Arbitrability of Fraud in India: A Need for Finality

Introduction

The growing trend of resolving commercial disputes through arbitration has made the inclusion of arbitration clauses in commercial contracts the standard practice. Against this backdrop, it is important to understand how the arbitrability of a dispute becomes a matter of consideration since it speaks to the jurisdiction and competence of the Arbitral Tribunal. The arbitrability of “fraud” in a dispute has been a cause of long-standing debate and deliberation for the authorities. Statutorily, the only recognition of “fraud” in relation to arbitration has been under Explanation 1 to Section 34(2)(b)¹ of the Arbitration and Conciliation Act, 1996² (Act) which lays down that an award can be set aside if it has been “induced or affected by fraud” and in the amended provision under Section 36³ of the Act, which allows an arbitral award to be unconditionally stayed if it is obtained by fraud. However, none of these provisions settle whether an allegation of fraud in the dispute itself that has been referred to in arbitration will render the said dispute beyond the scope of arbitration. Consequently, the courts have attempted to settle this matter.

Evolution of the judicial position in India

“Serious fraud” and “simple fraud” dichotomy

The jurisprudence in India regarding this subject-matter can be traced way back to 1962, when the Supreme Court in Abdul Kadir Shamsuddin Bubere v. Madhav Prabhakar Oak⁴ while interpreting the law in the Arbitration Act, 1940⁵ ruled out serious allegations of fraud from the purview of arbitration proceedings. Subsequently, a catena of judgments of the Supreme Court and various High Courts across the country has shaped the jurisprudence on the subject-matter that is adorned by ambiguities and conflicting views.

In N. Radhakrishnan v. Maestro Engineers⁶, the Court held that disputes involving allegations of fraud and serious malpractices can only be settled in court, on the premise that Arbitral Tribunals are not competent authorities to conduct bulky and detailed consideration of evidence. This view was directly challenged in Swiss Timing Ltd. v. Commonwealth Games 2010 Organising Committee⁷ (Swiss Timing) which ruled that arbitration clauses should be treated as distinct from the underlying contract and that a mere allegation of the contract being void due to inducement by fraud would not oust the jurisdiction of the Arbitral Tribunal. The Court also declared N. Radhakrishnan case⁸ to be per incuriam.

Subsequently, in A. Ayyasamy v. A. Paramasivam⁹, the Supreme Court attempted to put an end to the conflicting views by laying down a definite test, distinguishing between “serious allegations of fraud” and “fraud simpliciter”. It held that the latter would not mean that the dispute is beyond the scope of arbitration. However, the Court therein retained the characterisation of “serious allegation of fraud” as provided earlier in N. Radhakrishnan case¹⁰, reinforcing the idea that the complexity of the dispute and the requirement of considering voluminous evidence for its adjudication would render an allegation of fraud to be non-arbitrable.

An attitudinal shift

Post A. Ayyasamy case¹¹, the jurisprudence on this subject underwent further evolution in the larger Bench case of Rashid Raza v. Sadaf Akhtar¹² (Rashid Raza) wherein the Court tacitly did away with the premise, underpinning the previous judgments, that consideration of voluminous and complex evidence was beyond the competence of an Arbitral Tribunal. A twin test for arbitrability of fraud was also laid down therein which said that fraud would fall outside the purview of the Arbitral Tribunal if it directly impacts the validity of the arbitration agreement or has broader implications in the public domain beyond just the parties involved.

This marked a break from the previous jurisprudence of “complex fraud” and “fraud simpliciter”. In 2020, the Supreme Court, in Avitel Post Studioz Ltd. v. HSBC PI Holdings (Mauritius) Ltd.¹³ (Avitel) discussed the subject in-depth and further extrapolated the classification established in Rashid Raza case¹⁴. It refined the second test, clarifying that a dispute would be considered non-arbitrable due to fraud or corruption only when allegations of fraud are against the State or its instrumentalities, necessitating adjudication by a writ court. Regardless of such extrapolation, the Court maintained consistency in terms of its non-consideration of voluminous and complex evidence as a ground for determination of arbitrability. A year after this, for the first time, N. Radhakrishnan case¹⁵ reasoning on why allegations of fraud must be resolved in a public forum as a consideration of public policy was expressly overruled in Vidya Drolia v. Durga Trading Corpn.¹⁶, signifying the definite shift of the Indian jurisprudence in relation to the arbitrability of fraud. It held that the consideration of public policy has to stem from a purposive understanding of the statute itself, which came into being with the intent of promoting a culture of arbitration in the country. Therefore, unless the statute provided an express bar for reference to an Arbitral Tribunal or unless a court has exclusive jurisdiction, there should be a presumption in favour of arbitrability of a dispute. The Court upheld the test laid down in A. Ayyasamy case¹⁷ and further expounded a four-fold arbitrability test which stated that when the subject-matter relates to rights in rem, affects third-parties or relates to sovereign and public functions of the State, they will not be subjected to arbitration.

Subsequently, in N.N. Global Mercantile (P) Ltd. v. Indo Unique Flame Ltd.¹⁸, the Supreme Court upheld Vidya Drolia case¹⁹, affirming that civil aspects of fraud are arbitrable unless the fraudulent aspect is such that it renders the underlying arbitration agreement void.

Recent trends: Persisting ambiguities

The recent judgments have marked a tectonic shift in the attitude of the Supreme Court with regard to the arbitrability of fraud, from considering Arbitral Tribunals as an incompetent authority for adjudicating on allegations of fraud to holding that the same view is archaic and adopting a considerably progressive, pro-arbitration approach. This is reflected in how the High Courts have also started interpreting the law in this area. Recently, in Nilesh Shejwal v. Agrowon Agrotech Industries (P) Ltd.²⁰, the Bombay High Court observed that in contemporary arbitration practice, Arbitral Tribunals are entrusted with examining voluminous materials and evidence in various kinds of disputes and thus, rendering the notion that fraud is not arbitrable obsolete and deserves to be discarded. Similarly, the Delhi High Court too recently²¹ said that allegations of fraud must be addressed by the Arbitral Tribunal.

However, the issue has still not been put to rest. Despite the long line of judgments formulating the jurisprudence relating to the issue, the tests for determining whether a dispute should be referred to arbitration still depend on the courts’ subjective assessment of whether the allegations of fraud amount to a “serious” one. Thus, the views of different courts on similar allegations may be contradictory. For instance, in United Machinery & Appliances v. Greaves Cotton Ltd.²², criminal proceedings were initiated against the respondent for offences such as Section 420²³ of the Penal Code, 1860²⁴. The Court held that since a criminal case with respect to the agreement is pending against the defendant, it would not be proper to refer the disputes between the parties to the arbitration. Such a view ignores the established precedents such as in Swiss Timing case²⁵, which clarified that mere filing of a criminal complaint will not vitiate the arbitrability of a dispute. Despite significant judicial advancements, the arbitrability of fraud in India remains mired in uncertainty due to such subjective judicial interpretations.

Global perspectives: Comparisons with the UK and USA

Allegations of fraud are invoked by parties, often as a tactic to delay or avoid arbitration proceedings altogether, and the involvement of the courts at such a juncture contributes to further complexities leading to an overall negative impact on the arbitration framework in the country. This has been recognised by foreign jurisdictions such as the United Kingdom and the United States of America. In the United Kingdom, the Court of Appeal in Fiona Trust and Holding Corpn. v. Yuri Privalov²⁶, held that the Arbitral Tribunal is competent to come to conclusions as to whether the agreement was tainted by bribery or has been vitiated due to fraud, or misrepresentation. This ruling was later affirmed by the House of Lords in Fili Shipping Co. Ltd. v. Premium Nafta Products Ltd.²⁷, where it was observed that it would be absurd to assume that parties to a contract had decided that out of all their allegations against each other, some should first be resolved by a court before they proceed to arbitration. Similarly, the US Supreme Court’s decision in Prima Paint Corpn. v. Flood & Conklin Mfg. Co.²⁸ is landmark, when the Court first adopted the doctrine of separability in a case involving an allegation of fraud in the inducement of a contract. The Court therein directed that the parties be sent to arbitration, considering that it had not made any allegation of fraud which would vitiate the arbitration agreement itself. Thus, it was established that any question of fraud in the inducement of the contract containing the arbitration clause needed to be resolved in the arbitral proceedings itself. Further, in Buckeye Check Cashing, Inc. v. Cardegna²⁹, it held that unless the challenge is to the arbitration clause itself, a challenge to the validity of the contract on grounds such as fraud or illegality, must be adjudicated by the arbitrator in the first instance.

Conclusion: The need for legislative intervention

Therefore, as demonstrated, the jurisdictions of economically developed countries with an established culture of referring commercial disputes to arbitration have consistently upheld the competence of the Arbitral Tribunal to adjudicate on allegations of fraud in dispute. The clear distinction between the jurisprudence in India and that of these other jurisdictions is that the courts in such jurisdictions have taken an unequivocal, consistent stance in favour of arbitrability of fraud regardless of its “complexity”, thus maintaining an atmosphere that is conducive to a culture of arbitration. It indicated that to do away with the lack of clarity and subjectivity surrounding the subject-matter, there is a need for legislative intervention, which has also been the view of the Law Commission and courts in the past. The 246th Report³⁰ of the Law Commission recommended that fraud be made expressly arbitrable and proposed amendments. The Law Commission recommended an amendment to Section 16³¹ of the Act to make fraud, including “serious questions of law, complicated questions of fact or allegations of fraud, corruption, etc.” arbitrable. Despite such a recommendation, coupled with the evident complexity arising due to a lack of an express provision, the legislature has seemingly turned a blind eye towards the issue. Even in the latest Draft Arbitration and Conciliation (Amendment) Bill, 2024³², to the utter dismay of the stakeholders, there has been no inclusion of such a provision, thus indicating the legislature’s continuation of its hands-off approach to this issue.