Arbitration Reforms: The Case for Statutory Recognition of Arbitrability of Fraud

While recent judgements have attempted to address the controversy surrounding the arbitrability of fraud, a comprehensive solution is still lacking.
Payal Chawla
Payal Chawla

The Government of India has recently constituted an expert body to review the Arbitration and Conciliation Act, 1996 and propose reforms. One important reform would be the statutory recognition of arbitrability of fraud and to put an end to the ambiguity surrounding the issue.

In India, the arbitrability of fraud has been developed entirely by case law, and there has never been a statutory bar to arbitrability of fraud. In the case of Abdul Qadir Shamshuddin Bubere v. Madhav Prabhakar Oak (1962 AIR 406), the Supreme Court held that if serious allegations of fraud were made against a party, and that party desires that the matter be tried in open court, the court could refuse to refer the matter to arbitration. Despite the context of the decision being specific to the 1940 arbitration act, the Abdul Qadir case became the authoritative precedent against arbitrability of fraud in India, even though its observations were in obiter and limited to the right of a party to defend their good name in a public forum. Curiously this decision was based on an 1880 English case of Russel v. Russel (50 Md. App. 185 (1981) 436 A.2d 524), which held that serious allegations of fraud could be grounds for courts to decline reference to arbitration.

Importantly, in England, the debate was put to rest in 1979 with the case of Paczy v. Haendler & Natermann GMBH (No. 1) ([1980] EWCA Civ J1204-5), which held that courts had no discretion to set aside an arbitration agreement in cases of fraud in international commercial arbitrations. This principle was later codified in the UK Arbitration Act of 1996. Although statutorily there is a disparity between international and domestic arbitrations in the UK, the courts are inclined to send parties to arbitrate even in cases of fraud, and Russel is largely viewed as a pro-arbitration judgement.

The problem was further complicated by the Supreme Court's decision in N. Radhakrishnan v Maestro Engineers ([(2010) 1 SCC 72]). This decision was incorrect for several reasons, including being against the established principle that Section 8 is mandatory. The judgement was per incuriam, as it failed to distinguish the case of Hindustan Petroleum v. Pinkcity Midway Petroleum (2003 AIR SC 2881) and did not mention the case of Anand Gajapathi Raju v. P.V.G. Raju ((2000) 4 SCC 539).

The 246th Law Commission also expressed doubts about the correctness of the N. Radhakrishnan decision and recognized the conflicting decisions of the Supreme Court. The Commission recommended making fraud explicitly arbitrable by including Section 16(7), and stated that it “was important to set this entire controversy to rest and make issues of fraud expressly arbitrable” and proposed the inclusion of Section 16(7) to make fraud, including “serious question of law, complicated questions of fact or allegations of fraud, corruption etc.” arbitrable. Unfortunately, the proposed Section 16(7) was not included in the Arbitration and Conciliation (Amendment) Act, 2015, which is perplexing, considering that the language of Section 8 became more stringent with these amendments.

The case of A. Ayyasamy v A. Paramasivam, ((2016) 10 SCC 386), delivered after the 2015 amendments, was a missed opportunity to make fraud arbitrable. It was confounding that the judgement relied on the Black's Law Dictionary definition of fraud, as opposed to Section 17 of the Contract Act. The judgement also side-stepped the issue of void and voidable contracts.

Although Ayyasamy diluted the N. Radhakrishnan decision, it did not overrule it. Unfortunately, Ayyasamy added to the uncertainty by relying on a distinction between “serious fraud” and “fraud simpliciter”, which does not exist in law. While, the Court held that disputes involving alleged fraud or fraud simpliciter would be arbitrable, it also stated that issues related to serious fraud involving criminal wrongdoing would not be arbitrable. It is worth mentioning that Justice Chandrachud, in his concurring opinion, relied on the Fiona Trust and Holding Corpn. v Privalov ([2007] UKHL 40), which allowed arbitration even in cases involving bribery, thereby suggesting that all disputes related to fraud, whether simple or complex, should have been arbitrable. The limitation on arbitrability should have been limited to cases where the fraud affects the arbitration agreement itself. The two concurring judgements contain numerous propositions that appear contrary to one another, and it is challenging to extract a clear ratio therefrom.

In 2019, the Supreme Court had the opportunity to address the issue of arbitrability of fraud once again. Within a span of one year, three important decisions were delivered: Rashid Raza v Sadaf Akhtar (2019) 8 SCC 710, Avitel Post Studioz Limited v. HSBC Pi Holdings (Mauritius) Limited (2020 SCC OnLine SC 656), and Deccan Paper Mills Co. Ltd. v. Regency Mahavir Properties (2020 SCC OnLine SC 655).

Although the Supreme Court attempted to clarify the law and implicitly overruled Ayyasamy, it fell short of explicitly doing so. In Rashid Raza, a three-judge bench clarified that the  ratio of Ayyasamy's case was in paragraph 25, and not in paragraph 26. The Court also set out a “Two working test” formula for making a distinction between serious allegations of forgery/fabrication on the one hand, and “simple allegations” on the other -  i.e. “does this plea permeate the entire contract and above all, the agreement of arbitration, rendering it void, or (2) whether the allegations of fraud touch upon the internal affairs of the parties inter se having no implications in the public domain”.

As a general proposition of arbitrability, there is no quarrel with this test. Seen in that context,  (i) if a contract is void, and/or (ii)  if the dispute deals with rights in rem, it would not be arbitrable. However, when seen in the context of fraud, the first test is problematic – primarily because an allegation of fraud would not render an agreement void ab initio, and instead would merely make the contract in question, voidable. Respectfully, the court cannot at the prima facie stage test an agreement for arbitrability, if the contract is merely voidable.

A year later, the Supreme Court in Avitel was “inclined to adopt” the “reasoning” of the Single Judge in Swiss Timing v. Organizing Committee ((2014) 6 SCC 677) and observed that the same had “strong persuasive value”, even though it did not have precedential value. The Court also observed that N. Radhakrishnan had been “found to be wanting” and had been “tackled on the judicial side”. Avitel was affirmed by a three-judge bench in Deccan Paper Mills Co. Ltd. v. Regency Mahavir Properties (2020 SCC OnLine SC 655).

Swiss Timing is perhaps the most significant judgment on the arbitrability of fraud. Unfortunately, it was delivered in the context of Section 11 of the Arbitration and Conciliation Act, and lacks precedential value in view of State of West Bengal v. Associated Contractors (2015 SCC 1 32). It is the only judgment that addresses the distinction between void and voidable agreements and correctly applies the law regarding the arbitrability of fraud in that context.

An agreement that is void means it never becomes a contract, while a contract can be voidable under certain circumstances as defined in Sections 19 and 19A of the Contract Act. Fraud, as defined in Section 17 of the Contract Act, vitiates free consent and makes a contract voidable, but not void ab initio. The party whose consent was obtained through fraud can choose to proceed with the contract. Swiss Timing emphasized that a court should refer parties to arbitration unless there is a prima facie finding of no valid arbitration agreement. Sections 8 and 11 of the ACA are complementary provisions, and it is also settled law that the determination at this stage is prima facie, not final.

So while the final death knell was cast on N. Radhakrishnan, and Swiss Timing was relied upon, sadly, Avitel did not return a finding specifically with regard to “void” and “voidable” agreements in the context of fraud. And the confusion with regard to arbitrability of fraud has continued to perpetuate.

Additionally, the distinction between complicated fraud and fraud simpliciter is artificial and lacks a statutory basis in the Contract Act or criminal law. Any notion of complicated/simpliciter fraud is perilous for  litigants – a finding at the prima facie stage by a court of fraud being complicated, serious and/ or simple, could prejudicially affect the merits of a case. 

There is no inherent conflict between criminal and arbitral proceedings, as both can coexist. Many arbitrators are experienced retired judges or well-trained professionals, capable of handling complex cases. Giving statutory recognition to arbitrability of fraud would bring certainty and consistency to the legal framework. It would prevent parties from exploiting ambiguity to delay or obstruct arbitration.

Numerous jurisdictions have already codified fraud as arbitrable. Enacting legislation in India would demonstrate a commitment to promoting arbitration and aligning with international practices.

The controversy surrounding the arbitrability of fraud has resulted in inconsistent decisions and legal uncertainty. While recent judgements have attempted to address the issue, a comprehensive solution is still lacking. Legislative intervention is necessary to settle the matter conclusively.

Payal Chawla is a practicing advocate specializing in arbitration and commercial litigation and is the founder of JUSCONTRACTUS.

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