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Are Matters Of Fraud Arbitrable?

Resolution of disputes via arbitration has increased in the recent past, with parties opting for 'out of court' settlements to resolve their contractual disputations. The Arbitration and Conciliation Act, 1996, an amalgamation of three statues namely, The Arbitration Act 1940, which was exclusively for Domestic Awards.

The Arbitration (Protocol & Convention) Act, 1937, which was exclusively for enforcement of Geneva Convention Awards, and The Foreign Awards (Recognition and Enforcement) Act, 1961, which was exclusively for enforcement of New York Convention Awards, provides for consolidation and amendments of the law relating to Domestic Arbitration, International Commercial Arbitration and enforcement of foreign awards. The noticeable legislative intent of the Statute is to bring the Domestic and International law in consonance with the Model Law.

Arbitrability and Underlying Concepts

The foremost obstacle that stands in the way of commencement of the resolution process is 'Arbitrability' of the disputed matter. Arbitrability refers to whether the scope, extent of the statute/ entirety of the arbitration mechanism covers within its ambit the varied subject matters in the realm of party nonconcurrences. Primarily as arbitration is a dispute resolution mechanism that the parties can opt for to resolve their disagreements, it is imperative that there exists a clause or a separate arbitration agreement[1] betwixt the concerned parties to refer their disputations to an arbitrator(s).

Since an arbitration agreement can either be concluded as a separate agreement, or as a clause within a contract between the concerned parties, the contractual concept of the Doctrine of Privity of Contract sure does creep in. Simply, that means, only parties to a contract are allowed to sue each other to enforce their rights and liabilities and no stranger (third party) is allowed to confer obligations upon any person who is not a party to contract.

Two crucial theories to be acquainted with - Firstly, Rights in Rem, a right exercisable against the world at large. Actions in rem are directed against a property itself and determine the rights of the parties exercisable against the public at large. Secondly, Rights in Personam, a right in personam is one exercisable against specific individuals. In personam proceedings, decide the personal rights and interests of the parties named in the action.

Why Arbitration Proceedings are in personam - Contracts being strictly between the parties who are signatories to it, bind and make liable only those parties i.e. all duties, obligations, responsibilities, liabilities arising out and in relation to the agreed contract only define the legal relationship between the parties agreeing to the instrument.

Thus, contracts express an 'in personam' relationship, and since choice of referring disputes to arbitration are mutually decided by the parties via a contract, the mechanism of arbitration as well arises from and extends only to 'in personam' relationships. This further flows from the ideology of arbitration being highly confidential and private along with being exceedingly autonomous i.e., party autonomy.

An important question that arises is concerned with the Jurisdiction to try Arbitrability of matters, which can be looked at in two aspects:
  • As under the repealed 1940 Act, in the case of Nigam Ltd[2] the Supreme Court held that, arbitrability of claims depends on the construction of the clause in the contract and on this point the finding of the arbitrator is not conclusive and that ultimately it is the court that decides the controversy.
  • On the other hand, the 1996 Act empowers the arbitrators to decide such question, as it incorporates the principle of Kompetenze - Kompetenze.[3]
The Doctrine of kompetenz-kompetenz indicates that an arbitral tribunal is empowered and has the competence to rule on its own jurisdiction, including determining all jurisdictional issues, and the existence or validity of an arbitration agreement.

The underlying object of this doctrine is to minimize judicial intervention in order to ensure that the arbitral process is not thwarted at the very threshold, merely because a preliminary objection is raised by one of the parties.

The principle of Competence of Arbitral Tribunals was substantiated by the Supreme Court in the landmark case of Global Mercantile[4] in 2021 wherein the court held that, "The doctrine of kompetenz - kompetenz implies that the arbitral tribunal has the competence to determine and rule on its own jurisdiction, including objections with respect to the existence, validity, and scope of the arbitration agreement, in the first instance, which is subject to judicial scrutiny by the courts at a later stage of the proceedings"

To roughly glimpse over the concept of Section 16 of the Act and equivalent to that Article 16 of the UNCITRAL[5], it is imperative to give a look at the concept of 'separability' pertaining to the jurisdiction of the Tribunals to try their own matters. Simply, separability principle allows the very existence of the arbitral proceeding, preserving the arbitration clause and thus making it possible to resolve the dispute even when the main contract is invalid. The perspective on this particular aspect of jurisprudence in fact flows from 'autonomy' of the arbitration agreement, which is nothing but a 'fundamental legal principle'.

As stated earlier, the very adoption of the provision of Article 16 into the Statute, is a pro-arbitration move. There is well developed jurisprudence on this topic as dealt by the courts. For instance, Hon'ble Justice Indu Malhotra discussed the application of the doctrine of Kompetenze-Kompetenze in Northern Coal Field Ltd[6], wherein the intent behind incorporation of this principle was thrown light upon, 'This doctrine is intended to minimise judicial intervention, so that the arbitral process is not thwarted at the threshold, when a preliminary objection is raised by one of the parties.'

Moreover, the question of arbitrability of a dispute can be raised at three stages, namely:
  1. Before a court on an application under Section 11[7] of the Act or on an application under Section 8 of the Act.
  2. Before the arbitral tribunal itself during the arbitration proceedings by filing an application under Section 16 of the Act. (by virtue of the doctrine of kompetenze-kompetenze)
  3. Before the court at the stage of challenge to the award or its enforcement, under Section 34 or Section 48 of the Act.

The Arbitration and Conciliation Act of 1996 being a consolidating act, provides for the concept of arbitrability in Part I - Domestic Arbitration as well as Part II - International Commercial Arbitration.

Part I of the Act expressly provides that it will not affect any other law by virtue of which certain disputes may not be submitted to arbitration, and there exists a valid ground for challenging the enforcement of an arbitral award. Perusal of the below mentioned provisions would give clarity -

Section 2(3) - This Part shall not affect any other law for the time being in force under which certain disputes may not be submitted to arbitration.

Section 34(2)(b) - the Court finds that—(i) the subject-matter of the dispute is not capable of settlement by arbitration under the law for the time being in force.

Moreover, Under the Indian Arbitration Act, enforcement of a foreign award can be refused if the subject matter of the dispute is not capable of settlement by arbitration under the law of India. Perusal of the below mentioned provisions would give clarity -

Section 48. Conditions for enforcement of foreign awards - (2) Enforcement of an arbitral award may also be refused if the Court finds that—(a) the subject-matter of the difference is not capable of settlement by arbitration under the law of India.

Section 57. Conditions for enforcement of foreign awards.—(1) In order that a foreign award may be enforceable under this Chapter, it shall be necessary that— (b) the subject-matter of the award is capable of settlement by arbitration under the law of India.

Case Laws on Arbitrability

A landmark judgment of the Supreme Court in Booze Allen[8] strictly observed that the question of arbitrability is to be decided on the basis of the 'nature of rights' involved in the dispute. If the dispute involves a right in rem, the dispute is not arbitrable. However, if a dispute involves a right in personam, the dispute is arbitrable - "only where the subject matter of the dispute fell exclusively within the domain of courts, could the dispute said to be non-arbitrable. In general, , a right in rem would not be arbitrable but a right in personam would be capable of adjudication in private fora."

The Supreme Court applied the test and carved out a list of six categories of disputes that are not arbitrable - disputes which give rise to or arise out of criminal offences; matrimonial disputes; guardianship matters; insolvency and winding up matters; testamentary matters; and eviction or tenancy matters; disputes arising out of a trust deed under the Indian Trust Act, 1882, which was added by the Decision of the Supreme Court in 2016[9].

The most recent judgement on this ambiguity, solidifying the jurisprudence is the case of Vidya Drolia[10]. Wherein the three-judge bench of the SC while dealing with a tenancy issue delved into the arbitrability of fraud dubiety and in such a light drew juxtaposed the courts and the arbitration tribunals.

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;
  4. when the subject-matter of the dispute is expressly or by necessary Implication non-arbitrable as per mandatory statute(s).

By applying the Vidya Drolia Test, the Supreme Court went on to 'expressly' overrule:
  1. N. Radhakrishnan v. Maestro Engineers[11] and held that allegations of fraud in a civil dispute are arbitrable.
  2. HDFC Bank Ltd. v. Satpal Singh Bakshi[12] holding that disputes falling under the jurisdiction of the Debt Recovery Tribunal created under the Recovery of Debts Due to Banks & Financial Institutions Act, 1993 are non-arbitrable.
  3. Himangni Enterprises v. Kamaljeet Singh Ahluwalia[13] to hold that tenancy disputes under the Transfer of Property Act, 1882 ("Transfer of Property Act") are arbitrable in as much as there is no exclusive jurisdiction vested in another specific forum to apply and decide any special rights and obligations.

Analysis of the jurisprudence of 'Arbitrability of Fraud' laid down by the courts throughout the years
In 2010, N. Radhakrishnan v. Maestro Engineers,[14] the Division Bench of the Supreme Court, stated that matters involving fraud and malpractices "cannot be" referred to arbitration.

In 2010, Afcons Infra Ltd v. Cherian Varkey Construction Co P Ltd,[15] the Division Bench of the Supreme Court enlisted certain non-arbitrable matters which comprised, inter alia, cases involving serious and specific allegations of fraud, fabrication of documents, forgery, impersonation, coercion etc.

In 2014, World Sport Group (Mauritius) Ltd. v. MSM Satellite (Singapore) Pte. Ltd.,[16] the Division Bench of the Supreme Court while dealing with a foreign seated arbitration held that every kind of fraud is arbitrable, there exists no reasonable differentia for this different approach for foreign and domestic arbitration.

In 2015, VBHC, Mumbai Value Himes (P) Ltd v. Laxam Bhoir,[17] a Single Judge of the Bombay High Court, held that if allegations of fraud were not such as would have required heavy documentary or oral evidence which the arbitrator could not have handled, it was held that the case deserved to be referred for arbitration.

In 2016, Ayyasamy v. Paramasivam,[18] the Division Bench of Supreme Court held that once the arbitration agreement was there, the court had no discretion to deviate from compelling parties to proceed for arbitration. It further held that, only a case of 'serious fraud' involving 'criminal wrong doing' was an exception to arbitration; and for that aspect, the Radhakrishnan's Ruling[19] would be apt.

The Court ruled that mere allegations of fraud, which touch upon the internal affairs of the party and has no implication in the public domain, cannot oust the jurisdiction of an arbitral tribunal. On the basis of burden of proof, the court held that a very heavy onus lay on the party trying to avoid arbitration to show that the dispute was not arbitrable. The court did not entirely go against Radhakrishnan's Ruling, stated that it had to be given a narrow interpretation rather than a broad one.

In 2018, Ameet Lalchand v. Rishabh Enterprises,[20] a Single Judge of the Supreme Court interpreted Section 8 of the Act and further followed Ayyaswamy[21] by upholding that only serious allegations of fraud were non-arbitrable, while mere allegations of fraud would indeed be arbitrable. Only in serious and complicated cases which warrant a case of criminal offence, requiring appreciation of evidence, would such complex issues be decided by the civil court.

In 2019, Rashid Raza v. Sadaf Akhtar,[22] a Three Judge Bench of the Supreme Court formulated a twin test to determine what constitutes a complex fraud -
  1. does this plea permeate the entire contract and above all, the agreement of arbitration, rendering it void
  2. whether the allegations of fraud touch upon the internal affairs of the parties inter se having no implication in the public domain.

In 2020, Avitel Post Studioz Ltd v. HSBC,[23] a Three Judge Bench of the Supreme Court referred the decision of Ayyaswamy[24] that - ONLY cases of serious fraud allegations which were equivalent to criminal offences. In this case, Radhakrishnan's Ruling[25] was termed as Bad Law and hence forth discontinued. The court came up with a two-pronged test in relation to the scope of arbitration w.r.t to fraudulent matters.
  1. The first scenario involves an arbitration agreement that cannot be said to exist - This would involve cases in which a party cannot be said to have entered into an agreement to arbitrate at all.
  2. The second scenario is where allegations of arbitrariness, fraud or malafide conduct are made against the "state or its instrumentalities".
In 2020, Decan Paper Mills v. Regency Mahavir,[26] a Three Judge Bench, wherein the Supreme Court relied on Avitel Post[27] and held that in the matter before hand, the tests were not fulfilled on the alleged fraud as the fraud lay within the scope of performance of the contract /under Section 17[28] of the Indian Contract Act, 1872, and hence referred the case to arbitration.

In 2020, Vidya Drolia v. Durga,[29] a Three judge bench of the Supreme Court while dealing with a tenancy issue delved into the arbitrability of fraud dubiety and in such a light drew juxtaposed the courts and the arbitration tribunals. Hence, observed that allegations of fraud could be made the subject matter of arbitration when they related to a civil dispute. The exception to this rule is a dispute arising out of fraud which would vitiate and invalidate the arbitration clause itself.

In 2021, NN Global Mercantile v. Indo Unique,[30] a Single Judge Bench of the Supreme Court once again reinforced the position in contemporary arbitration jurisprudence that civil aspect of fraud is arbitrable with the only exception being a fraud that went to the root of the underlying contract and impeached the arbitration clause itself. It was further clarified that criminal aspect of fraud that attracted penal consequences and criminal sanctions could only be adjudicated by a court of law since it may result in a conviction which falls in the realm of public law.

Analysis and Conclusion
Encapsulating the ideas of the article, it is certainly precise to aver that, when the allegation of fraud is serious, such would be deemed as a reasonable ground for not referring the dispute for arbitration. It is further evaluated that where the nature of fraud is serious there is a possibility of some criminal offense being attached to the allegation of fraud.

As evaluating criminal charges necessitates a thorough examination of pieces of evidence, witnesses, etc., it is thought that the civil courts would perform better in these situations than the arbitral tribunal. The parties' agreement cannot be declared invalid based on the charge of fraud simpliciter alone.

Accordingly, the disputes arising out of allegations of fraud can be duly resolved through arbitration if and only if the allegation does not include serious allegations. The very reason for dichotomising this ground of fraud is to offer a liberal construction of arbitration agreements not only widen the horizon and the scope of arbitration, but also to ensure speedy justice.

Thusly, fraud is arbitrable (fraud simpliciter) as well non-arbitrable (serious fraud). So as to summarise, to the extent that the fraud stretches to the whole of the contract i.e. the allegations of fraud permeating the entire contract, and subsequently questioning the very existence of the same, then the arbitrability has to be answered in negative, whereas, if there exists a mere fraud on the surface level, which can be treated as a 'civil' dispute per se, then the dispute can surely be referred to Arbitration.

In addition to the above stated stance of fraud as is interpreted by the apex court in varied decisions over the years, it is apropos to take into consideration the amendment ordinance of 2020[31] which in fact took the shape of the Arbitration and Conciliation (Amendment) Act, 2021.The said amendment has in fact accommodated an 'automatic stay' of a kind, on any such award that has been challenged due to presence of fraud in the underlying contract.

This addendum can be seen in the proviso which has been annexed to section 36 vide the 2021 amendment. It states that the court shall unconditionally stay an award pending disposal of the challenge under section 34, where a prima facie case is made that the underlying contract and the arbitration clause, or the making of the award itself was induced or effected by fraud or corruption.

Adjoining a provision comprising the grant of an unconditional stay is not nascent to the 1996 Act. Prior to the Arbitration and Conciliation (Amendment) Act, 2015[32], there did exist a grant for an automatic stay in the enforcement provision i.e. section 36, once the award had been challenged u/s 34 of the 1996 Act; and such stay remained until the 'setting aside' application was finally decided.

However, such a provision led to great misuse and opened a flood gate of litigations by simply permitting the award debtor to challenge the award and subsequently delay the enforcement of the same. Consequently, taking this into consideration the law commission in the 2015 amendment (post amendment) decided to do away with such a menacing provision by completely scrapping the grant of an unconditional stay, and replaced section 36. The post 2015 amendment era demanded the award debtor to file a separate application for staying the enforcement of the award, to be decided by the court, thus doing away with frivolous litigation.

However, the pattern of granting an automatic stay was refashioned by the law commission in the 2021 amendment. Now, the court would only grant such an unconditional stay if it is prima facie satisfied that arbitration agreement or contract or making of the award was induced by fraud or corruption.

This proviso is in the form of a mandate as the legislators have used the phrase 'shall', signifying no discretion whatsoever. Despite the 2021 amendment being restrictive in granting unconditional stays, the backlashes that might arise when the losing party makes false allegations of fraud would no doubt deter the arbitration proceedings.

End-Notes:
  1. Arbitration and Conciliation Act, 1996, s 7.
  2. UP Rajkiya Nirman Nigam Ltd vs Indure (P) [1996] 2 SCC 667 (Supreme Court)
  3. Arbitration and Conciliation Act 1996, s 16.
  4. NN Global Mercantile v. Indo Unique, 2021 SCC OnLine SC 13 (Supreme Court)
  5. UNCITRAL Model Law on International Commercial Arbitration 1985, art 16.
  6. Uttarakhand Purv Sainik Kalyan Nigam Ltd. v. Northern Coal Field Ltd [2020] 2 SCC 455 (Supreme Court)
  7. DLF Home Developers Ltd. v. Rajapura Homes Pvt. Ltd. & Anr., 2021 SCC OnLine SC 781.
  8. Booz Allen & Hamilton vs SBI Home Finance, [2011] 5 SCC 532 (Supreme Court)
  9. Shri Vimal Kishor Shah v. Jayesh Dinesh Shah & Others Civil Appeal No.8164/ 2016
  10. Vidya Drolia vs Durga, [2021] 2 SCC 1 (Supreme Court)
  11. [2010] 1 SCC 72 (Supreme Court)
  12. [2013] 134 D.R.J. 556 (Delhi High Court)
  13. [2017] 10 SCC 706 (Supreme Court)
  14. [2010] 1 SCC 72 (Supreme Court)
  15. [2010] 8 SCC 24 (Supreme Court)
  16. [2014] 11 SCC 639 (Supreme Court)
  17. AIR 2015 NOC 1127 (Bombay High Court)
  18. [2016] 10 SCC 386 (Supreme Court)
  19. [2010] 1 SCC 72 (Supreme Court)
  20. [2018] 15 SCC 678 (Supreme Court)
  21. [2016] 10 SCC 386 (Supreme Court)
  22. [2019] 8 SCC 710 (Supreme Court)
  23. 2020 SCC OnLine SC 656 (Supreme Court)
  24. [2016] 10 SCC 386 (Supreme Court)
  25. [2010] 1 SCC 72 (Supreme Court)
  26. AIR 2020 SC 4047 (Supreme Court)
  27. 2020 SCC OnLine SC 656 (Supreme Court)
  28. The Indian Contract Act 1878, s 17.
  29. [2021] 2 SCC 1 (Supreme Court)
  30. 2021 SCC OnLine SC 13 (Supreme Court)
  31. https://egazette.nic.in/WriteReadData/2021/225832.pdf
  32. https://lawmin.gov.in/sites/default/files/ArbitrationandConciliation.pdf

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