Litigation Newsletter – Arbitrability Of Fraud

Introduction

The concept of arbitrability which means whether a particular dispute can be resolved through arbitration rather than traditional court system, has undergone significant evolution in Indian legal system. Traditionally Indian courts viewed fraud as matter of at most seriousness to the extent that the matters relating to fraud was not sent for arbitration. However, with growing transformation of arbitration as an effective mechanism this position has gradually given way to a more modern understanding.

With the growing emphasis on dispute resolution mechanism, the courts in recent times sought to clarify that arbitration is competent to adjudicate on issues of fraud. This article traces the Indian judiciary's approach to arbitrability of fraud starting from early resistance to contemporary acceptance through landmark Supreme Court and High Court judgements.

Tests Laid down by the SC for Arbitrability of Fraud

The Supreme Court in the case of A. Ayyasamy v. A. Paramasivam the SC laid tests to determine arbitrability of fraud. The Court in this matter specifically dealt with the question of what constitutes as “serious” allegations of fraud. It was held that when the allegation of fraud permeates the entire contract and above all, the agreement of arbitration, rendering it void, the same would be serious in nature and thus, non-arbitrable. However, simple cases of fraud which touch upon the internal affairs of the parties inter se having no implication in the public domain can be decided by arbitration.

Further, the bench in the case of Vidya Drolia and others v. Durga Trading Corporation laid down a fourfold test for determining when the subject matter of a dispute in an arbitration agreement is not arbitrable:

1. when cause of action and subject matter of the dispute relates to actions in rem, that do not pertain to subordinate rights in personam that arise from rights in rem.
2. when cause of action and subject matter of the dispute affects third party rights; have erga omnes effect; require centralized adjudication, and mutual adjudication would not be appropriate and enforceable;
3. when cause of action and subject matter of the dispute relates to inalienable sovereign and public interest functions of the State and hence mutual adjudication would be unenforceable; and
4. when the subject-matter of the dispute is expressly or by necessary implication non-arbitrable as per mandatory statute(s).

Non Arbitrable Matters

Applying the above test, the bench observed that insolvency or intracompany disputes, grant and issue of patents and registration of trademarks, Criminal cases, Matrimonial disputes, Matters relating to probate, testamentary matter, disputes which are to be adjudicated by the DRT under the DRT Act etc. are not arbitrable.

Specifically dealing with the aspect of non-arbitrability in cases of fraud because of voluminous evidence, the SC held that:

“The ground on which fraud was held to be non-arbitrable earlier was that it would entail voluminous and extensive evidence and would be too complicated to be decided in arbitration. In contemporary arbitration practice, arbitral tribunals are required to traverse through volumes of material in various kinds of disputes such as oil, natural gas, construction industry, etc. The ground that allegations of fraud are not arbitrable is a wholly archaic view, which has become obsolete, and deserves to be discarded.”

Evolution of Contemporary Arbitration Practice

Further a case similar to the dispute at hand was the case of Nilesh Shejwal vs Agrowon Agrotech Industries Pvt. Ltd.1 involving misappropriation of funds, misuse of the company brand, and breach of trust/contract as grounds for termination. A criminal complaint was also filed invoking sections 409, 420, and 477A of the Indian Penal Code. However, the Bombay High Court overruled the past views of several High Courts which held that fraud disputes involving voluminous evidence were unfit for arbitration. The Court ultimately noted that due to evolution of contemporary arbitration practice, wherein arbitral tribunals routinely navigate through extensive material in various dispute types, the tribunals were more than competent to decide such matters. Thus, it held that the previous notion of fraud being non-arbitrable due to complexity is archaic and no longer applicable in modern arbitration practices.

Although, the Apex Court in N. Radhakrishnan V. Maestro Engineers (2010) held that there is no doubt that where serious allegations of fraud are made against a party, and the party who is charged with fraud desires that the matter should be tried in open court, that would be a sufficient cause for the court not to order an arbitration agreement to be filed and not to make the reference. However, the same was explicitly overruled in the case of Vidya Drolia & Others v. Durga Trading Corporation, highlighting the evolving nature of arbitration in India.

Even in the case of NN Global Mercantile v. Indo Unqiue Flame, the Hon'ble SC has held that arbitrability of fraud is no longer an issue relating to the competence of the arbitrator, or dealing with voluminous evidence. Arbitrators are competent to deal with allegations of civil fraud. The court also reiterated the Ayyswamy decision to hold that –

“The Court made a distinction between cases where there are allegations of serious fraud and fraud simplicitor. Mere allegations of fraud simplicitor are not a sufficient ground to decline reference to arbitration. Parties may be referred to arbitration where allegations of fraud pertain to disputes between parties inter se, and have no implication for third parties. The courts may, however, refuse to make a reference to arbitration only in those cases where there are very serious allegations of fraud, which make a virtual case of criminal offence of fraud, or where allegations of fraud are so complicated, that it becomes absolutely essential that such complex issues be decided only by the civil courts on appreciation of voluminous evidence. This would also include those cases where there are serious allegations of forgery or fabrication of documents, or where fraud is alleged with respect to the arbitration clause itself, or where the fraud alleged is of such a nature that it permeates the entire contract, including the agreement to arbitrate.”

Conclusion

The jurisprudence surrounding the arbitrability of fraud in India has undergone important transformations. What was once viewed as exclusion from the scope of arbitration is now evolved into more balanced approach. The Supreme Court in Ayyasamy, Vidya Drolia, and N.N. Global Mercantile demonstrates clear towards recognising arbitration as a legitimate forum even for resolving disputes involving allegations of fraud.

Arbitration practice today has developed to handle such evidence intense proceedings. The earlier apprehension on such cases no longer holds true and the current stance reinforces arbitration as a competent mechanism for resolving a variety of commercial disputes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.