Arbitrability of fraud

Arbitrating in India can involve recalcitrant respondents trying to frustrate the proceedings, and claimants trying to bring claims that would ideally be litigated before courts. Unfortunately, the jurisprudence around whether a claim is arbitrable or not has not followed a consistent pattern yet it can have profound consequences for the parties involved.

With India-seated arbitrations, a court finding that a dispute is non-arbitrable will refuse to refer the dispute to arbitration, compelling the parties to litigate in court.

Conversely, an arbitral tribunal choosing to decide on a non-arbitrable issue could also have consequences.

If it is an India-seated arbitration, the award can be set aside. If it is a foreign-seated arbitration, Indian courts can refuse enforcement.

It therefore becomes essential to understand the state of play when it comes to understanding which disputes are arbitrable under Indian law including for the purposes of this article when there are allegations of fraud.

Starting at the beginning: Radhakrishnan v. Maestro Engineers 

The Indian Arbitration & Conciliation Act, 1996 (Arbitration Act) does not specify if a dispute becomes non-arbitrable when there are allegations of fraud.

Any discussion on the arbitrability of fraud in India under the current Arbitration & Conciliation Act (Arbitration Act) must begin at the Supreme Court of India’s decision in N. Radhakrishnan v. Maestro Engineers.

The dispute arose between partners in a partnership firm with one partner levelling allegations of malpractice and forgery against the other. The accuser expressed his intention to arbitrate the dispute in accordance with the arbitration agreement in the partnership deed. The partner, in response, approached the civil court to sue for a declaration that the accuser had stopped being a partner in the firm. The accuser pointed the civil court to the arbitration agreement, and asked the court to refer the dispute to an arbitral tribunal, as required under the Arbitration Agreement. The Supreme Court, in appeal, found that the case involved “allegations of fraud and serious malpractice”, and could therefore only be settled by a civil court with detailed evidence. It was not arbitrable.

The underlying logic

The Supreme Court explained why some disputes were incapable of being resolved by arbitration in Booz Allen Hamilton v. SBI Home Finance. The Supreme Court said that disputes relating to “rights in rem” (i.e., against the world at large) could not be resolved by arbitration, which was a private contractual mechanism. The court also provided examples of these kind of disputes such as criminal offences, divorce, child custody, insolvency, succession and eviction. However, it did not explicitly address the question of fraud.

The winding road since

A dispute over a partnership deed again reached the Supreme Court over questions of arbitrability amid allegations of fraud. In a 2016 decision in A. Ayyasamy v. A. Paramasivan, the Supreme Court moderated its finding in Radhakrishnan: the court said that mere allegations of fraud would not be enough to remove the dispute from arbitration and send it to a court.

The court said that the allegations needed to be serious enough to constitute a criminal offence, complex in nature, and require extensive evidence which made a court a more appropriate forum. Failing these, the court said alleging fraud could simply become a convenient device to avoid arbitration.

Elaborating on this, the Supreme Court explained in Rashid Raza v. Sadaf Khan in 2019 that there were two tests to judge whether a dispute involving allegations of fraud were arbitrable or not: (i) did the plea “permeate” the entire contract and leave the arbitration agreement void? and (ii) did the allegations of fraud have any implications in the public domain, or were they limited to the contracting parties?

Current state of play

The law on the subject is currently as the Supreme Court has set in its 2020 decision in Vidya Drolia v. Durga Trading Corporation. The court recognised that arbitration was an unsuitable mode of dispute resolution when the dispute affected parties who were not bound by the arbitration agreement, and these could only be resolved through litigation in court. It also agreed that the sovereign functions of the State (i.e., granting monopoly rights, executive power, taxation, police powers, etc.) were not arbitrable, just like State functions that had a public interest element, like marriage, citizenship, patents, etc.

However, it also said that complexity was not a good enough reason to avoid arbitration and overruled the decision in Radhakrishnan v. Maestro. It found that allegations of fraud could be subject to arbitration when they related to a civil dispute. A limited exception was carved out where fraud which would vitiate the arbitration agreement would make the dispute non-arbitrable.

The Supreme Court’s decision in Vidya Drolia marked a welcome move away from a distrust of arbitration as a mechanism and should serve to clarify and limit the circumstances in which a party attempts to allege fraud simply to avoid arbitration.

Review the latest judgement on arbitrability of disputes: