A sentinel’s toil in arbitrability of fraud: The A. Ayyasamy judgement

Justice Aharon Barak in his famous treaties on Proportionality defines it as a legal construction. He further argues that it is a methodological tool which consists of four components: a proper purpose, a rational connection, necessary means, and a proper relationship between the benefit obtained from accomplishing the proper purpose and the harm caused to the statutory right—the final component is also referred to as “proportionality stricto sensu” (balancing). These four components constitute the restriction clause’s nucleus. They are critical for comprehending proportionality. In this piece we shall discuss how Justice A K Sikri’s judgement in A. Ayyasamy v. A Paramasivam & Ors [‘A. Ayyasamy’]—delivered in 2016—had laid down the foundation of using proportionality as a tool of interpretation on the question(s) of arbitrability.

In A. Ayyasamy the Supreme Court had clarified and partially overruled its earlier decision in N. Radhakrishnan v. Maestro Engineers. Justice Sikri speaking for the bench had conceptualized a dual criterion for determining the arbitrability of fraud, categorizing charges of fraud into simple and sophisticated frauds. Thus, it was held that that simple fraud occurred when allegations of fraud concerned only the parties’ internal affairs and had no spillover effect on the public domain, whereas complex fraud occurred when allegations of fraud concerned the heart of the agreement or the validity of the arbitration clause/agreement itself. The Court further observed that mere charges of fraud simpliciter would not undermine the effect of the parties’ arbitration agreement, and the parties can be referred to arbitration. However, where severe claims of fraud are made, they are to be treated as non-arbitrable and should be decided exclusively by a civil court.

While concurring with Justice A K Sikri’s conclusion, Dr Justice D Y Chandrachud discussed how the parties in the instant case, relying on the judgement in N. Radhakrishnan, attempted to avoid arbitration by creating a false claim of fraud. Additionally, Justice Chandrachud cited that the doctrine of severability of the arbitration clause from the main contract is a critical factor that lends credence to the view that the arbitrator’s adjudicatory power remained unaffected when determining whether the main contract was influenced or fraudulently obtained. He continued by stating that the burden of establishing that the issues were not amenable to arbitration would be on the party seeking to avoid it.

It is submitted that the analysis in A. Ayyasamy sets the background for applying the necessity test (Erforderlichkeit) of proportionality in such cases. It is also referred to as the requirement of “the less restrictive means.” According to this test, the adjudicator has to choose – of all those means that may advance the purpose of the limiting law – that which would least limit the legal right(s) in question. This proportionality test is predicated on the premise that the use of the law’s means – or the requirement to use such means – is required only when the purpose cannot be accomplished through the use of alternative (hypothetical) legislative means that satisfy the rational connection test and have a lower level of restriction on the right in question.

Here a principle was established that should assist the court when a defense of fraud is raised to oppose arbitration: it is always preferable for parties to expressly state that disputes regarding the contract’s validity will not be adjudicated by arbitration, and in the absence of such a statement, the parties’ intent to refer disputes to arbitration should be respected. The requirement for the means prescribed by contract’s validity derives from the fact that no other hypothetical option exists that would be less detrimental to the asserted right while serving the law’s objective equally well.

The Supreme Court’s division bench judgement in A. Ayyasamy was subsequently affirmed by a larger bench of three Supreme Court judges in Rashid Raza v. Sadaf Akhtar [‘Rashid Raza’] in 2019. In Rashid Raza, while hearing an appeal from a Jharkhand High Court ruling dismissing the petitioner/ appellant’s Section 11 petition due to perceived charges of significant fraud, the court applied the reasoning of A. Ayyasamy and formulated a two-part working test: first, whether the plea of fraud pervades the entire contract as well as the arbitration agreement, rendering it void; and second, whether the fraud claims apply solely to the part of the contract subject to arbitration.

Although the Rashid Raza decision was a step in the right way, the quandary surrounding the arbitrability of fraud persisted and was revisited by the Supreme Court in Avitel Post Studioz Limited v. HSBC PI Holdings [‘Avitel’]. Accusations of fraud were made in this instance during criminal procedures including serious charges such as forgery and impersonation. After applying the tests established in Ayyasamy and Rashid Raza, the Court established the Public Flavor Test, concluding that “serious allegations of fraud” justifying the exclusion of arbitration could arise only if two conditions were met: first, the arbitration clause/agreement itself was non-existent. And secondly, when claims of arbitrary, fraudulent, or mala fide behavior are made against the state or its instrumentalities, necessitating the writ court’s consideration of the matter. Additionally, the Court determined that misrepresentation, diversion of funds, and impersonation are all private problems with no public dimension.

Vidya Drolia v. Durga Trading Corporation [Vidya Drolia] is the most recent case in the saga of the emergence of arbitrability of frauds in India. While concurring with its earlier judgements in A. Ayyasamy, Rashid Raza, and Avitel, the Supreme Court expressly disregarded the dicta in N Radhakrishnan and affirmed Justice Sikri’s position in A. Ayyasamy that claims of fraud are arbitrable if they arise out of a civil dispute. Additionally, the Court decided that disputes involving fraud may be arbitrated, provided the fraud does not “vitiate and invalidate the arbitration provision” or create issues affecting real property rights, necessitating adjudication in the public arena.

Going back to the necessity test of proportionality, it is submitted that the same is predicated on the premise that the law’s objective is a proper one.  Thus, in examining the requirements of need, no room is left for an analysis of the purpose of law’s validity. Similarly, there is no room to question the wisdom behind establishing that purpose, or the very need to establish it. The premise which was set by Justice Sikri in A. Ayyasamy has reached to its conclusion in Vidya Drolia. At the moment, the settled legal position in India regarding the arbitrability of fraud is that claims of fraud that pervade the entire contract and affect not just the parties’ internal affairs but also their real property rights are non-arbitrable.

The conclusion of the Supreme Court in A. Ayyasamy, that a simple charge of fraud simplicitor would not be sufficient to negate the impact of the parties’ arbitration agreement sets the premise for the test of proportionality to be applicable in commercial disputes as well. Proportionality asks whether the decision, rule or policy limits the relevant right in the least intrusive way compatible with achieving the given level of realisation of the legitimate aim. This implies a comparison with alternative hypothetical acts (decisions, rules, policies, etc.) which may achieve the same aim to the same degree but with less cost to the legal rights. As Nicholas Emiliou suggested, the judicial standard against which a public measure is tested, should be whether it could be substituted by another means which is ‘milder’ but ‘equally effective’ in achieving the ends pursued. ‘Milder’ is the measure which causes the least possible adverse repercussions on the legal status of the party concerned. A measure can be considered as ‘equally effective’ when it is suitable to achieve actually and with, at least, equal intensity the desired end.

Vidya Drolia v. Durga Trading Corporation [Vidya Drolia] is the most recent case in the saga of the emergence of arbitrability of frauds in India. While concurring with its earlier judgements in A. Ayyasamy, Rashid Raza, and Avitel, the Supreme Court expressly disregarded the dicta in N Radhakrishnan and affirmed Justice Sikri’s position in A. Ayyasamy that claims of fraud are arbitrable if they arise out of a civil dispute. Additionally, the Court decided that disputes involving fraud may be arbitrated, provided the fraud does not “vitiate and invalidate the arbitration provision” or create issues affecting real property rights, necessitating adjudication in the public arena.

The post A sentinel’s toil in arbitrability of fraud: The A. Ayyasamy judgement appeared first on The Daily Guardian.