Whether the allegations of fraud would vitiate the arbitration agreement, and what would be the measure of damages in case of contract entered into on the basis of fraud or misrepresentations, are the issues answered by the Honw'ble Supreme Court of India in its recent judgment in the case of Avitel Post Studioz Ltd. & Ors. Versus HSBC PI Holdings (Mauritius) Ltd1.
Brief facts of the case
- The HSBC PI Holdings (Mauritius) Ltd ("HSBC") entered into a Share Subscription Agreement dated 21.04.2011 ("SSA") and a Shareholder Agreement dated 6.05.2011 ("SHA") with an Indian company namely Avitel Post Studioz Ltd. ("Avitel India") for acquiring 7.8% of paid-up capital of Avitel India for a total consideration of USD 60 million. The SHA was executed for the purpose of defining the relationship between the parties after execution of the SSA. Both these agreements had identical dispute resolution clauses providing for settlement of disputes through arbitration to be conducted under the aegis of Singapore International Arbitration Centre ("SIAC") in accordance with the International Arbitration Rules. It was specifically agreed by the parties that save and except the provisions of Section 9, Part 1 of Indian Arbitration and Conciliation Act, 1996 (Act") shall not be applicable. Significantly, the basis of execution of the aforesaid agreements was the representations made by the Jain Family, who were the promoters of Avitel India, to HSBC that they were in advance stage of finalizing a contract with British Broadcasting Corporation ("BBC") to convert the BBC's film library from 2D to 3D. It was represented that the said contract was expected to generate a revenue of USD 300 million in the first phase and ultimately over USD 1 billion. It was also represented that the investment made by HSBC would be used to purchase equipment for Avitel Post Studioz FZ LLC ("Avitel Dubai") to service the BBC contract. Avitel Dubai was 100% subsidiary of Avitel Holdings Ltd., Mauritius ("Avitel Mauritius"), which, in turn was 100% subsidiary of Avitel India (Avitel India, Avitel Mauritius, and Avitel Dubai are collectively referred to as the "Avitel Group").
- HSBC grew suspicious about the Avitel Group's business of digitising films and Ernst & Young and KPMG, Dubai were engaged to inquire into business activities of the Avitel Group and return finding in that regard. Based on the preliminary findings of Ernst & Young and KPMG Dubai, HSBC discovered that the purported BBC contract was non-existent and was set up by the Avitel India to induce HSBC into investing the aforesaid money of USD 60 million in the shares of Avitel India. It was further discovered that though Avitel Dubai received payment of USD 60 million, however, about USD 51 million were siphoned off to companies in which the Jain Family i.e. promoters of Avitel India had a stake.
- In the above circumstances, disputes arose and the matter was referred to SIAC, which initially appointed an Emergency Arbitrator in terms of an Application made by HSBC and subsequently constituted a tribunal of three arbitrators, in terms of the agreement.
Proceeding before the Arbitral Tribunal
- The Emergency Arbitrator passed two Interim Awards dated 28.05.2012 and 29.05.2012 in the SSA and the SHA directing Avitel India and Avitel Dubai to refrain from disposing of or dealing with or diminishing the value of their assets up to USD 50 million. The Emergency Arbitrator further permitted HSBC to deliver copies of the Interim Awards to financial institutions in India and the UAE with which any of the said two Avitel companies held or may hold or be signatory to accounts with a request that the financial institutions freeze such accounts consistent with the Interim Awards. On 27.07.2012 the Emergency Arbitrator amended the aforesaid Interim Awards thereby giving further relief to HSBC by directing Avitel India and Avitel Dubai to cease and desist from prohibiting or inhibiting Ernst & Young and KPMG Dubai from conducting investigations into the financial affairs of Avitel Dubai and Avitel Mauritius.
- A three member tribunal, constituted under the auspicious of SIAC, decided the disputes vide Formal Final Award in SSA dated 27.09.2014 holding that Avitel India made false and misleading representations to HSBC in order to induce HSBC to invest in Avitel India. The Tribunal held that Avitel Group were jointly and severally liable to HSBC in tort of deceit as well as for fraudulent misrepresentation under the Contract Act. The Tribunal awarded USD 60 million to HSBC towards damages along with interest @4.25% p.a. besides awarding legal and other costs in favour of HSBC. Arbitral Tribunal also directed for cancellation of shares of HSBC after full and final payment of awarded amount by Avitel Group to HSBC.
- Proceedings initiated for challenging the award in India under Section 34 of the Act, 1996 were held to be not maintainable vide judgment of Bombay High Court dated 28.09.2015. Appeal under Section 37 of the Act was also dismissed on 05.05.2017 on the ground that no such proceedings was maintainable in India. HSBC moved the Bombay High Court on 15.04.2015 for enforcement of Foreign Final Award dated 27.09.2014 which proceeding are still pending. The judgment of the Supreme Court which is the subject matter of the present arbitration is not concerned with the Petition challenging the Award or enforcement thereof.
Proceedings under Section 9 of the Act in India before Hon'ble Bombay High Court ("BHC")
- On 30.07.2012, i.e. during pendency of the arbitral proceedings, HSBC filed a Petition under Section 9 of the Act before the BHC seeking a direction to the Avitel India to deposit security amount to the extent of HSBC's claim of USD 60 Million. A Ld. Single Judge of BHC directed Avitel India vide order dated 22.01.2014 to deposit any shortfall in its account with the Corporation Bank so as to maintain a balance of USD 60 million during pendency of the arbitration proceedings.
- In an intra court appeal, the Ld. Division Bench vide order dated 31.07.2014 took the view that measure of damages may not be the amount of loss ultimately suffered by HSBC but it can at best be the difference between the price paid by HSBC in acquiring the shares in Avitel India and the price HSBC would have received had it resold the said shares in the market. According, the Ld. Division Bench modified the order in appeal and directed that Avitel India would maintain USD 30 million, instead of USD 60 million, in its account during pendency of the arbitration proceedings. On the issue of arbitrability of the dispute due to allegations of fraud by HSBC, the Ld. Division Bench held that such allegations were primarily in the context of "fraud" and "Misrepresentation" as defined under Section 17 &18 of the Contract Act thus establishing a civil profile of the dispute. Ld. Division Bench thus held that the disputes were arbitrable. Both HSBC as well as Avitel India challenged the order of the Ld. Division Bench dated 31.07.2014 before the Hon'ble Supreme Court of India.
Decision of the Hon'ble Supreme Court of India
- Allowing the appeal of HSBC, and dismissing the appeal of Avitel India, the Hon'ble Supreme Court directed that reduction of amount of USD 60 million to USD 30 million by the Ld. Division Bench was not justified. It was held that USD 60 million was rightly directed to be set aside by the Ld. Single Judge in the facts and circumstances of the case. For arriving at the aforesaid finding, the Hon'ble Supreme Court primarily dealt with the following two issues:
- What is the substantive law in India qua arbitrability when allegation of fraud are raised by one of the parties to Arbitration Agreement?
- What would be the quantum of damages that can be claimed in cases where contract is voidable due to fraud and misrepresentation?
- For deciding the first issue, the Hon'ble Apex Court referred to almost all its earlier judgments on the issue of arbitrability of disputes in the face of allegations of fraud. It was noted that in Afcons Infrastructure Ltd. v. Cherian Varkey Construction Co. (P) Ltd.2 (para 27) it was held that the cases involving serious and specific allegation of fraud, fabrication of documents, forgery, impersonation, coercion, etc. and the cases involving prosecution for criminal offences would fall in the category of cases not suitable for ADR process. Similarly, it was noted that in Booz Allen & Hamilton Inc. v. SBI Home Finance Ltd.3 (para 36), while listing the category of non-arbitrable cases, disputes relating to rights and liabilities giving rise to or arise out of criminal offences were held to be non-arbitrable. It was noted that in Radhakrishnan v. Maestro Engineers4 (para 21), the apex court held that since the case related to allegations of fraud and serious malpractices on the part of the respondents, such a situation could only be settled in court through furtherance of detailed evidence by either parties and such a situation could not be properly gone into by the arbitrator. The apex court cited with approval the decision in the case Swiss Timing Ltd. v. Commonwealth Games 2010 Organising Committee5, where a Single Judge Bench of the apex court, while dealing with a petition for appointment of arbitrator, held that judgment in the case of N. Radhakrishnan v. Maestro Engineers was per incuriam and did not lay down the correct law. It was further held in Swiss Timing that only in cases where the court, on a meaning full reading of the contract, can readily conclude that the contract was void, it would be justified to decline reference to arbitrator. However, where the contract is only voidable, like in the case of Section 17 & 18 of the Contract Act, it is not possible to shut arbitration. The apex court also noted that in its earlier judgment in the case of A. Ayyasamy v. A. Paramasivam6, it was held that only where serious question of fraud were involved that arbitration could be refused. The apex court further noted that in its recent judgment in the case of Rashid Raza v. Sadaf Akhtar7, it was held that there was a distinction between serious allegations of forgery/fabrication in support of the plea of fraud as opposed to "simple allegations". It was held in Rashid Raza that working tests were - (i) whether the plea permeate the entire contract and above all, the agreement of arbitration, rendering it void; (ii) whether the allegations of fraud touch upon the internal affairs of the parties inter se having no implication in the public domain. After noting the judgments as aforesaid, the Hon'ble Supreme Court held that "serious allegation of fraud" arise only if either of the two tests were satisfied and not otherwise. The court further held paragraph 27(vi) of Afcons (supra) and paragraph 36(i) of Booz Allen (supra) should now be read subject to a rider that the same set of facts may lead to civil and criminal proceedings and if it is clear that civil disputes involved question of fraud and misrepresentation etc. which can be subject matter of such proceedings under Section 17 of the Contract Act, and/or the tort of deceit, the mere fact that criminal proceedings can or have been instituted in respect of the same subject matter, would not lead to conclusion that a dispute ceases to be arbitrable.
- The apex court further held that there can be a distinction between a contract obtained by a fraud or performance of contract being initiated by fraud. The second category of fraud which vitiates the performance of the contract would fall outside section 17 of the Contract Act and would be governed by tort of deceit, leading to a claim of damages and not of recession of contract itself. However, the court held that both kind of fraud are subsumed within the expression "fraud" when it comes to arbitrability of an agreement which contains an arbitration clause.
- As regards the second issue regarding measure of damages for fraudulent misrepresentation by which a party to the contract is induced to enter into the contract, the court held that there is only one measure of damages in such cases namely the loss truly suffered by the parties affected who must be put back in the same place as if he had never entered into the transaction. In an action for deceit the price paid less valuation at the transaction date is simply a method of measuring such a loss. Referring to the finding in the Formal Final Award dated 27.09.2014, the court observed that it was clear that most of the representations made by Avitel Group and the Jain Family to HSBC, were false.
- The Court held that in the case before it the measures for damages for fraudulent misrepresentation is not the difference between value of shares on the date of making the contract and the value HSBC would have realised if it had resold the share in the market, rather the measure for damages would be to put HSBC in the same position as if the contract had never been entered into, which is, the entitlement to recover the price paid for the shares and all consequential losses. Accordingly, the court held that the Division Bench's finding as to measure of damages could not be acceded to.
This judgment reinforces the radical departure made in 1996 Act intending to strengthen the efficacy of arbitration. It was held that as long as the arbitration agreement is found to exists, mere allegations of fraud or initiation of criminal proceedings would not render the disputes to be non-arbitrable. It is only in those rare situations where the contract containing arbitration clause is found to be void that arbitration clause would also cease to exist. Inter-se allegation of "fraud" by one of the parties merely render the contract voidable as per Section 17 of the Contract Act and applying the principle of separability of arbitration clause /agreement from the underlying contract, parties cannot be permitted to avoid arbitration merely on the basis of such allegations of fraud. However, where serious allegations of fraud have implication in the public domain, satisfying the court that it will be just and in the interest of all the parties not to proceed with arbitration, court may relegate the parties to civil court and not to arbitration. However, such cases would be very few and in other cases, courts would not allow any party to arbitration to avoid arbitration merely by raising a bogey of the underlying contract being void.
1 Civil Appeal No. 5245 of 2016, Civil Appeal No. 5158/2016 and Civil Appeal No. 9820/2016 decided on 19.08.2020. This appeal was against judgement dated 31.07.2014 passed by DB of BHC in appeal arising out of petition filed under Section 9 of the Act.
2 (2010) 8 SCC 24
3 (2011) 5 SCC 532
4 (2010) 1 SCC 72
<5 (2014) 6 SCC 677
6 (2016) 10 SCC 386
7 (2019) 8 SCC 710
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