CAN ARBITRATION BE INVOKED IN CASE OF FRAUD IN THE PRESENCE OF AN ARBITRATION CLAUSE?

Arbitrability of fraud has been perceived as one of the contentious issues in the arbitration. It involves the question of the category of issues that can and cannot be submitted to arbitration.

In the year 1960, the Supreme Court, in the famous case of Abdul Kadir Shamsuddin Bubere v. Madhav Prabhakar Oak expressed that the serious allegations of fraud are sufficient ground for not making a reference to arbitration. In this case, the Apex Court referred to the case of Russell v. Russell wherein the Court had held that “in case where fraud is charged, the Court will directly refuse the dispute to arbitration but in case the objection to arbitration is there by a party charging the fraud, the Court will not accede it until and unless a prima facie case of fraud is proved”.

In the year 2016, the case of A. Ayyasamy v. Paramasivam & Ors cleared the air about the same. In this case, an arbitration clause was explicitly mentioned in the partnership deed which imposed an obligation on the parties to solve the dispute only through arbitration. The partnership deed had been made for running a hotel. The Defendant filed a civil suit contending that as partners, they are under an obligation to participate in the administration of the hotel and that the Appellant had failed to do the needful. The Appellant, after receiving the summon, objected and made an application under the Arbitration and Conciliation Act raising the objection that the suit is not maintainable as the agreement between the two parties contained an arbitration clause which states any dispute that arises between them has to be solved only through arbitration and it is incumbent upon the Court to refer the said matter to arbitration. To this, the Respondent referred to the case of N. Radhakrishnan v. Maestro Engineers wherein the Apex Court of India had expressed that “where fraud and serious malpractices are alleged, the matter can only be settled by the Court and such a case cannot be referred to an arbitrator as the arbitrator, being a creature of contract, has limited jurisdiction”. It was held that the Courts are more equipped to adjudicate serious and complex allegations, and are competent in offering a wider range of relief to the parties in dispute. On the other hand, the Appellant expressed that the case of N. Radhakrishnan was found to be per incuriam by the Apex Court of India in a subsequent case of Swiss Timing ltd. v. Commonwealth Games 2010 Organizing Committee wherein the Court vehemently expressed that under Section 11 of the Arbitration and Conciliation Act, 1996, fraud can be adequately dealt by the arbitrator. It was further stated that the allegations of fraud were not a bar to refer the matter to arbitration, and that the only bar to refer parties to arbitration are those which are specified in Section 45 of Arbitration and Conciliation Act, 1996. So, in the case of A. Ayyasamy v. Paramasivam & Ors, it has been stated that:

1. Allegations of fraud are arbitrable unless they are serious and complex in nature

2. Unless fraud is alleged against the arbitration agreement, there is no impediment in arbitrability of fraud

3. The decision in the Swiss Timing case did not overrule the judgment of N. Radhakrishnan case. The judgment only differentiates between ‘simplicitor fraud’ and ‘serious fraud’, and concludes while ‘serious fraud’ is best left to be determined by the Court, ‘simplicitor fraud’ can be decided by the arbitral tribunal.

While the High Court of Madras upheld the decision passed by the trial Court in the case of A. Ayyasamy vs Paramasivam & Anr, the SC later reversed the judgment of the HC of Madras stating that the arbitration clause cannot be ignored by the Court. The Court vehemently expressed that “mere allegation of fraud is not sufficient to detract partied from the obligation to submit their disputes to arbitration”. It said that “mere allegations of fraud” are arbitrable whereas “serious allegations of fraud” are not.

The Ayyasamy vs Paramasivam & Anr case was affirmed in the subsequent case of Rashid Raza v. Sadaf Akhtar. In this case, the Supreme Court of India applied the principles from Ayyasamy and laid down a two-pronged test. One, it had to be determined whether the allegations of fraud permeated the entire contract, and especially the arbitration agreement, thereby rendering it void. Next it had to be determined whether the allegations pertained to the internal affairs of the parties inter se or whether they had an implication on the public domain. Since Rashid Raza pertained to a partnership dispute and the siphoning of funds, and there was no allegation which would have vitiated the entire partnership agreement, or more specifically, the arbitration clause, the Court referred the matter to anarbitrator.

The last such decision was in the case of Avitel. Herein, the Supreme Court interpreted the tests laid down in the cases post Ayyaswamy. It held that the first test is satisfied only when it is clear that the party against whom the breach has been alleged, could not have entered into the arbitration agreement in the first place, and thus, no arbitration agreement or clause can be said to exist. The second test is satisfied when allegations of “arbitrary, fraudulent, or malafide conduct” are made against either the State or its instrumentalities and thus, require to be heard by a court exercising writ jurisdiction, as the matters lie in the public domain.

The jurisprudence on the arbitrability of disputes at the reference stage has been settled for the time being. The Court in Vidya Droliav. Durga Trading Corp. considered the amended Sections 8 and 11, which prescribes only prima facie review by the Court at the reference stage and subject to adjudication by the Court only when the agreement is null and void and not capable of adjudication by the tribunal. It also limits the Court’s interference to situation when the agreement is incapable of being adjudicated upon. It can be inferred that after the 2015 Amendment, the Legislature aimed at preventing bootstrapping by equipping the arbitral tribunal to decide issues of arbitrability instead of the judicial authorities at the reference stage.

Further, in the case of Booz Allen and Hamilton Inc. v. SBI Home Finance Limited and Ors, it was stated by the Court that the cases where the subject matter falls exclusively within the domain of public for a(right in rem), such disputes cannot be decided by the Arbitral Tribunal but by the Courts only and the disputes where the subject falls under the private for a (right in personam) are arbitrable. However, this is not a rigid or inflexible rule. In this case, the Court had laid down six non-arbitrable categories set out which was relating to trusts, trustees and beneficiaries arising out of trust deed and the Trust Act. The Court, then added the seventh category to the six non-arbitrable categories in the case of Vimal Kishore Shah v. Jayesh Dinesh Shah.

According to the basic principle and the object behind Arbitration and Conciliation Act, 1996, arbitration is essentially a voluntary assumption of an obligation by contracting parties to resolve their disputes through a private tribunal. Therefore, it is the duty of the Court to refer the parties to arbitration so that the purpose and object of Arbitration and Conciliation Act, 1996 could not be destroyed. Further, this principle should guide the approach when a defense of fraud is raised before a judicial authority to oppose a reference to arbitration. The arbitration agreement between the parties stands distinct from the contract in which it is contained, as a matter of law and consequence. Even the invalidity of the main agreement does not ipso jure result in the invalidity of the arbitration agreement. Parties having agreed to refer disputes to arbitration, the plain meaning and effect of Section 8 must ensue.

Considering the abovementioned judgements, we can conclude with the fact that wherever such disputes are there consisting of the both nature civil as well as criminal and where the dispute is a subject matter to Arbitration due to presence of a valid arbitration clause in the partnership deed, the Courts can only entertain, if the nature of the matter is grave and evidence are required to prove the dispute and taken on record.

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