In the past few months, we have witnessed some critical developments in the legal position on 'arbitrability of fraud', both on the legislative and the judicial front. The present article attempts to briefly examine these developments in the backdrop of earlier judicial pronouncements on this subject and comment on whether they would reinforce a pro-arbitration approach and encourage arbitration in India as a mode of dispute resolution.
A. The Radhakrishnan case – the decision that stands overruled.
In N. Radhakrishnan v. Maestro Engineers1, the respondents instituted a suit before the civil court for declaratory and injunctive reliefs. The appellants in turn moved an application under Section 8 of the Arbitration and Conciliation Act, 1996 (Arbitration Act) raising a plea to refer the parties to arbitration. The trial court rejected the appellant's application filed under Section 8 of the Arbitration Act, and the High Court further affirmed this order of rejection in a revision petition preferred by the appellant. The respondents objected to the appellant's plea for reference to arbitration on the ground that the appellant raised issues of serious fraud and malpractices that only a civil court could resolve. A two-Judge bench of the Hon'ble Supreme Court while reaffirming the High Court decision held that the matters involving allegations of fraud and serious malpractices cannot be referred to arbitration.
The decision in N. Radhakrishnan was reiterated on several occasions. However, the single Judge of the Hon'ble Supreme Court in the case of Swiss Timing Ltd. v. Commonwealth Games 2010 Organising Committee2 pointed out that the decision in N. Radhakrishnan ran counter to the law laid down in the case of Hindustan Petroleum Corporation Ltd. v. Pinkcity Midway Petroleums.3 In Hindustan Petroleum, the Apex Court held that where disputes were subject to an arbitration agreement, it was mandatory for a civil court to refer the parties at dispute to arbitration. The single Judge in Swiss Timing held that the observations in Hindustan Petroleum laid the correct law and further opined that the judgment in N. Radhakrishnan was bad in law for two reasons. Firstly, the judgment in Hindustan Petroleum was neither followed nor distinguished by the bench in N. Radhakrishnan. Secondly, the provision contained under Section 16 of the Arbitration Act on the competence of an arbitral tribunal to rule over its jurisdiction was not taken into consideration by the bench in N. Radhakrishnan. Therefore, the single Judge in Swiss Timing concluded that N. Radhakrishnan judgment did not set out the correct position of law and could not be relied upon.
The Hon'ble Supreme Court's division bench in A. Ayyasamy v. A. Paramasivam and Ors.4 held that once there was an arbitration agreement amongst the parties, the court had no discretion to deviate from compelling the parties to proceed for arbitration. As far as the correctness of the decision in N. Radhakrishnan is concerned, it was held in A. Ayyasamy that the judgment in N. Radhakrishnan did not necessarily subscribe to the broad proposition that a mere allegation of fraud was enough to not refer parties to arbitration. To allow such a plea would be a misreading of the decision in N. Radhakrishnan, given the fact that more often than not, parties lay allegations of fraud to derail the matter from being arbitrated upon. Therefore, the bench in A. Ayyasamy held that the burden lied heavily upon the party trying to avoid the arbitral proceedings to show that the dispute was not arbitrable. It was only in case of a serious issue of fraud involving criminal wrongdoing that the exception to arbitrability carved out in N. Radhakrishnan would come into existence. Thus, the impact of N. Radhakrishnan was reduced to some extent in A. Ayyasamy by way of a narrow interpretation.
B. The Avitel Post Studioz case
The Avitel Post Studioz Limited and Ors. v. HSBC PI Holdings (Mauritius) Limited and Ors.5 case was the first decision that set straight the conundrum around the law on the arbitrability of fraud. The case involved two agreements through which the respondent had agreed to invest in the appellants' corporation based on their representations. Disputes emerged amongst the parties as the first respondent, HSBC, alleged that the appellants fraudulently induced them to invest the monies in the appellants' corporation. The Hon'ble Supreme Court noted that the decision in this case would depend upon the substantive law in India regarding arbitrability of fraud. While discussing the position of law in length, the Hon'ble Apex Court referred to its Single Judge judgement in Swiss Timing to observe that while the judgment was not a binding precedent, it still had a strong persuasive value.
The reasoning in Swiss Timing and the decision in A. Ayyasamy was adopted by the Hon'ble Supreme Court to reiterate that only cases with very serious fraud allegations that virtually made a criminal offence were to be treated as non-arbitrable and the court would decide such matters. However, where there were mere allegations of fraud simpliciter, the Hon'ble Supreme Court held that it might not be necessary to nullify the arbitration agreement as the arbitral tribunal could determine such issues. Consequently, the Hon'ble Supreme Court further concluded that the N. Radhakrishnan judgment was bad in law and would not continue to have precedential value.
The following two tests were emphasised by the Apex Court to determine what constitutes "serious allegation of fraud":
- Whether the plea permeates the entire contract and above all, the agreement of arbitration, rendering it void?; or alternatively
- Whether the allegations of fraud touch upon the parties' internal affairs inter se having no implication in the public domain?
The Hon'ble Supreme Court then relied upon the judgment in Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd.6 and Afcons Infrastructure Ltd. v. Cherian Varkey Construction Co. (P) Ltd.7 to address a situation where the same set of facts may lead to civil and criminal proceedings. The Apex Court held that the mere fact that criminal proceedings could be or have been instituted in respect of the same subject matter would not lead to the conclusion that a dispute that is otherwise arbitrable would cease to be so.
C. The Deccan Paper Mills case
In Deccan Paper Mills v. Regency Mahavir8, the first respondent had filed an application under Section 8 of the Arbitration Act. The appellant challenged the enforceability of the arbitration agreement on the ground that the same was null and void. The appellant argued that the disputes in the instant matter arose out of contracts that were fraudulently executed. The matter reached the Hon'ble Supreme Court after the district court at Pune and thereafter the Bombay High Court referred the parties to arbitration. The Hon'ble Supreme Court relied upon its judgment in Avitel Post Studioz wherein it was held that when the alleged fraud lies within the scope of performance of the contract or under Section 17 of the Indian Contract Act, 1872 – the dispute would be arbitrable. The Apex Court further clarified that the decision in N. Radhakrishnan was bad in law and had no legs to stand on. It was reiterated that merely because a particular transaction may have criminal overtones, it does not mean that its subject matter becomes non-arbitrable. In view of recent judgments,9 it observed that there has been a sea of change in Section 8 as we see in the Arbitration Act today, vis-à-vis Section 20 of the Arbitration Act of 1940. It was held that if an action was brought before a judicial authority and all conditions of Section 8 were met, then such judicial body shall refer the parties to arbitration unless it finds that prima facie, no valid arbitration agreement exists. Therefore, the Hon'ble Supreme Court concluded that the judgment of the Bombay High Court needed no interference.
D. The Vidya Drolia case
In Vidya Drolia v. Durga Trading Corporation10, a three-Judge bench of the Hon'ble Supreme Court undertook a thorough assessment of the law on arbitrability in contemporary jurisprudence. While the larger moot point related to the law on the arbitrability of landlord and tenant disputes, the Hon'ble Supreme Court also looked into the arbitrability of fraud. The judgment in Vidya Drolia noted that it would be entirely wrong to mistrust and treat arbitration as a flawed or inferior adjudication process unfit to deal with public policy aspects of a legislations. The Hon'ble Supreme Court drew a parallel between arbitral tribunals and courts. It was held that arbitrators, like courts, are bound to be impartial and independent, adhere to natural justice and follow a fair and just procedure. On the validity of the N. Radhakrishnan judgment, the bench in Vidya Drolia respectfully agreed with the decision in Avitel Post Studioz and Deccan Paper Mills Co. Ltd. In conclusion, the N. Radhakrishnan judgement was overruled while the bench in Vidya Drolia observed that allegations of fraud could be made the subject matter of arbitration when they related to a civil dispute. The exception to this rule is a dispute arising out of fraud which would vitiate and invalidate the arbitration clause itself.
E. The N. Global Mercantile Pvt. Ltd. case
In the N.N. Global Mercantile Pvt. Ltd.11 case, the Hon'ble Supreme Court once again reinforced the position in contemporary arbitration jurisprudence that civil aspect of fraud is arbitrable with the only exception being a fraud that went to the root of the underlying contract and impeached the arbitration clause itself. It was further clarified that criminal aspect of fraud that attracted penal consequences and criminal sanctions could only be adjudicated by a court of law since it may result in a conviction which falls in the realm of public law.
The Hon'ble Supreme Court also noted that the old norm that fraud was non-arbitrable was prevalent because it would entail voluminous and extensive evidence, and would be too complicated to be decided in arbitration. However, in modern-day arbitrations, the tribunals are required to navigate through volumes of material in various kinds of disputes. Therefore, the Hon'ble Supreme Court concluded that the notion that allegations of fraud, forgery, or fabrication are non-arbitrable is a wholly archaic view and needs to be discarded.
F. The Arbitration and Conciliation Amendment Ordinance 2020
Now that the recent judicial pronouncements on the arbitrability of fraud have been discussed, it is pertinent to also look at a significant development in the legislative domain.
The Arbitration and Conciliation Ordinance 202012 ("Ordinance") was passed recently to introduce the opportunity to seek an unconditional stay on enforcement of arbitral awards in cases where the underlying contract, the arbitration agreement or the arbitral award were induced and effected with fraud and corruption.
The Ordinance adds a proviso in Section 36 which states that the court shall unconditionally stay an award pending disposal of the challenge under section 34 to the award where a prima facie case was made that:
- the underlying contract and the arbitration clause; or
- the making of the award itself was induced or effected by fraud or corruption.
An explanation of the proviso clarifies that the amendment shall apply to all cases regardless of whether the court proceedings or the respective arbitration proceedings were commenced before or after the Arbitration and Conciliation (Amendment) Act, 2015. Thus, the amendment made to Section 36 vide the Ordinance shall have a retrospective application.
The judicial pronouncements discussed above are indeed a welcome development. These judgments would enable the Indian arbitral regime to move closer to the goal of becoming a mature jurisdiction by adopting more and more principles of modern arbitration law jurisprudence. The judgments not only meet the object of reducing interference of the courts in the arbitral process but also are a clear indication of the trust and faith that the Indian courts have reposed in methods of alternative dispute resolution.
On the contrary, the Ordinance is like a double-edged sword which can swing either way. It is not uncommon for parties in India to use fraud as a first line of defence to avoid arbitration. While the decisions in Avitel, Deccan Paper Mills, Vidya Drolia and N.N Global have consistently narrowed the scope of interference of courts in matters of fraud, the Ordinance could potentially act as a set-back. It will be interesting to see how the courts would interpret the key words in the Ordinance such as "inducement", "fraud" and "corruption" in cases to come.
1 N. Radhakrishnan v. Maestro Engineers (2010) 1 SCC 72.
2 Swiss Timing Ltd. v. Commonwealth Games 2010 Organising Committee (2014) 6 SCC 677.
3 Hindustan Petroleum Corporation Ltd. v. Pinkcity Midway Petroleums (2003) 6 SCC 503.
4 A. Ayyasamy v. A. Paramasivam and Ors. (2016) 10 SCC 386.
5 Avitel Post Studioz Limited and Ors. v. HSBC PI Holdings (Mauritius) Limited and Ors. 2020 (4) ArbLR 1 (SC): 2020 SCC OnLine SC 656.
6 Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd. (2011) 5 SCC 532.
7 Afcons Infrastructure Ltd. v. Cherian Varkey Construction Co. (P) Ltd. (2010) 8 SCC 24.
8 Deccan Paper Mills v. Regency Mahavir AIR 2020 SC 4047: 2020 SCC OnLine SC 655.
9 Ameet Lalchand Shah v. Rishabh Enterprises (2018) 15 SCC 678; Mayavati Trading Pvt. Ltd. v. Pradyut Deb Burman (2019) 8 SCC 714; Emaar MGF Land Ltd. v. Aftab Singh (2019) 12 SCC 751.
10 Vidya Drolia v. Durga Trading Corporation (2021) 2 SCC 1: 2020 SCC OnLine SC 1018.
11 N.N. Global Mercantile Pvt. Ltd.2021 SCC OnLine SC 13.
12 Arbitration and Conciliation Ordinance 2020. Available at - https://legalaffairs.gov.in/sites/default/files/The%20Arbitration%20and%20Conciliation%20%28Amendment%29%20Ordinance%202020.pdf)
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