Arbitration In IndiaThe Conundrum of Arbitrability of Fraud in Disputes

INTRODUCTION

Arbitration as an Alternate Dispute Resolution (hereinafter referred to as “ADR”) mechanism is flexible and effective. It is therefore the most preferred method of resolving disputes for parties who wish to settle the disputes outside of Courts. Businesses and international organizations, as well as their varied tie-ups, have seen rapid growth and involvement in the Indian market. This has also resulted in a significant increase in business conflicts and has prompted the Corporate Sector to have their cases decided by Arbitrators rather than in Open Courts. International Organizations prefer Arbitration because of the autonomy and flexibility it offers in terms of the seat and venue of the proceedings, which ultimately enable the parties to decide the applicable law.

Though Arbitration is one of the most preferred ADR mechanisms, there are certain issues that are associated with it. One of the issues impeding the Arbitration process in India is the Arbitrability of Frauds under the Arbitration and Conciliation Act, 1996 (hereinafter referred to as “Arbitration Act”). In this article we shall discuss the Evolution of Arbitrability of Fraud and the current legal position.

BACKGROUND: ARBITRABILITY OF FRAUD

There are certain disputes that can be resolved by Arbitration and there are certain disputes that can be solely adjudicated by the Courts. Arbitrability refers to the capacity of a dispute to be resolved by way of Arbitration. The Convention on Recognition and Enforcement of Foreign Arbitral Awards, 1958(commonly referred to as the New York Convention) also contains a provision under Article V(2)(a) which pertains to the refusal of the recognition and enforcement of the Award on the basis that the subject matter of the dispute is not capable of being settled through Arbitration by the law of that country.

The pertinent issue here is whether a dispute pertaining to Fraud can be adjudicated through Arbitration. The previous Arbitration Act, i.e., the Arbitration Act,1940 excluded the arbitrability of frauds, and the subject was first challenged in a historic Supreme Court (hereinafter referred to as “SC”) decision in Abdul Kadir Shamsuddin Bubere v. Madhav Prabhakar Oak (1962 AIR 406). In this case the SC took the view that the Court shall not entertain a dispute pertaining to Arbitration if the party charged with fraud desires a public enquiry. The SC determined that the issue of fraud contained numerous complexities that need to be addressed in Court. Thus, this decision signalled the beginning of an era in which frauds were covered by the blanket exception of arbitrability for an extended length of time.

Furthermore, in the case of N. Radhakrishnan v M/s Mastero Engineers & Ors (Civil Appeal No. 7019 of 2009),the SC found that significant charges of accounting malpractices and financial manipulation in a partnership business cannot be dealt with effectively by an Arbitrator. As a result, it denied the application submitted under Section 8 of the Arbitration Act. This decision came as a precedent signifying a regressive approach pertaining to the Arbitration proceedings in India which may have set back India in emerging as an Arbitration friendly jurisdiction.

EVOLUTION OF ARBITRABILITY OF FRAUD DISPUTES

The judgement of Booz-Allen & Hamilton Inc v SBI Home Finance Ltd. (Supreme Court, Civil Appeal No. 5440 of 2002) is a cornerstone in the doctrine of dispute arbitrability. The SC categorised the conflicts and established criteria for deciding which types of disputes were arbitrable based on the type of rights involved in the case, namely ‘right in rem’and ‘right in personam’. A right in remcan be exercised against society as a whole, but a right in personamcan only be enforced against one person. Thus, any issues concerning rights in personamcan be resolved through Arbitration, while problems involving rights in remcannot be resolved through Arbitration.Furthermore, in Swiss Timing Ltd v. Commonwealth Games Organizing Committee (Supreme Court, Arbitration Petition No.34 of 2013), the SC attempted to correct the path set by N. Radhakrishnan Case by pronouncing the judgement per incuriam. The “Doctrine of Severability” was applied to the Arbitration Agreement by the Supreme Court. It took the view that while evaluating any objections to the presence or legality of the Arbitration Agreement, the Arbitration provision, which is part of the contract, must be considered as an independent agreement.

• Distinction between Simpliciter Frauds and Complex Frauds

The SC in A. Ayyasamy v. Ayyasamy Paramasivam (Supreme Court, Civil Appeal no. 8245-8246 of 2016)(Ayyasamy Case)has made an attempt to distinguish between arbitrable and non-arbitrable offences. The SC took the view that in situations where the subject matter is solely within the purview of the public fora, such disputes would be non-arbitrable and would be handled only by the Courts.

Further, it took the view that claims of Fraud Simpliciter would not be sufficient to render the Arbitration Agreement between the parties null and void. Only the disputes involving severe allegation of fraud must be resolved by the Courts. The Court also stated that if charges of fraud are concerned with the internal operations of the party in question and shall have no public implications, the Arbitration Clause need not be avoided and the parties may be referred to Arbitration.

• Test for Complex Frauds:

In affirming the verdict of Ayyasamy Case, the SC established new criteria for differentiating between simple and complex frauds:

1. Whether the plea under Section 11 for the appointment of an Arbitrator pervades the whole contract and agreement, rendering it invalid.
2. Whether the alleged fraud was linked to the parties’ internal business and hence had no impact in the public realm.

Applying the twin test, the SC determined that there were no accusations of fraud that might invalidate the partnership deed as a whole or, in particular, the Arbitration Clause at issue in the said deed.

CURRENT LEGAL POSITION

In the Case of Avitel Post Studioz Ltd. v. HSBC PI Holdings Ltd. (Civil Appeal No.5145 of 2016 (Avitel Case),the SC clarified the Arbitrability of Frauds. After observing the standards put out in the Ayyasamy case, SC established a twin test (Public Flavor Test) and found that “serious accusations of fraud” warranting the exclusion of Arbitration could emerge only if two conditions were met:

1. Serious charges of where Arbitration Agreement itself does not exist due to the nature of the fraud
2. Where the charges are leveled against the State or its Agents for Arbitrary, fraudulent, or mala fide behavior the questions become public and must be addressed by a Writ Court.

The recent Case of Vidya Darolia v. Durga Trading Corporation (SC, Civil Appeal No. 2402 of 2019), brought an end to the tale of the growth of Arbitrability of Frauds in India. While concurring with the findings in Case of Ayyasamy, Swiss Timings, and Avitel, the SC specifically rejected ratio in the N Radhakrishnan Case and declared that Claims of Fraud in Civil Disputes are Arbitrable.

The SC proposed a Four-Fold test and held that disputes are not arbitrable when the main reason of action/subject matter of the dispute:

• Relates to actions in rem that do not relate to subordinate rights in personam that arise from rights in rem
• Affects third party rights;
• Has ‘erga omnes’ effect andrequires centralized and mutual adjudication
• Relates to inalienable sovereign rights.

Any affirmative response to these four criteria articulated by the Courts would deem the matter non-arbitrable. The SC further concluded that fraud-related issues can be the topic of arbitration proceedings, as long as the fraud does not “vitiate and invalidate the arbitration provision” or raise issues that impact rights in remand thus demand adjudication in the public arena.

AMLEGALS REMARKS

After much legal wrangling, the embargo imposed by the N Radhakrishnan Case has finally been lifted; the Courts have now adopted a Pro-Arbitration stance. The SC has developed certain standards pertaining to the Arbitrability of Frauds which are favourable to Arbitration, but their efficiency is yet to be seen.

However, there still persists a reasonable doubt pertaining to the battle between the Courts and Tribunals over situations where there is no effect on the parties or cases where the consequence is in the public domain. As a result, the Courts will be required to decide on each issue individually on the basis of the facts and circumstances of each case. It will be interesting to note the developments that follow with regards to the Arbitrability of Fraud.

For any query or feedback, please feel free to connect with vineeta.tekwani@amlegals.com or nikita.mulay@amlegals.com.