India: Supreme Court Settles Position On The Arbitrability Of Disputes Where Fraud Is Alleged

Delivering a pro-arbitration judgment, the division bench of the Hon'ble Supreme Court of India (SC) comprising of Justices A K Sikri and Dr D Y Chandrachud, in the case of A Ayyasamy v A Paramasivam & Ors1 through a judgment dated 4 October 2016, has held that unless the fraud in question is of a serious and complicated nature, the jurisdiction of the arbitrator would not be ousted. Mere allegations of fraud simplicitor would not take away from the arbitrability of a dispute where a valid arbitration agreement was in existence.

Facts of the Case

The parties to the proceedings were brothers and partners in a partnership firm carrying on the business of running a hotel. Certain disputes relating to the business arose between the parties. In spite of the partnership deed containing an arbitration clause, the respondents filed a civil suit against one of the partners (the appellant) before the local District Court seeking a declaration that they, as partners, were entitled to participate in the administration of the hotel and sought a permanent injunction against the appellant from interfering with the same right. The appellant moved an application under Section 8 of the Arbitration and Conciliation Act, 1996 (Act) raising an objection to the maintainability of the civil suit on the ground that the partnership deed contained an arbitration clause and thus it was mandatory for the disputes to be referred to arbitration.

The application was opposed by the respondents on the ground that acts of fraud were attributable to the appellant and hence the dispute could not be adjudicated by the arbitral tribunal. The fraud alleged, related to siphoning of certain funds of the partnership firm by the appellant. The respondents relied on the judgement of the SC in the N. Radhakrishnan case2. The appellant argued that the said judgment was per incuriam of the law subsequently laid down by the SC in the Swiss Timing case3. The District Court dismissed the Section 8 application relying on N. Radhakrishnan. The appellant filed a revision petition before the High Court (HC) where the same issue was agitated. The HC relied on the order in the N. Radhakrishnan case and dismissed the petition. The appellant, thereafter filed the present appeal before the SC.

Issue

The issue before the SC was whether the mere allegation of fraud by one party against the other would be sufficient to exclude the subject matter of the dispute from arbitration. The SC also decided if the view taken by the HC to rely on N. Radhakrishnan in light of the decision in the Swiss Timing Case was correct or not.

Analysis

Justice A K Sikri, on behalf of the Division Bench began with the observation that the Act itself did not contain any specific provision excluding any category of disputes by terming them to be non-arbitrable. The SC observed that, in light of various pronouncements relating to the scope of judicial intervention, unless it was shown that there was a law which makes the subject matter of the dispute incapable of being settled by arbitration – the principle of least interference by courts should be followed while deciding on the arbitrability of the disputes. The SC went on to differentiate between cases where the allegations of fraud were of a serious and complicated nature that would not only constitute a criminal offence but also require extensive evidence and cases where fraud was merely alleged by one party against the other.

The judgment in Booz Allen4 and the 246th Law Commission Report were referred to by Justice Sikri on behalf of the Division Bench while discussing whether the present dispute was capable of adjudication and settlement by arbitration. The order in Booz Allen held that only where the subject matter of the dispute fell exclusively within the domain of courts, could the dispute said to be non-arbitrable. In general, , a right in rem would not be arbitrable but a right in personam would be capable of adjudication in private fora. The SC in Booz Allen and more recently in Vimal Kishor Shah5 have outlined the following instances which would be outside the purview of arbitration:

  • disputes relating to rights and liabilities which give rise to or arise out of criminal offences;
  • matrimonial disputes;
  • guardianship matters;
  • insolvency and winding up;
  • testamentary matters;
  • eviction or tenancy matters; and
  • disputes interse between trust, trustees, and beneficiaries.

According to Justice Sikri, the Law Commission Report has recognised and has drawn a distinction between serious allegations of fraud and fraud simplicitor and therefore it followed that only serious allegations of fraud are to be treated as non-arbitrable which should be decided by civil courts.

Justice Dr D Y Chandrachud, while agreeing with the view taken by Justice A K Sikri, discussed how the parties, while relying on the judgment passed in N. Radhakrishnan, have sought to avoid arbitration by raising a frivolous allegation of fraud. Additionally, Justice Dr D Y Chandrachud also cited that the doctrine of severability of the arbitration clause from the main contract is an important element which would lead credence to the view that adjudicatory power of the arbitrator remained unaffected for considering if the main contract was affected by fraud or undue influence. He further went on to hold that burden of proof that the disputes were not capable of adjudication by arbitration would lie on the party which was avoiding the same. A further principle which should assist the court when a defence of fraud is raised to oppose arbitration, was laid down, which was that it would always be easier for parties to expressly state that disputes regarding the validity of the contract would not be adjudicated by arbitration and in the absence of the same, the intent of the parties to refer disputes to arbitration should be respected.

Held

The SC held that mere allegation of fraud simplicitor would not be a ground to nullify the effect of an arbitration agreement between the parties. Only in those cases where the courts, while dealing with Section 8 of the Act, find that there are very serious allegations of fraud which make a clear case of criminal offence or where allegations of fraud are so complicated that it becomes absolutely essential that such complex issues can be decided only by a civil court on the appreciation of the voluminous evidence, should the court avoid the arbitration agreement by dismissing a Section 8 application and proceed with trying the suit on merits. The SC held that the allegations in this case were not so serious that an arbitrator would be unable to rule on it and directed the parties to arbitration. To save the time of parties, the SC also appointed an arbitrator for the present dispute.

Comments

By virtue of this judgment, the SC has certainly settled the controversy over the arbitrability of fraud and further laid to rest the dispute regarding the applicability of the principle brought out by the Swiss Timing case over the judgment passed in N. Radhakrishnan. The judgment also guides on the approach to be followed by the court while deciding an application under Section 8 of the Act where the defence of fraud is raised. Further, while discussing international jurisprudence on the subject of arbitrability, it states that in keeping with other common law jurisdictions, India should evolve towards strengthening the institutional efficacy of arbitration. The judgment is a departure from the principle of arbitrability of fraud when it comes to foreign seated arbitration vis-à-vis domestic arbitration where the SC6 has held that in the case of arbitrations covered by New York Convention, the Court can decline to make a reference only if it comes to the conclusion that the arbitration agreement is null and void and not on the ground of fraud.

While this judgment is a welcome step and in the right direction, however it would still leave the determination regarding the seriousness of the fraud to the subjective adjudication of the court. Therefore not only would fraud be required to be specifically pleaded, the fraud pleaded would necessarily require to be of a serious and grave nature.

Footnotes

1. Civil Appeal Nos 8245 & 8246 of 2016

2. N Radhakrishnan case v Maestro Engineers & Ors (2010) 1 SCC 72 where the Hon'ble Supreme Court has held that questions of fraud cannot be referred to arbitration and should be tried by a civil court

3. Swiss Timing Ltd v Commonwealth Games 2010 Organising Committee (2014) 6 SCC 677 where in an application under Section 11 of the Act, the SC has held that allegations of fraud can be arbitrated upon and the policy of least interference by civil courts should be applied when deciding on the arbitrability of the disputes.

4. Booz Allen & Hamilton Inc v SBI Home Finance Limited & Ors (2011) 5 SCC 532

5. Shri Vimal Kishor Shah and Ors v Mr. Jayesh Dinesh Shah and Ors. Civil Appeal no 8164 of 2016

6. World Sport Group (Mauritius) Ltd v MSM Satellite (Singapore) Pte Ltd 2014 (11) SCC 639

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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