Arbitrability of fraud in India: One door closes another window opens!

December 2020

1. Introduction

The term “arbitrability” refers to whether a dispute or classes of disputes are capable of being settled through arbitration. The Arbitration and Conciliation Act, 1996 (the “Act”) omits to define the contours of arbitrability; a position that has not changed even after the amendments over the years. As a result, the onus to decide the arbitrability of several types of disputes fell into the hands of the judiciary and the legal position seems to have been nebulous. Disputes involving fraud have been the subject of nuanced discussion and conflicting decisions by the judiciary. Despite the attempt made by the Supreme Court (“SC”) in various cases to offer clarity, ambiguity has persisted and parties have continually resorted to citing fraud, collusion, or malpractice in a bid to avoid arbitration. However recent developments demonstrate that India is perhaps closer to achieving a solution that would settle the debate.

This newsletter seeks to analyze the jurisprudence surrounding the arbitrability of fraud in India, evaluates how SC has now taken a pro-arbitration approach on this issue, and examines the recent Arbitration and Conciliation (Amendment) Ordinance, 2020 (the “Ordinance”) and its possible impact.

2. Overview of Evolving Jurisprudence

The first landmark decision on arbitrability of fraud was delivered by a three-judge bench of the SC in Abdul Kadir v. Madhav Prabhakar Oak (“Abdul Kadir”).[1] In this case, the SC introduced a threshold test for fraud. It was held that a dispute containing “serious allegations of fraud” cannot be decided by an arbitral tribunal since fraud involves complicated factual questions that are better decided by a civil court. This judgment is the bedrock for subsequent decisions in which the SC sought to assess the seriousness of fraud. The position remained the same when a two-judge bench of the SC in N. Radhakrishnan v. Maestro Engineers (“Radhakrishnan”)[2] upheld Abdul Kadir’s decision, which was under the 1996 Act and it was a setback to arbitrations in India. In this case, the SC declined to refer the parties to arbitration despite the clear and unequivocal language of section 8[3] as it felt that serious allegations of fraud were at play. This displayed an unwillingness on part of the SC to follow the legislative mandate and showed a lack of confidence in the tribunal’s ability to adjudicate such disputes.

However, a single-judge bench of SC in Swiss Timing Limited v. Organising Committee Commonwealth Games[4] (“Swiss Timing”) rejected this decision and held that (a) the Radhakrishnan bench completely ignored the settled law which mandates a civil court to refer disputes to arbitration if an arbitration agreement exists between the parties; (b) an arbitral tribunal is competent to rule on its own jurisdiction including any objection on the existence or validity of the arbitration agreement; and (c)  an arbitration clause in a contract is separable from other terms, and a decision by a tribunal that the contract is null and/or void would not render the arbitration clause automatically invalid. However, since this judgment was delivered by a single-judge, its importance was nullified to an extent as a two-judge bench had held otherwise.

Thereafter a two-judge bench of the SC in A. Ayyasamy v. Paramasivam and Ors. (“Ayyasamy”)[5] re-visited the issue of arbitrability of fraud. It not only upheld Swiss Timing but also enhanced the threshold of “seriousness.” The court held that a distinction has to be made between simple and complex allegations of fraud. According to the SC, disputes that involve simple fraud i.e. which touched upon the internal affairs of the parties would be arbitrable, whereas complex fraud disputes were non-arbitrable. The SC also laid down a three-fold test for complex fraud viz., (i) if there is a requirement of reviewing voluminous evidence, or (ii) the allegations of fraud are such that they permeate the entire contract including the arbitral clause, or (iii) if allegations of arbitrary, fraudulent or mala fide conduct are made against the state or its instrumentalities that affects the public at large. While Ayyasamy judgment could not overrule Radhakrishnan decision since both benches were of the same strength; however, the former was affirmed in 2019 by a three-judge bench in Rashid Raza v Sadaf Akhtar[6] where the SC again had to decide whether allegations of fraud between two partners in a partnership deed could be decided by an arbitral tribunal. The SC followed Ayyasamy’s decision and held that the allegations of fraud between the partners fell on the side of “simple allegations” and thus were arbitrable.

While Ayyasamy tried to resolve the ambiguity by creating two classes of fraud; however it created some grave issues. Firstly, while laying down the test for serious fraud it failed to address what constituted “serious allegations of fraud” which opened the doors to inconsistent interpretation. Secondly, in order to determine the seriousness of the fraud, Ayyasamy gave assent to the courts to conduct a strict and meticulous inquiry into the allegations of fraud. This meant a potential increase in judicial intervention thereby resulting in delays that goes against the ethos and swiftness of arbitration. 

3. Avitel: New Beginnings

In Avitel Post Studios Limited v HSBC Pi Holding (Mauritius) (“Avitel”)[7] the SC again assessed the question of seriousness of fraud. In this case, Avitel and its promoters represented to HSBC that they are in the advanced stage of finalizing a lucrative contract with BBC that is expected to generate revenues of upto USD 1.3 billion. A meeting was held between the parties where Avitel introduced BBC’s Chief Technical Officer or CTO to HSBC. After this meeting, HSBC executed a shareholders agreement and invested USD 60 million in Avitel’s equity capital. The shareholders agreement provided for arbitration in Singapore, conducted by Singapore International Arbitration Centre (“SIAC”). Subsequently, HSBC discovered that there was no contract between BBC and Avitel, the CTO was an imposter, and the money invested was siphoned off to Avitel’s promoter’s companies. HSBC invoked the arbitration clause alleging fraud by Avitel. The arbitrator passed an award in favour of HSBC and directed Avitel to refrain from diminishing the value of their assets up to USD 50 million. Since foreign awards are not enforceable in India unless an application is filed in the Indian courts, HSBC approached Bombay high court, seeking an order compelling Avitel to deposit a security of USD 60 million. Separately, HSBC filed a criminal complaint against Avitel alleging cheating and criminal conspiracy under the India Penal Code.  The single judge of the Bombay high court froze Avitel’s bank account and directed it to maintain a security deposit of USD 60 million. On appeal by Avitel, a two-judge bench of the high court maintained this position and held that allegations of fraud in the case were arbitrable. But, it reduced the total deposit to be maintained in the frozen account to USD 30 million. However, Avitel appealed and the matter went to the SC.

The SC held that although fraud ought to be decided in an open court; however, every allegation of fraud cannot oust the jurisdiction of the arbitrator. While discussing the “serious allegations of fraud,” the SC laid down the following two substantially narrower tests. (i) Does fraud permeate the entire contract including the arbitration agreement and renders it void. (ii) Whether there are allegations against the State or its instrumentalities, relating to arbitrary, fraudulent, or mala fide conduct giving rise to the question of public law as opposed to contractual questions between the parties.

The SC stated that the first test involves those cases where allegations of fraud relate to the arbitral clause and are of such nature that, if proved, would result in the arbitral clause being vitiated. The court further stated that an arbitral clause is separable from the other terms in the contract and a finding that the contract was induced by fraud will not impact the validity of the arbitral clause. The second test involves those cases where the facts have a direct implication on matters concerning public law and are required to be settled in a judicial court. The SC clarified that allegations of impersonation, false representations, and diversion of funds are all internal affairs of the parties having a civil character and should not be construed as “serious allegations of fraud.” Applying the aforesaid test, the SC found that the dispute was civil in nature and capable of being adjudicated by the arbitral tribunal. Further, the fact that HSBC initiated separate criminal proceeding is of no consequence on the arbitrability of such disputes. The SC held that the full claim amount of USD 60 million be kept aside for enforcement of the award in India.

These two tests are of huge significance as the SC took a positive step towards synergising the law and created a uniform standard. The first test recognised the independence of the arbitral clause and minimised the scope for judicial interference since the arbitral clause is rarely invalid due to fraud. Further, there is clarity that fraud under civil law, bereft of public ramifications would be arbitrable; and, the fact that parallel criminal proceedings have been initiated does not mean the matter is no longer arbitrable.

4. The Ordinance: One step forward two steps back?  

While Avitel is a progressive development; however, the recent Ordinance seems to take this progress two steps back. It inserts a second proviso to section 36(3) of the Act and allows a party to get an unconditional injunction or stay on the enforcement of the arbitral award, pending disposal of its challenge, if the court is prima-facie satisfied that the arbitration clause or the contract, which is the basis of the award, was induced or affected by fraud or corruption.

This is problematic for several reasons. Firstly, it seems redundant since an aggrieved party could challenge the award on grounds of violation of public policy[8] under section 34, and the court too, for reasons as it deems fit, could grant a stay on its enforcement under section 36(3). Moreover, it is not the arbitration clause, rather, the arbitral award that should be made with fraud to avail the ground of public policy under the Act. Therefore, arguably, if a ground is not available to a party for setting aside an award, how it can be used to seek a stay on its enforcement? Further, pursuant to Avitel it is within the arbitral tribunal’s jurisdiction to decide issues of fraud but the Ordinance gives another opportunity at the enforcement stage to unscrupulous litigants to escape their obligations and stall enforcement.

Secondly, the use of the word prima facie also casts doubts about the scope of inquiry the court may undertake while granting an unconditional stay. It is unclear whether a mere assertion of fraud or corruption is enough or whether ample evidence will need to be given to secure an unconditional stay. In any case, such allegations would already have been dealt with in detail by the arbitral tribunal. Therefore, to second-guess its reasoning and re-appreciate the evidence would be contrary to the fundamental objective of arbitration as a swift alternative dispute resolution mechanism.

5. Conclusion

The decision of the SC in Avitel brings clarity to decades of ambiguity around “serious allegations of fraud.” The judgment dilutes the scope of “seriousness” and provides that as long as the arbitration clause exists, allegations of fraud would not render the disputes to be non-arbitrable. In rare situations where the allegations are directed towards the arbitration clause rendering it void, the arbitral tribunal would be devoid of its power to decide the dispute. Furthermore, allegations of fraud that have an implication in the public domain would qualify the test of “seriousness” and attract the fraud exception to arbitration but those that relate to internal affairs of the parties will be arbitrable, howsoever serious they may seem. Practically, this judgment limits the extent to which an award can be challenged on the basis of arbitrability and public policy. 

However, the recent Ordinance, may create hurdles when it comes to enforcement of arbitral awards. In case of a challenge, it is possible the SC may intervene just as they have been doing and strike down this provision in order to uphold the principle of minimal intervention. If that is so, then while a door may have closed, but, perhaps, another route may be available through an open window in the future!

Author

Rishi Sehgal

[1] AIR 1962 SC 406

[2] (2010) 1 SCC 72

[3] Section 8 provides that when an action is brought before a judicial authority, which is subject matter of an arbitration agreement between the parties, it shall direct the parties to go for arbitration

[4] (2014) 6 SCC 677

[5] A. Ayyasamy v. Paramasivam and Ors., (2016) 10 SCC 386

[6] Rashid Raza v. Sadaf Akhtar (2019) 8 SCC 710

[7] Avitel Post Studios Limited v. HSBC Pi Holding (Mauritius), MANU/SC/0601/2020

[8] An award is said in conflict with the public policy of India if (i) the making of the award was induced by fraud or corruption or (ii) it is in contravention with the fundamental policy of Indian law or (iii) it is in conflict with the most basic notions of morality or justice