Demystifying the Arbitrability of Fraud 

I. Introduction

Arbitration has evolved as the most preferred form of alternate dispute resolution method mostly owing to a surge in commercial disputes and intent of parties to resolve them expeditiously before a private forum. However, it has not been immune from contentious and debatable issues which are witnessed from time to time, leading to considerable amount of judicial intervention and delay in adjudication. One such issue that has plagued arbitration is whether allegations of fraud can be adjudicated under the regime of arbitration. This issue arises because arbitration is restricted to deciding only the rights in personam (against a particular person) and excludes rights in rem (affecting other persons such as matters involving crimes, matrimony, insolvency, winding-up, testamentary matters, trust[1], etc.).[2] Whereas fraud is an issue which may not solely be inter se between the parties but also permeates into the realm of public law in certain occasions. In other words, it possesses dual characteristic, capable of being decided as a right in personam as well as a right in rem. The element of ‘fraud’ goes into the root of the intention of the parties to enter into a contract[3]. This very idiosyncrasy of fraud has led to a major conundrum in the arbitration regime, resulting into diverse views.

Recently, the Supreme Court in  Avitel Post Studioz Ltd. v. HSBC PI Holdings (Mauritius) Ltd. [4] dated 19 August 2020 (Avitel) had the occasion to deal with this issue. Before discussing the recent decision by the Supreme Court, it is important to set out the jurisprudence surrounding arbitrability of fraud.

II. Evolution of jurisprudence on arbitrability of fraud

The line of decisions on arbitrability of fraud started with the judgment by a three-Judge Bench of the Supreme Court in Abdul Kadir Shamsuddin Bubere v. Madhav Prabhakar Oak[5] (Abdul Kadir”). In Abdul Kadir, the Supreme Court while placing reliance on various English judgments such as Russel v. Russel[6], held that the Court will, in general, refuse to refer a dispute to arbitration if the party charged with 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[7].

However, in N. Radhakrishnan v. Maestro Engineers[8], (Radhakrishnan), which involved allegations of malpractices in account books and manipulation of records of the partnership firm, the Supreme Court sought to rely on its ruling[9] of Abdul Kadir judgment. While doing so, it held that wherever serious allegations of fraud are raised, it would necessarily mean that they should be tried in a court of law and therefore, rejected the application filed under Section 8 of the Arbitration & Conciliation Act, 1996 (as amended) (“the Arbitration Act”).  This simpliciter rejection to refer the parties to arbitration shifted the course of this issue. Not only did the Supreme Court overlook its own judgment in  Hindustan Petroleum Corp. Ltd. v. Pink City Midway Petroleums[10], and P. Anand Gajapathi Raju v. P.V.G. Raju[11], but also did not consider the aspect where a party can subterfuge the arbitration agreement on simpliciter allegations of fraud. The Court in Radhakrishnan[12] also overlooked the fact that in contrast to Arbitration Act, 1940, the scheme of reference under Section 8 of Arbitration Act, 1996 was radically different where reference to arbitration was mandatory upon existence of arbitration agreement.

The decision in Radhakrishnan[13] set the clock backwards on the approach qua arbitration in India, as it led to arbitration clauses being rendered redundant and increased the scope for judicial interference.

III. Attempted course correction by adopting pro-arbitration approach

The course adopted in Radhakrishnan’s[14] judgment was sought to be corrected by the Supreme Court in  Swiss Timing Ltd. v. Commonwealth Games Organizing Committee[15], (Swiss Timing) and World Sport Group (Mauritius) Ltd.  v. MSM Satellite (Singapore) Pte Ltd.[16], (World Sport Group)  where the Court made bold and remarkable attempts to rectify the past precedents while dealing with applications filed under Sections 11 and 45 of the Arbitration Act respectively, which were resisted primarily on the grounds of fraud being alleged.

In Swiss Timing case[17], where the appointment of the arbitrator under Section 11 was resisted on grounds of pendency of criminal proceedings nullifying the arbitration clause, the Court appointed the arbitrator by keeping in the line with the spirit of the Arbitration Act. It was held that, when a judicial authority is faced with an arbitration clause in an agreement, it is mandatory for the authority to refer parties to arbitration. The Court notably applied the doctrine of severability of arbitration agreement.The Court also dealt with  Radhakrishnan[18]  judgment and rightly held the same to be per incuriuam[19]. The Court also observed that, it is only when the contract is ex facie void, from a meaningful reading of the contract without requirement of further proof, that the appointment cannot be made under Section 11 of the Arbitration Act. However, as this   judgment was made by a Single Judge in an application filed under Section 11, Radhakrishnan[20] judgment could not be overruled in Swiss Timing.[21]

The Supreme Court in World Sport Group[22] was faced with a similar question while dealing with reference to foreign seated arbitration under Section 45 of the Arbitration Act. The Supreme Court not only allowed the application but also went a step further and observed that where allegations of fraud in the procurement or performance of a contract are alleged, there is no reason for arbitral tribunal to decline jurisdiction.

IV. Recommendations by the 246th Law Commission Report on the issue

The 246th Report of the Commission on ‘Amendment to the Arbitration and Conciliation Act, 1996[23] (“the Law Commission Report”) attempted to resolve the issue of arbitrability of fraud by legislative mechanism while attempting to achieve pro–arbitration approach. In the Law Commission Report, it was suggested to introduce a blanket provision after sub-section (6) to Section 16 of the Arbitration Act bestowing upon the tribunal, the power to make an award despite allegations of fraud.[24]

However, this amendment was not brought in by the Legislature and the issue pertaining to arbitrability of fraud persisted before the courts of law. The Supreme Court in  Ayyasamy[25] (cited hereinafter) observed that Parliament may have felt, as was mentioned by Lord Reid in British Railways Board and Herrington[26], that it was unable to make up its mind and instead, leave it to the courts to continue, case by case, deciding upon what should constitute an exception to fraud.[27]

Although the Law Commission Report took note of the conundrum surrounding the arbitrability of cases involving allegations of fraud, the recommended provision was clouded with ambiguity and elusiveness, which is evident from the use of the phrases “serious question of law, complicated questions of fact or allegations of fraud, corruption etc.

V. Arbitrability of disputes – Rights in personam[28]and rights in rem[29]

The Arbitration Act is silent on exclusion of disputes of any category of disputes from its purview, which renders them non–arbitrable. Nonetheless, the Arbitration Act recognises the power of the court to set aside the award if the subject- matter is not arbitrable under the law for the time being in force.[30] 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.

Arbitrability of dispute is dependent upon the nature of rights involved in the disputes – right in personam and rights in rem. The Supreme Court, in  Afcons Infrastructure Ltd. v. Cherian Varkey Construction Co. (P) Ltd.[31] (“Afcons”) and Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd.[32] (“Booz Allen”)  have made an attempt to categorise the disputes which are non–arbitrable, which includes, inter alia, cases involving serious and specific allegations of fraud and prosecution of criminal offences.[33] The rationale for such categorisation is that such matters relate to actions in rem and hence, cannot be subject to arbitration which is a private forum for the parties. However, this broad categorisation of the cases must be read in light of the judgment laid down in the Ayyasamy case[34] (cited hereinafter).

VI. Twin test to determine “seriousness of fraud” evolved in Ayyasami case

VII. The judgement passed by the Supreme Court in Ayyasamy v. A. Paramasivam[35], (Ayyasamy) proved to be a greeting respite in the arena of fraud relating disputes arising under a contract containing an arbitration clause.

The Supreme Court in  Ayyasamy case, was dealing with an application preferred by the appellants (i.e. the original applicants) under Section 8 of the Arbitration Act, which faced resistance on the ground that acts of fraud were attributable to the applicants and the dispute was not arbitrable[36]. The lower courts, placing reliance on  Radhakrishnan case[37], rejected the reference to arbitration observing that there were allegations of fraud. The Supreme Court reversed the finding of the lower courts by holding that mere allegation of fraud cannot be a ground to nullify the effect of arbitration agreement between the parties. The Court laid emphasis on whether its jurisdiction has been ousted rather than determining if it has jurisdiction. It was held that a reference to arbitration is to be rejected only when the allegations are of serious and complicated nature, which requires extensive evidence and trial before a court. The decision of the Supreme Court was in consonance with the principle of kompetenz kompetenz (embodied in Section 16 of the Act) under which the arbitral tribunal has the power to decide on its own jurisdiction.

It is noteworthy that  Ayyasamy case[38] (passed by a Bench of same strength as that of Radhakrishnan case[39]), did not overrule the judgment in  Radhakrishnan case expressly, but laid down the criteria for sifting of cases involving serious allegations of fraud and simpliciter allegations of fraud, the former being non–arbitrable. The Supreme Court propounded the twin test in order to assess the ‘seriousness’ of fraud, viz. “(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 principles evolved in the judgment in  Ayyasamy[40] judgment were thereafter applied by the Supreme Court in  Rashid Raza v. Sadaf Akhtar[41], (Rashid  Raza), which has been passed by a Full Bench. By doing so, the Supreme Court has impliedly, overruled the decision passed in Radhakrishnan case[42].

VIII. Supreme Court’s decision in Avitel Post Studioz Ltd. HSBC PI Holdings (Mauritius) Ltd.

The test underlying the determination of arbitrability of fraud has evolved significantly in the judgments passed by the Supreme Court in  Ayyasamy[43] and Rashid Raza[44]. However, the issue came up once again before the Supreme Court in Avitel case[45], from an order passed under Section 9 of the Arbitration Act for interim measures applied by a foreign party award-holder. In Avitel case[46], HSBC alleged fraudulent inducement while entering into contract with Avitel Group. The award was passed in favour of HSBC, upholding its contentions. Thereafter, HSBC applied for interim measures before the courts in India, when Avitel set up a defense that there were serious allegations of fraud and certain criminal cases were also pending and therefore, no orders should be passed.

After due consideration of the facts, the Court applied the twin test laid down in Ayyasamy case[47] and (as also applied in Rashid Raza case[48]), and held that the allegations of impersonation, false representation and diversion of funds were inter parties and did not have any ‘public flavour’. In view of the same, the Supreme Court dismissed the appeal, and upheld the orders passed under Section 9 of the Arbitration Act. In Avitel case[49], the Court reiterated the position of law pertaining to arbitrability of fraud and applied the same while dealing with the application for interim measures.

The Supreme Court in Avitel[50] also clarified that the criteria of arbitrability as laid down in Booz Alllen[51] and Afkons[52] cases cannot be read in bereft of the twin test laid down in  Ayyasamy case[53] while considering the arbitrability issue of fraud. It is not a rarity that the same set of facts can give rise to civil as well as criminal action under law[54]. Therefore, any dispute involving ‘fraud’ either under Section 17 of the  Contract Act, 1872 and/or tort of deceit, the mere fact that criminal proceedings have been initiated in respect of the same subject-matter would not lead to the conclusion that a dispute which is otherwise arbitrable (by applying the twin test), ceases to be so.

IX. CONCLUSION

Although the judgment in  Ayyasamy case[55] had a pivotal role to play in the arena of cases involving the determination of arbitrability of fraud, the conundrum revolving around the issue still lingered. This appears to be mostly because the judgment in  Radhakrishnan[56]  was not overruled and continued to be heavily relied upon by the parties resisting the reference of disputes to arbitration on mere allegation of fraud.

The non-adoption of the recommendation of the Law Commission Report to introduce sub–section (7) in Section 16 of the Arbitration has left it to the courts to apply the test while dealing with the applications filed under the provisions of the Arbitration Act, whenever faced with resistance to the arbitrability of the dispute on the basis of the allegations of fraud. In any event, the introduction of such a provision would have been repugnant in cases where the allegations of fraud possess ‘public flavour’, which makes such disputes non–amenable to arbitration. Not to mention that the suggested provision was¸ prima facie, obscure and would have unleashed another line of litigation.

The Supreme Court, in Avitel case[57], has negated the precedential value of  Radhakrishnan case[58] and has made sincere efforts through its judgments in  Ayyasamy[59] and Rashid Raza[60] to demystify the arbitrability of fraud. However, the responsibility of the courts to determine if the allegations of fraud are serious or simpliciter in nature and if they attract ‘public flavour’ continue to be intact with them. As much as the intent of the courts have been to take a pro–arbitration approach, it appears that the judicial interference is inevitable, since the courts are burdened to go into the merits of the case in order to scrutinise if the allegation of fraud negates the existence of the arbitration clause itself or renders the dispute incapable of being arbitrable.


*Partner,  IndusLaw

**Senior Associate, IndusLaw

***Associate, IndusLaw

[1]Vimal Kishor Shah v. Jayesh Dinesh Shah, (2016) 8 SCC 788

[2]Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd., (2011) 5 SCC 532

[3]Section 17 of the  Contract Act, 1872

[4] 2020 SCC OnLine SC 656

[5] AIR 1962 SC 406

[6] [1880] 14 Ch D 471

[7] See Abdul Kadir, AIR 1962 SC 406  at p. 713

[8] (2010) 1 SCC 72

[9]Abdul Kadir, AIR 1962 SC 406.  “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.”

[10] (2003) 6 SCC 503 

[11](2000) 4 SCC 539

[12] (2010) 1 SCC 72

[13] Ibid

[14] Ibid

[15](2014) 6 SCC 677

[16] (2014) 11 SCC 639

[17] (2014) 6 SCC 677

[18] (2010) 1 SCC 72

[19]See Footnotes 10 and 11

[20] (2010) 1 SCC 72

[21]Also clarified in State of W. B. v. Associated Contractors, (2008) 6 SCC 740

[22] (2014) 11 SCC 639 

[23] Report No. 246 on  Amendments to the Arbitration and Conciliation Act, 1996 (August 2014)   

[24]Amendment to Section 16, 246th Law Commission Report at p. 50 – After sub-section (6), insert sub-section “(7). The arbitral tribunal shall have the power to make an award or give a ruling notwithstanding that the dispute before it involves a serious question of law, complicated questions of fact or allegations of fraud, corruption etc.”

[25] Ayyasamy v. A. Paramasivam, (2016) 10 SCC 386

[26] 1972 AC 877 [House of Lords]

[27] This case is referred to in Lord Brandon’s judgment in La Pintada (supra) and distinguished at p. 130 of his judgment.

[28] A right or interest protected solely against the specific individuals

[29]A right exercisable against the world at large such as actions determining the title to property

[30]Sections 34(2) (b) and  48 (2) of the Arbitration Act

[31] (2010) 8 SCC 24

[32] (2011) 5 SCC 532

[33]Para 27 in Afcons case and para36 in  Booz Allen case and new category of disputes arising under the Trust Deeds governed by the Trust Act, 1882 have been added in  Vimal Kishor Shah v. Jayesh Dinesh Shah, (2016) 8 SCC 788

[34] (2016) 10 SCC 386

[35] Ibid5

[36]Reliance was placed on Radhkrishnan case

[37] (2010) 1 SCC 72

[38] (2016) 10 SCC 386

[39] (2010) 1 SCC 72

[40] (2016) 10 SCC 386

[41] (2019) 8 SCC 710

[42] (2010) 1 SCC 72

[43] (2016) 10 SCC 386

[44] (2019) 8 SCC 710

[45] 2020 SCC OnLine SC 656 

[46] Ibid

[47] (2016) 10 SCC 386

[48] (2019) 8 SCC 710

[49] 2020 SCC OnLine SC 656

[50] Ibid

[51] (2011) 5 SCC 532

[52] (2010) 8 SCC 24

[53] (2016) 10 SCC 386

[54]Guru Grant Saheb SthanMeerghatVanaras v. Ved Prakash,  (2013) 7 SCC 622

[55] (2016) 10 SCC 386

[56] (2010) 1 SCC 72

[57] 2020 SCC OnLine SC 656 

[58] (2010) 1 SCC 72

[59] (2016) 10 SCC 386

[60] (2019) 8 SCC 710

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