) and read down the said judgment by holding as follows:

“45. …The judgment in N. Radhakrishnan [N. Radhakrishnan v. Maestro Engineers, (2010) 1 SCC 72 : (2010) 1 SCC (Civ) 12] has, however, been utilised by parties seeking a convenient ruse to avoid arbitration to raise a defence of fraud:

45.1. First and foremost, it is necessary to emphasise that the judgment in N. Radhakrishnan [N. Radhakrishnan v. Maestro Engineers, (2010) 1 SCC 72 : (2010) 1 SCC (Civ) 12] does not subscribe to the broad proposition that a mere allegation of fraud is ground enough not to compel parties to abide by their agreement to refer disputes to arbitration. More often than not, a bogey of fraud is set forth if only to plead that the dispute cannot be arbitrated upon. To allow such a plea would be a plain misreading of the judgment in N. Radhakrishnan [N. Radhakrishnan v. Maestro Engineers, (2010) 1 SCC 72 : (2010) 1 SCC (Civ) 12] . As I have noted earlier, that was a case where the appellant who had filed an application under Section 8 faced with a suit on a dispute in partnership had raised serious issues of criminal wrongdoing, misappropriation of funds and malpractice on the part of the respondent. It was in this background that this Court accepted the submission of the respondent that the arbitrator would not be competent to deal with matters “which involved an elaborate production of evidence to establish the claims relating to fraud and criminal misappropriation”. Hence, it is necessary to emphasise that as a matter of first principle, this Court has not held that a mere allegation of fraud will exclude arbitrability. The burden must lie heavily on a party which avoids compliance with the obligation assumed by it to submit disputes to arbitration to establish the dispute is not arbitrable under the law for the time being in force. In each such case where an objection on the ground of fraud and criminal wrongdoing is raised, it is for the judicial authority to carefully sift through the materials for the purpose of determining whether the defence is merely a pretext to avoid arbitration. It is only where there is a serious issue of fraud involving criminal wrongdoing that the exception to arbitrability carved out in N. Radhakrishnan [N. Radhakrishnan v. Maestro Engineers, (2010) 1 SCC 72 : (2010) 1 SCC (Civ) 12] may come into existence.

45.2. Allegations of fraud are not alien to ordinary civil courts. Generations of judges have dealt with such allegations in the context of civil and commercial disputes. If an allegation of fraud can be adjudicated upon in the course of a trial before an ordinary civil court, there is no reason or justification to exclude such disputes from the ambit and purview of a claim in arbitration….”

Thereafter, Justice D.Y. Chandrachud referred to the position of law qua arbitrability of fraud in various jurisdiction including United Kingdom where the statutory scheme has undergone a change towards allowing conferring arbitral tribunal the jurisdiction to consider and rule on issues of fraud. The Court also referred to the American judgment on the said aspect of the matter and various leading authors including Russel in arbitration and International Commercial Arbitration by Gary B Borne. In the above context, paragraph 53 and 56 reads as follows:

“53. The Arbitration and Conciliation Act, 1996, should in my view be interpreted so as to bring in line the principles underlying its interpretation in a manner that is consistent with prevailing approaches in the common law world…”

..

56. The legal position has been succinctly summarised in International Commercial Arbitration by Gary B. Born [ 2nd Edn., Vol. I, p. 846] thus:

“…The fact that one party may have fraudulently misrepresented the quality of its goods, services, or balance sheet generally does nothing to impeach the parties’ agreed dispute resolution mechanism. As a consequence, only fraud or fraudulent inducement directed at the agreement to arbitrate will, as a substantive matter, impeach that agreement. These circumstances seldom arise: as a practical matter, it is relatively unusual that a party will seek to procure an agreement to arbitrate by fraud, even in those cases where it may have committed fraud in connection with the underlying commercial contract.”

In the case of Ameet Lal Chand Shah v. Rishabh Enterprises [16], the Supreme Court reiterated in paragraph 37 that it is only where serious questions of fraud are involved, the arbitration can be refused.

Then comes the judgment in the case of Rashid Raza v. Sadaf Akhtar [17] where the Three Judge Bench of the Supreme Court while following A. Ayyasamy (supra) laid down two working tests as follows:         

4. The principles of law laid down in this appeal make a distinction between serious allegations of forgery/fabrication in support of the plea of fraud as opposed to “simple allegations”. Two working tests laid down in para 25 are: (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.

In a recent significant judgment in the case of Avitel (supra), the Three Judge Bench of the Supreme Court, while dealing with a case arising out of a Section 9 proceeding, succinctly dealt with the entire history of the law. It may be mentioned that though the seat of arbitration in this case was outside the territory of India, the parties by contract had agreed that Section 9 of Part I will apply. The Supreme Court while holding N. Radhakrishnan (supra) to be lacking in precedential value, broadly relied upon the reasoning of the Ld. Single Judge in Swiss Timing (supra). The Court while acknowledging that the judgment delivered by the Ld. Single Judge in exercise of his jurisdiction under Section 11 of the Act in Swiss Timing (supra) cannot be said to be a binding precedent, however, the Supreme Court held that the Ld. Judge’s reasoning has strong persuasive value which the Court was inclined to adopt and held as follows:

“17. These provisions, together with section 8 of the 1996 Act, which now makes it mandatory to refer an action which is brought before a judicial authority, which is the subject matter of an arbitration agreement, to arbitration, if the conditions of the section are met, all point to a sea change from the 1940 Act which was repealed by this 1996 Act….

18. It will be seen from section 20 of the 1940 Act, as was held in Abdul Kadir (supra), that a wide discretion is vested in the Court if sufficient cause is made out not to refer parties to arbitration. It was in that context that the observations in Abdul Kadir (supra) as to serious allegations of fraud triable in a civil court, being “sufficient cause” shown under section 20(4) of the 1940 Act were made….

19. ….As against this, sections 5, 8 and 16 of the 1996 Act reflect a completely new approach to arbitration, which is that when a judicial authority is shown an arbitration clause in an agreement, it is mandatory for the authority to refer parties to arbitration bearing in mind the fact that the arbitration clause is an agreement independent of the other terms of the contract and that, therefore, a decision by the arbitral tribunal that the contract is null and void does not entail ipso jure the invalidity of the arbitration clause. Even otherwise, N. Radhakrishnan (supra) did not refer to the ratio of Abdul Kadir (supra) correctly. As has been seen by us hereinabove, Abdul Kadir (supra) held that serious allegations of fraud are not made out when allegations of moral or other wrongdoing inter parties are made. In particular, it was held that discrepancies in account books are the usual subject matter in account suits, which are purely of a civil nature. For all these reasons, we are broadly in agreement with the observations of Nijjar, J. rendering N. Radhakrishnan (supra) lacking in precedential value.”

The Supreme Court after further noticing the judgment in Ameet Lal Chand Shah (supra) and Rashid Raza (supra) held as follows:

34. After these judgments, it is clear that “serious allegations of fraud” arise only ifeither 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 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.

35. At this stage, it is necessary to deal with the broad statement of the law in Afcons (supra) and Booz Allen (supra). When Afcons (supra) refers in paragraph 27(iv) to “cases involving serious and specific allegations of fraud, fabrication of documents, forgery, impersonation, coercion, etc.”, this must now be understood in the sense laid down in Ayyasamy (supra) and Rashid Raza (supra)…” 

With regard to the issue of non-arbitrariness on the ground of ‘cases involving prosecution of criminal offences’, the Supreme Court analysed the law on the subject threadbare and stated that it is well settled that the same set of facts may have civil as well as criminal consequences and findings rendered in a civil proceeding do not bind the criminal proceeding and vis-a-versa, as standard of proof required in the two proceedings is entirely different. Civil cases are decided on preponderance of evidence while in a criminal case, the burden lies on the prosecution to prove the case beyond reasonable doubt. Ultimately, the Supreme Court in paragraph 42 held as follows:

42. 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.”

The Supreme Court further dealt with Sections 10, 14, 17 and 19 of the Indian Contract Act and drew the difference between contracts obtained by fraud and performance of contract (which is perfectly valid) being vitiated by fraud and cheating and the latter would fall outside Section 17 of the Indian Contract Act in which the remedy for damage would be available but not the remedy of for treating the contract itself as void. The Court held that the fraud that is practiced outside Section 17 of Contract Act i.e., in the performance of contract may be governed by tort of deceit, which would lead to damages, but not rescission of contract itself. Significantly, in paragraph 46, the Supreme Court held as follows:

“46. Both kinds of fraud are subsumed within the expression “fraud” when it comes to arbitrability of an agreement which contains an arbitration clause.”

The Three Judge bench of Supreme Court in Deccan Paper Mills Co. Ltd. v. Regency Mahavir Properties & Ors. [18] followed Avitel (supra) and held as follows:

“4.…If the subject matter of an agreement between parties falls within section 17 of the Indian Contract Act, 1872, or involves fraud in the performance of the contract, as has been held in the aforesaid judgment, which would amount to deceit, being a civil wrong, the subject matter of such agreement would certainly be arbitrable. Further, we have also held that merely because a particular transaction may have criminal overtones as well, does not mean that its subject matter becomes non-arbitrable…”.

The Three Judge bench of Supreme Court speaking through Justice Sanjiv Khanna in Vidya Drolia (supra), while holding that the tenancy landlord dispute under the Transfer of Property Act is arbitrable, concurred with the view of Avitel (supra) in paragraphs 73 and 74 and overruled N. Radhakrishnan (supra) in paragraph 78 which are quoted hereinbelow:

“78. In view of the aforesaid discussions, we overrule the ratio in N. Radhakrishnan inter alia observing that allegations of fraud can (sic cannot) be made a subject matter of arbitration when they relate to a civil dispute. This is subject to the caveat that fraud, which would vitiate and invalidate the arbitration clause, is an aspect relating to nonarbitrability…..”

In a significant recent judgment, a Three Judge Bench of the Supreme Court in the case of N.N. Global Mercantile (supra)analysed the law in great detail and, inter alia, held that even disputes voluminous evidence and documents are arbitrable, thereby, diluting the earlier position of law in this aspect of the matter to some extent. The relevant paragraphs of the aforesaid judgment are as follows:

“96. The judgment in N. Radhakrishnan (supra) is based on an outdated view of the law propounded in Russel v. Russel, which ante-dates even the first English Arbitration Act of 1899. Arbitrability of fraud is no longer an issue relating to the competence of the arbitrator, or dealing with voluminous evidence. Arbitrators are competent to deal with allegations of civil fraud. The judgment in Russel is obsolete, …

  …

110. The civil aspect of fraud is considered to be arbitrable in contemporary arbitration jurisprudence, with the only exception being where the allegation is that the arbitration agreement itself is vitiated by fraud or fraudulent inducement, or the fraud goes to the validity of the underlying contract, and impeaches the arbitration clause itself. Another category of cases is where the substantive contract is “expressly declared to be void” under Section 1044 of the Indian Contract Act, 1872 where the agreement is entered into by a minor (without following the procedure prescribed under the Guardian and Wards Act, 1890) or a lunatic, which would be with a party incompetent to enter into a contract.

111. The civil aspect of fraud can be adjudicated by an arbitral tribunal. The civil aspect of fraud is defined by Section 17 of the Indian Contract Act, 1872 …

113. In the case of voidable agreements, such disputes would be arbitrable, since the issue whether the consent was procured by coercion, fraud, or misrepresentation requires to be adjudicated upon by leading cogent evidence, which can very well be decided through arbitration. Until it so proved and upheld as per Sections 2(i) and (j) of the Indian Contract Act, 1872 such an agreement would remain enforceable, and is not void.

116. The ground on which fraud was held to be non arbitrable earlier was that it would entail voluminous and extensive evidence, and would be too complicated to be decided in arbitration. In contemporary arbitration practice, arbitral tribunals are required to traverse through volumes of material in various kinds of disputes such as oil, natural gas, construction industry, etc. The ground that allegations of fraud are not arbitrable is a wholly archaic view, which has become obsolete, and deserves to be discarded. However, the criminal aspect of fraud, forgery, or fabrication, which would be visited with penal consequences and criminal sanctions can be adjudicated only by a court of law, since it may result in a conviction, which is in the realm of public law.

…”

Thus, there are two aspects of fraud that may come in the way of reference to arbitration being (I) serious allegations of fraud; and (II) cases involving prosecution of criminal offences.

So far as the ground of serious allegations of fraud is concerned, a Two Judge Bench of the Supreme Court in A. Ayyasami (supra) had held that reference to arbitration can be refused when (i) there are very serious allegations of fraud which make a virtual case of criminal offence or where the allegations of fraud are so complex that it would be more appropriate that the same may be decided by a civil court on account of voluminous evidence that would be required to be produced; (ii) where there are serious allegations of forgery/ fabrication of documents in support of the plea of fraud; (iii) where the fraud is alleged against the arbitration provisions itself or is of such a nature that permeates the entire contract including the agreement to arbitrate.

However, refusal to refer the parties to arbitration was held to be impermissible where there are simple allegations of fraud touching upon the internal affairs of the parties inter se and it has no implication in the public domain.

In Rashid Raza (supra), while interpreting A. Ayyasamy (supra) the Three Judge Bench of the Supreme Court culled out two working principles therefrom which are 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.

The Three Judge bench of the Supreme Court in the case of Avitel (supra) read the aforesaid judgments to mean that “serious allegations of fraud are satisfied only if either of the two tests are satisfied and not otherwise and further explained the two tests as stated above. The Supreme Court further held that paragraph 27 (iv) of Afcons (supra), namely, ‘cases involving serious and specific allegations of fraud, fabrication of documents, forgery, impersonation, coercion, etc.’ must now be understood in the sense as laid down in A. Ayyasamy (supra) and Rashid Raza (supra). The Three Judge Bench of the Supreme Court, in the case of N.N. Global Mercantile (supra), inter alia, held that the ground that allegations of fraud are not arbitrable is a wholly archaic view, which has become obsolete, and deserves to be discarded. The Court, thus, appears to have diluted the earlier position of law to some extent and has clearly held that even dispute involving voluminous documents and evidence are also arbitrable.

As per Avitel (supra), the aforesaid 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 breach is alleged cannot be said to have entered into the agreement relating to arbitration at all. The Supreme Court in N.N. Global Mercantile (supra)further explained that arbitration can be refused if the substantive contract is void in the sense that it is entered into by an incompetent party. A composite reading of the aforesaid two judgments would show that serious allegations of fraud for refusing reference to arbitration will take place only if the substantive contract and/ or the arbitration clause itself is void on account of the same being entered into by an incompetent person as per the Indian Contract Act. Other aspects of fraud even if it invalidates the underlying contract and/ or the arbitration clause itself perhaps, in my humble view, have to be gone into by the arbitral tribunal since as per N.N. Global Mercantile (supra) even issues involving voluminous documents and evidence can be adjudicated through arbitration. The Court in the said case further held that in case of voidable agreements covered by Section 19 of the Indian Contract Act, disputes would be arbitrable since the issue whether the consent was procured by coercion, fraud, or misrepresentation requires to be adjudicated upon by leading cogent evidence, which can very well be decided through arbitration.

Thus, taking a cumulative view of the matter, the position of law is stated as follows:

(i) The civil aspect of fraud falling under Section 17 of the Contract Act, 1872 is considered to be arbitrable in contemporary arbitration jurisprudence. This is subject to the exception of serious allegation of fraud which vitiates and invalidates the underlying contract and/ or the arbitration clause itself, thereby, rendering it void. A composite reading of the aforesaid judgments would show that serious allegations of fraud for refusing reference to arbitration will take place only if the substantive contract and/ or the arbitration clause itself is void on account of the same being entered into by an incompetent person as per the Indian Contract Act.

(ii) Other aspects of fraud even if it invalidates the underlying contract and/ or the arbitration clause itself perhaps, in my humble view, have to be gone into by the arbitral tribunal since as per N.N. Global Mercantile (supra) even issues involving voluminous documents and evidence can be adjudicated through arbitration;

(iii) Mere allegations of fraud simplicitor relating to the internal affairs of the parties inter se without any implication in the public domain is not a permissible ground to refuse reference to arbitration;

(iv) Reference to arbitration can be refused when allegations are made against the State or its instrumentalities of arbitrary, fraudulent or malafide conduct, thus, necessitating hearing by a writ court in which questions are raised which are not predominantly arising from the contract itself or breach thereof, but questions arising in the public law domain;

(v) Fraud that is practiced outside Section 17 of Contract Act, i.e., in the performance of contract may be governed by tort of deceit, which would lead to damages, but not rescission of contract itself, has also been held to be arbitrable;

(vi) In case of voidable agreements covered by Section 19 of the Indian Contract Act, disputes would be arbitrable since the issue whether the consent was procured by coercion, fraud, or misrepresentation requires to be adjudicated upon by leading cogent evidence, which can very well be decided through arbitration;

(vii) The ground on which fraud was held to be non-arbitrable earlier was that it would entail voluminous and extensive evidence, and would be too complicated to be decided in arbitration. In contemporary arbitration practice, arbitral tribunals are required to traverse through volumes of material in various kinds of disputes such as oil, natural gas, construction industry, etc. The ground that allegations of fraud are not arbitrable is a wholly archaic view, which has become obsolete, and deserves to be discarded.

So far as the ground relating to ‘prosecution for criminal offence’ is concerned, the Supreme Court in Avitel (supra) has held that the said ground is “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.

In N.N. Global Mercantile (supra) the Three Judge Bench further held that the criminal aspect of fraud, forgery, or fabrication, which would be visited with penal consequences and criminal sanctions can be adjudicated only by a court of law, since it may result in a conviction, which is in the realm of public law. However, this would, in my humble opinion, be subject to the rider mentioned hereinabove in Avitel(supra).

Position of law in foreign seated arbitration/ foreign awards:

The applicability of Part I of the 1996 Act to International Commercial Arbitrations held outside India has been the subject matter of various decisions of the Supreme Court. The Supreme Court in Bhatia International v. Bulk Trading SA [19] had held that provisions of Part I of the 1996 Act will apply to international commercial arbitrations held out of India unless the parties by agreement, express or implied, excludes all or any of its provisions. This was followed in Venture Global Engg. LLC v. Tech Mahindra Ltd. & Anr. [20]. However, the Constitutional Bench of the Supreme Court in the case of BALCO [21] held that Part I of the 1996 Act is applicable only to arbitrations which take place within the territory of India but held that the judgment will apply prospectively. However, by way of the 2016 amendment, a proviso has been inserted to Section 2 (2) which reads as follows:

“Provided that subject to an agreement to the contrary, the provisions of section 9, section 27 and clause (a) of sub-section (1) and sub-section (3) of section 37 shall also apply to international commercial arbitration, even if the place of arbitration is outside India, and an arbitral award made or to be made in such place is enforceable and recognized under the provisions of part II of this Act”[22].

The issue of arbitrability of fraud in the case of a foreign seated arbitration governed by Part II of the Act, in my humble opinion, can be raised at the stage of Section 9 or at the stage of enforcement under Section 48(2)(a) of the 1996 Act.

It may also be pointed out that even if the issue of fraud is adjudicated upon by a foreign seated arbitral tribunal, the issue of arbitrability of fraud can be gone into at the stage of enforcement if it is sought to be enforced in India inasmuch as Section 48 (2) (a) clearly provides that enforcement of an arbitral award may be refused if the court finds that the subject matter of the difference is not capable of settlement by arbitration under the law of India.

So far as adjudication of fraud in a proceeding under Section 45 of the 1996 Act is concerned, the Two Judge Bench of the Supreme Court in the case of World Sport Group (Mauritius) Ltd. v. MSM Satellite (Singapore) Pte. Ltd. [23] has held that fraud cannot be adjudicated in a Section 45 proceedings and has held as follows:

36…In the case of such arbitrations covered by the New York Convention, the Court can decline to make a reference of a dispute covered by the arbitration agreement only if it comes to the conclusion that the arbitration agreement is null and void, inoperative or incapable of being performed, and not on the ground that allegations of fraud or misrepresentation have to be inquired into while deciding the disputes between the parties.

It may, however, be humbly pointed out that the said observations are perhaps, made in the context of allegation of fraud in the normal sense requiring detailed examination of evidences/ documents etc. but may perhaps not cover situations of fraud, as stated above, where the contract and/or the arbitration clause itself is void on the ground of the same being entered into by an incompetent party.

****

Parthiv K. Goswami is an Advocate.  Research inputs for this article were provided by Ishan Bisht, Advocate.


[1] (1962) 3 SCR 702 

[2] [1880] 14 Ch D 471

[3] [1942] AC1 130

[4] (2010) 8 SCC 24

[5] (2011) 5 SCC 532

[6] (2021) 1 SCALE 475

[7] (2021) 2 SCC 1

* The Three Judge Bench of the Supreme Court in N.N. Global Mercantile Pvt. Ltd. (supra) has, in paragraphs 95-96 thereof, doubted the correctness of the view of the Three Judge Bench in Vidya Drolia (supra) with regard to another aspect of the matter and has referred the said issue to a Constitution Bench of Five judges.

[8] (2010) 1 SCC 72

[9] See page 4 above

[10] 2020 (9) SCALE 733

[11] (2014) 6 SCC 677

[12] (2003) 6 SCC 503

[13] (2000) 4 SCC 539

[14] (2016) 10 SCC 386

[15] (2015) 1 SCC 32

[16] (2018) 15 SCC 678

[17] (2019) 8 SCC 710

[18] AIR 2020 SC 4047

[19] (2002) 4 SCC 105

[20] (2018) 1 SCC 656

[21] Bharat Aluminium and Co. v. Kaiser Aluminium and Co., (2012) 9 SCC 552

[22] w.e.f. 23.10.2015.

[23] (2014) 11 SCC 639

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