Evolving jurisprudence of arbitrability of fraud

By Faranaaz Karbhari, Mahafrin Mehta and Sharan Shetty, HSA Advocates
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Operating on the tenets of party autonomy, the arbitration clause has become a boilerplate in most commercial contracts. The Arbitration and Conciliation Act, 1996, does not specifically exclude any category of disputes as being non-arbitrable. However, sections 34(2)(b) and 48(2) state that an award will be set aside if the subject matter of the dispute is incapable of settlement by arbitration.

Faranaaz Karbhari
Faranaaz Karbhari
Counsel
HSA Advocates, Mumbai

The Indian Arbitration Act, 1940, was the first to govern arbitration as a mechanism for dispute resolution. In the case of Abdul Kadir Shamsuddin Bubere v Madhav Prabhakar Oak (1961), the Supreme Court held that when serious allegations of fraud were made against a party, and the party, which was charged with fraud, desired the matter to be tried in open court, this would be sufficient cause for the court not to order an arbitration agreement to be filed. It was also stated that not every allegation imputing some kind of dishonesty that implied dishonesty/misconduct would amount to serious allegations of fraud.

In N Radhakrishnan v Maestro Engineers, it was held that matters of fraud required detailed evidentiary examination, and if a dispute involved substantial allegations of fraud it would not be subject to arbitration on the ground of public policy. However, in the case of Swiss Timing v Organising Committee, Commonwealth Games 2010, the N Radhakrishnan case was critiqued and declared per incuriam. The Supreme Court’s decision in Booz Allen and Hamilton Inc v SBI Home Finance Ltd laid down the foundation to determine whether a dispute would be amenable to arbitration or not. It was held that if a dispute concerned a right in rem, then it would not be arbitrable, and if the dispute pertained to right in personam it would be arbitrable.

Mahafrin Mehta
Mahafrin Mehta
Principal associate
HSA Advocates, Mumbai

Furthermore, certain types of disputes were categorised as non-arbitrable, namely: (1) disputes which arise out of criminal offences; (2) matrimonial disputes; (3) guardianship matters; (4) insolvency matters; (5) testamentary matters; and (6) eviction/tenancy-related matters governed by special statutes. The test to determine seriousness of fraud was developed in the case of A Ayyasamy v A Paramasivam & Ors, where the Supreme Court elucidated on fraud simpliciter and serious fraud, and held that a mere allegation of fraud by one party against the other cannot be a ground to hold that a matter is not arbitrable. Allegations of fraud should not only be serious, but also such that might taint the material validity of the contract and arbitration clause. In the case of Avitel Post Studioz Ltd v HSBC PI Holdings (Mauritius) Ltd, the Supreme Court held that the above-mentioned N Radhakrishnan case was no longer a good precedent and clarified that merely because some facts involve civil and criminal proceedings, it would not necessarily lead to a conclusion that the disputes are not arbitrable.

Sharan Shetty
Sharan Shetty
Trainee associate
HSA Advocates, Mumbai

Furthermore, it was held that section 17 of the Contract Act, 1872, would be applicable if the contract itself is obtained by fraud or cheating, thereby creating a distinction between a contract obtained by fraud and post-contract fraud.

In 2016, the Supreme Court carved out a seventh category of non-arbitrable disputes, i.e. cases arising out of trust deeds and the Trust Act, 1882. In 2018, the court held that disputes arising out of the Consumer Protection Act, 1986, are not arbitrable.

Further, in Vidya Drolia v Durga Trading Corporation, the Supreme Court commented on the competency of an arbitral tribunal to deal with public policy matters, and expressly overruled N Radhakrishnan. A four-fold test was propounded to determine when the subject matter of a dispute in an arbitration agreement is not arbitrable.

An answer in the affirmative to any of the four tests would declare the dispute non-arbitrable. It was also held that allegations pertaining to fraud are arbitrable only when they relate to a civil dispute. Following the above-mentioned case of Vidya Drolia, in NN Global Mercantile Pvt Ltd v Indo Unique Flame Ltd, the Supreme Court upheld the arbitrability of civil aspects of fraud except in cases where the underlying contracts have fraudulent roots that impeach the arbitration clause.

Although there have been varying views on the arbitrability of fraud, the evolving jurisprudence has significantly contributed in considerably resolving the issue, which make it clear that disputes involving fraud can be arbitrated, provided that the arbitration agreement itself is not rendered void due to fraud.

Faranaaz Karbhari is of counsel, Mahafrin Mehta is a principal associate and Sharan Shetty is a trainee associate at HSA Advocates, Mumbai.

HSA Advocates

HSA Advocates

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