Determining ‘complex fraud’ and arbitrability of disputes

After the implementation of Act of 1996, the issue regarding arbitrability of disputes where allegations of fraud were raised, came up for consideration before the Supreme Court in N. Radhakrishnan v. Maestro Engineers (N. Radhakrishnan case) where, it relied heavily on Abdul Kadir’s case (which based its decision on Old Arbitration Act) and held that wherever serious allegations of fraud are raised in a case in which there is an arbitration agreement, it should be tried in a court of law. 

‘Fraud’ is a misrepresentation of the truth or concealment of a material fact to induce another to act to his detriment. Its ingredients are an intention to deceive, use of unfair means, deliberate concealment of material facts, or abuse of position of confidence. 

THERE has been a lot of debate on the issue whether in those cases where fraud has been alleged, disputes can be referred for arbitration when arbitration agreement exists between the parties. The question ultimately arise for consideration is whether the Court or the Arbitral Tribunal has the jurisdiction to decide such issues. The said issue, for the first time, had arisen before the Supreme Court in Abdul Kadir Shamsuddin Bubere v. Madhav Prabhakar Oak1 (“Abdul Kadir’s case”) where, certain disputes arose out of a partnership agreement entered into between the parties for cutting of forest. These disputes related to not maintaining proper books of account, inflating the stock of goods in statement of accounts etc. The courts below rejected the application filed under Section 20 of the Arbitration Act, 1940 (“Old Arbitration Act”) seeking reference to arbitration inter alia on the ground that serious allegations of fraud have been made. However, while allowing the appeal and considering that dispute is inter se between parties, the Supreme Court specifically observed 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. Therefore, looking to the allegations which have been made in the case, the Court held that there are no such serious allegations of fraud as would be sufficient for the court to say that there is sufficient cause for not referring dispute to arbitration. 

While referring the matter to arbitration, it also observed that in cases, where serious allegations of fraud are made against a party and the party charged with fraud desires that the matter should be tried in open court, that would be sufficient cause for the court not to make reference to arbitration. ‘Fraud’ is a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his detriment. Its ingredients are an intention to deceive, use of unfair means, deliberate concealment of material facts, or abuse of position of confidence. Section 10 of the Indian Contract Act, 1872 (“Contract Act”) states that all agreements are contracts if they are made with 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 further 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.

 In Fazal D. Allana v. Mangaldas M. Pakvasa3, the Bombay High Court held that Section 17 only applies if the contract itself is obtained by fraud or cheating. A distinction was made between (i) a contract being obtained by fraud and; (ii) performance of contract being vitiated by fraud or cheating. The latter would fall outside Section 17 as in such case the remedy for damages would be available, but not the remedy for treating the contract itself as being void. Hence, Section 17 itself talks about two things:

 Where a party was induced to enter into a contract by fraud or cheating, and; 

Where performance of contract is vitiated by fraud or cheating for which remedy for damages are available in law. 

With respect to Sr. No. (a) above, a dispute can either be inter-se between the parties which does not affect the public at large or, it can be a dispute where relief is being claimed against public at large. In the former case, the right exercised by a party is a right in personam. Whereas, in the latter case, the right being exercised by a party is a right in rem. Undisputedly, the judgment in Abdul Kadir’s case was delivered when the Old Arbitration Act was in force and under Section 20, court had wide discretion to not refer a matter for arbitration if “sufficient cause” was shown. However, the implementation of the Arbitration and Conciliation Act, 1996 (“Act of 1996”) completely overhauled the Old Arbitration Act. The Act of 1996 – (a) under Section 5, restricts the intervention of court in arbitration matters; (b) under Section 8, makes it mandatory for a court to refer the matter to arbitration where there exists an arbitration agreement between the parties, and; (c) under Section 16, incorporates the principle of ‘kompetenz-kompetenz’ thereby giving Arbitral Tribunal the right to rule on its own jurisdiction. 

Keeping in mind these changes brought-in with the implementation of the Act of 1996, the question which now arise for consideration is whether the judgment rendered in Abdul Kadir’s case still holds the field. In terms of Section 8 of the Act of 1996, no discretion lies with the court to not refer a matter for arbitration when arbitration agreement exists between the parties4. After the implementation of Act of 1996, the issue regarding arbitrability of disputes where allegations of fraud were raised, came up for consideration before the Supreme Court in N. Radhakrishnan v. Maestro Engineers5 (“N. Radhakrishnan case”) where, it relied heavily on Abdul Kadir’s case (which based its decision on Old Arbitration Act) and held that wherever serious allegations of fraud are raised in a case in which there is an arbitration agreement, it should be tried in a court of law. However, it did not consider Sections 5, 8 and 16 of the Act of 1996 and also, completely failed to consider that in Abdul Kadir’s case, it was specifically held that serious allegations of fraud are not made out when allegations of moral or other wrongdoing inter parties are made. 

Therefore, it is clear that till 2010 that is, when judgment in N. Radhakrishnan’s case was delivered, there was no criteria/test to determine in which cases, disputes can / cannot be referred to arbitration when allegations of fraud were raised. It was entirely left to the discretion of courts. It was in Afcons Infrastructure Ltd. v. Cherian Varkey Constructions Co (P) Ltd.6 and Booz Allen Hamilton Inc. v. SBI Home Finance Ltd.7 that the Supreme Court categorized what kind of disputes can / cannot be referred to arbitration even if arbitration agreement exists between the parties. While doing so, it also carved out a non-exhaustive list of disputes which are incapable of being subject to private arbitration. It observed that if the dispute is capable of adjudication only by a public forum or the relief claimed can only be granted by a special court or Tribunal, then even if arbitration agreement exists, the dispute cannot be referred to arbitration. Further, cases inter alia involving serious and specific allegations of fraud, fabrication of documents, forgery, impersonation, coercion etc and cases involving prosecution for criminal offences are not suitable for arbitration.

 Subsequently, in Swiss Timing Ltd. v. Commonwealth Games 2010 Organising Committee8 (“Swiss Timing’s case”), the Supreme Court was again vexed with similar issue regarding arbitrability of disputes where allegations of fraud were made. It is a judgment in context of Section 11 of the Act of 1996 and by a Single Judge where, the Supreme Court had the occasion to deal with N. Radhakrishnan’s case as well. The court did not accept the law as laid down in N. Radhakrishnan’s case since applicability of Section 8 of the Act of 1996 was not considered and decision was based on the law as laid down in Abdul Kadir case, which in turn, had relied upon Section 20 of the Old Arbitration Act. In Swiss Timing’s case, the court held that when a judicial authority is shown an arbitration clause in an agreement, it is mandatory for the authority to refer parties to arbitration and it was for the Arbitral Tribunal to decide whether there is any substance in plea of fraud raised by the Respondent.

 Thereafter, it was in A. Ayyasamy v. A Paramasivam9 (“Ayyasamy’s case”) that the Supreme Court settled the law as to in which cases, where allegations of fraud have been raised, matter can / cannot be referred to arbitration under Section 8 of the Act of 1996 even if arbitration agreement exists between the parties. The issue before the Court was where there are serious allegations of fraud against a party, is it still mandatory for the Court to refer the matter to arbitration? While dealing with the said issue, the court classified ‘allegations of fraud’ into two categories:

 Allegations of serious fraud – Cases where there are serious allegations of fraud which make a virtual case of criminal offence or where allegations of fraud are so complicated that voluminous evidence needs to be produced, for instance, in cases of forgery/ fabrication of documents, where fraud goes to the validity of contract itself which contains an arbitration clause, they are to be treated as non-arbitrable and it is only the civil court which should decide such matters and; 

Allegations of fraud simpliciter – Cases where there are allegations of fraud simpliciter and such allegations are merely alleged, for instance, allegations which touch upon internal affairs of the party inter se and has no implication in the public domain and it will not nullify the effect of arbitration agreement, such issues can be decided by Arbitral Tribunal and held that while considering an application under Section 8, courts should siftly go through the materials for the purpose of determining whether nature of dispute is such that it cannot be referred to arbitration or, that 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.

 It also impliedly over-ruled the judgment in N. Radhakrishnan’s case as it has been utilized by parties to avoid arbitration. The judgment in Ayyasamy’s case was then applied in Rashid Raza v. Sadaf Akhtar10 (“Rashid Raza’s case”) where the dispute arose out of partnership deed and related to siphoning of funds. 

The Supreme Court, with great clarity, explained the judgment in Ayyasamy’s case, which in turn had explained N. Radhakrishnan’s case, as referring only to such serious allegations of fraud as would vitiate the arbitration clause along with the agreement, and allegations of fraud which are not merely inter parties, but affect the public at large. In Rashid Raza’s case, it laid down two working tests to ascertain whether dispute can be referred to arbitration or not when allegations of fraud are raised:

 Does the plea permeate the entire contract and above all, the agreement of arbitration, rendering it void; or

 Whether the allegations of fraud touch upon the internal affairs of the parties inter se having no implication in the public domain.

 These complex working tests were further clarified by the Supreme Court in Avitel Post Studioz Limited & Ors v. HSBC PI Holdings (Mauritius) Limited11 (“Avitel’s case”) where, after considering the above precedents, it laid down two tests to satisfy that there exists ‘serious allegations of fraud’:

 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. 

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 domain.

 Thus, the expression ‘serious allegation of fraud’ as used in the judgments delivered prior to Ayyasamy’s case and Rashid Raza’s case are to be understood by applying the above two tests and merely because civil and criminal proceedings are pending or have been filed on same set of facts, cannot lead to a conclusion that a dispute which is otherwise arbitrable, ceases to be so.

 Therefore, the above decisions now amply clarify the position that in those cases, where allegations of fraud have been made and arbitration agreement exists between the parties, the concerned authority – be it the court or Arbitral Tribunal, has to go through the materials placed on record and exercise its discretion keeping in mind the above two working tests laid down to come to a conclusion whether dispute is arbitrable or not. 

Heavy burden lies on the party who opposes reference to arbitration. Thus, the Supreme Court has narrowed down the criteria for deciding whether case involves ‘serious allegations of fraud’ or such allegations are being made just to avoid arbitration. These judgments repose immense faith in the Arbitral Tribunal and, is also, in tune with the vision of the Parliament to make India a global hub of arbitration & India’s approach to revamp the ADR process.