Arbitrability of Fraud in India

Arbitrability of disputes involving allegations of fraud has always entailed uncertainty and unpredictability in the actions of the courts in India. Consider a case where one party in a dispute alleges commission of fraud by the other party. Can such a case involving allegations of fraud be arbitrable? In the absence of explicit guidelines indicating the scope of arbitrability of fraud, parties were often left in a peculiar situation. This issue however, has been finally settled by the Hon’ble Supreme Court of India in Avitel Post Studioz Limited Ors. vs. HSBC PI Holdings (Mauritius) Ltd. (2020 SCC OnLine SC 656) wherein the court decided that allegations of fraud do not necessarily mandate setting aside of an award involving such a dispute. Prior to this decision, the courts followed the decision in Maestro Engineer’s case (2010 1 SCC 72) wherein it was held that cases of fraud involving ‘serious allegations of fraud’ are not arbitrable. The Avitel decision of the Hon’ble Supreme Court therefore, brings the law in India in consonance with the settled law in United Kingdom and other major arbitration jurisdictions such as France. This Article discusses the analysis of the issue by the Supreme Court of India.

Prior to discussion on the law, it is necessary to acquaint the reader with the facts of the case. HSBC had entered into an agreement with the appellants and executed Share Subscription Agreement (SSA) and Shareholder’s Agreement (SHA) with the latter. HSBC had thus invested around USD 60 million in the appellant company on the basis of a representation by the appellants that they were in advanced discussions with BBC to upgrade their film library and were on the verge of receiving a contract amounting to over USD 300 million. However, upon entering the aforementioned agreements with the appellants, HSBC discovered that the appellants were never in any such discussion with BBC and the latter denied any such contact with the appellant. On a probe being conducted into the appellant company, it was discovered that the money received from HSBC had been siphoned off to other companies of the appellants. Thus, HSBC commenced arbitration in Singapore and obtained an award against the appellants. While the arbitration was pending, HSBC obtained an injunctive relief against the appellants under Sec. 9 of Arbitration Act, 1996. The appeal before the Hon’ble Supreme Court arose out of this injunctive relief wherein the court held that the dispute cannot be held to be not arbitrable due to allegations of fraud.

The Hon’ble Supreme Court, after conducting a comprehensive analysis of several authorities including decisions of foreign courts and academic contributions, held that a dispute will be arbitrable only if it involves ‘serious allegations of fraud’ which shall be ascertained on the basis of the tests laid down in this judgement. Mere allegation of fraud or wrongdoing will not render a dispute non-arbitrable. The court examined three issues which would be of interest to the reader. First, the court developed tests to determine whether the dispute is arbitrable due to allegations of fraud or not. Second, the court examined whether the criminal and civil proceedings pertaining to fraud can be conducted simultaneously and whether their respective decisions have any bearing on the other. Third, the court examined the nature of fraud vis-à-vis the Contracts Act, 1872 and remedies available to the innocent party.

Considering the first issue, the court held that there are two conditions under which the dispute, on allegations of fraud, can be held to be not arbitrable. First, where the arbitration clause or agreement itself cannot exist due to some inability or statutory bar under the Contracts Act, 1872 or if the court finds that the party against whom the breach is alleged cannot be said to have entered into the agreement relating to arbitration at all. Second, if the allegations are made against the State or an instrumentality of State necessitating petition to a writ court. In the latter cases, the rationale for non-arbitrability is that the questions arising out of such disputes are not necessarily pertaining to breach of contract but instead questions arising out of public policy, to be decided by the courts. The Apex Court further held that acts of impersonation, false representation and diversion of funds do not possess a public policy element to attract the fraud exception, hence arbitrable.

Secondly, the court made a distinction between the criminal and civil proceedings arising out of the same dispute. These proceedings can be conducted parallel to one another and the decision of either proceedings shall not have an effect on the other. If fraud has been committed under the ambit of Contract Act 1872, it has a civil nature and is arbitrable subject to the aforementioned tests. The mere fact that criminal proceedings have been instituted arising out of the same act of fraud does not render the dispute non-arbitrable. Therefore, arbitration can continue despite criminal proceedings against the party guilty of breach.

Finally, the court examined the difference between a contract obtained by fraud and a contract, which is perfectly valid, but its performance is vitiated by fraud. The former case will fall under the ambit of Section 17 of Contracts Act, 1872 however, the latter, considering that the act occurred after the contract was entered into, will be outside the scope of Section 17. If the fraud falls under Section 17, the contract is rendered voidable. On the other hand, where the fraud is committed outside the scope of Section 17, the guilty party shall be liable for damages but the innocent party will not have the option to rescind the contract. It is pertinent to mention that both these kinds of fraud come under the ambit of the word ‘fraud’ as regards the arbitrability of a dispute.

The court thereafter held that there existed no such fraud to vitiate the arbitration clause and render the dispute non-arbitrable. Further, there was no public policy element present in the dispute either. Considering that neither of the two aforementioned tests had been satisfied, the court held that HSBC had made out a strong prima facie case necessitating the injunctive relief, thereby rejecting the appeal.

In conclusion, the Avitel judgement reinforces the Hon’ble Supreme Court’s effort to strengthen the efficacy and efficiency of arbitrations in India. The court has continually adopted the stance which favours arbitration of disputes. Considering that the Avitel judgment has substantially reduced the scope of fraud rendering a dispute non-arbitrable, the judgement brings India a step closer to the standards of arbitration framework it strives to reach. The court, with this judgement, has established the tests on which the arbitrability of disputes involving allegations of fraud shall be ascertained and provided the scope of remedies available to the parties. The court held that the allegations of fraud will not allow parties to avoid arbitration unless the tests laid down by the court are satisfied. Hence, the Indian law on arbitrability of fraud is now on par with the settled law in countries like England and France.

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