Supreme Court: The bench of RF Nariman and Navin Sinha, JJ has held that “serious allegations of fraud” as a ground for exemption from arbitral proceedings 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 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.
BACKGROUND OF THE CASE
The Court was hearing an appeal from the interlocutory judgment and order passed in the appeal under section 9 of the Arbitration and Conciliation Act, 1996 by the Bombay High Court in a dispute between HSBC and Avitel India.
HSBC made an investment in the equity capital of Avitel India for a consideration of USD 60 million in order to acquire 7.8% of its paid-up capital. This was done after Avitel India told HSBC that it was at a very advanced stage of finalising a contract with the British Broadcasting Corporation [BBC] to convert the BBC’s film library from 2D to 3D. This contract was expected to generate a revenue of USD 300 million in the first phase, and ultimately over USD 1 billion and hence, an investment of USD 60 million was required. HSBC, however, discovered that he purported BBC contract was non-existent and was set up by the Appellants to induce HSBC into investing the aforesaid money. Though Avitel Dubai received the entire investment proceeds of USD 60 million, it appeared that around USD 51 million were not used to purchase any equipment to service the BBC contract, but appeared to have been siphoned off to companies in which its promoters, the Jain family, had a stake.
RELEVANT PROVISIONS UNDER CONTRACT ACT
Section 10 of the Contract Act states that all agreements are contracts if they are made with the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void. Section 14 states that consent is said to be free when it is not caused inter alia by fraud as defined in section 17. Importantly, the section goes on to say that consent is said to be so caused when it would not have been given but for the existence, inter alia, of such fraud. Where such fraud is proved, and consent to an agreement is caused by fraud, the contract is voidable at the option of the party whose consent was so caused.
EFFECT OF INSTITUTION OF CRIMINAL PROCEEDINGS
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.
DISTINCTION BETWEEN CONTRACT BEING OBTAINED BY FRAUD AND PERFORMANCE OF A BEING VITIATED BY FRAUD
Explaining the difference between a contract being obtained by fraud and performance of a contract (which is perfectly valid) being vitiated by fraud or cheating, the Court said that the latter would fall outside section 17 of the Contract Act, in which the remedy for damages would be available, but not the remedy for treating the contract itself as being void. This is for the reason that the words “with intent to deceive another party thereto or his agent” must be read with the words “or to induce him to enter into the contract”, both sets of expressions speaking in relation to the formation of the contract itself. This is further made clear by sections 10, 14 and 19, all of which deal with “fraud” at the stage of entering into the contract. Even section 17(5) which speaks of “any such act or omission as the law specially deals to be fraudulent” must mean such act or omission under such law at the stage of entering into the contract.
Thus, fraud that is practiced outside of section 17 of the Contract Act, i.e., in the performance of the contract, may be governed by the tort of deceit, which would lead to damages, but not rescission of the contract itself. Both kinds of fraud are subsumed within the expression “fraud” when it comes to arbitrability of an agreement which contains an arbitration clause.
RULING ON THE FACTS
After reading the issues and some of the material findings in the Foreign Final Award, the Court came to the conclusion that the issues raised and answered are the subject matter of civil as opposed to criminal proceedings. The Court said that the fact that a separate criminal proceeding was sought to be started and may have failed was of no consequence whatsoever.
The Court further held that a reading of the Foreign Final Award in this case would show that a strong prima facie case has indeed been made out as the Award holds the BBC transaction as a basis on which the contract was entered into and the USD 60 million paid by HSBC, which would clearly fall within fraudulent inducement to enter into a contract under section 17 of the Contract Act. Such a contract would be voidable at the instance of HSBC. Also, the findings on the siphoning off of monies that were meant to be allocated for the performance of the BBC contract would attract the tort of deceit.
It, hence, concluded:
- That there is no such fraud as would vitiate the arbitration clause in the SSA entered into between the parties as it is clear that this clause has to be read as an independent clause. Further, any finding that the contract itself is either null and void or voidable as a result of fraud or misrepresentation does not entail the invalidity of the arbitration clause which is extremely wide
- That the impersonation, false representations made, and diversion of funds are all inter parties, having no “public flavour” as explained in paragraph 14 so as to attract the “fraud exception”.
[Avitel Post Studioz Ltd. v. HSBC PI Holdings (Mauritius) Ltd., 2020 SCC OnLine SC 656, decided on 19.08.2020]
