January 28, 2022

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Demystifying the notion of fraud and arbitration – special reference to the case of Rashid Raza v. Sadaf Akhtar

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Image source: https://blog.ipleaders.in/significance-choosing-seat-arbitration-comparative-analysis/

This article has been written by Matisha Bansal, pursuing a Certificate Course in Arbitration: Strategy, Procedure and Drafting fromLawSikho. It has been edited by Prashant Baviskar (Associate, LawSikho) and Ruchika Mohapatra (Associate, LawSikho).

It has been published by Rachit Garg.

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In recent years, the number of disputes has increased. Coupled with the low disposal rate, our judicial system is witnessing one of the largest backlogs with more than 4.5 crore cases pending before all the courts throughout India, as on 15th September 2021. This has led to a situation of exorbitant delays in the adjudication and settlement of the disputes. The judicial system and the government, in its endeavor to achieve its aim of “speedy disposal of cases and reduction in pendency of cases” has heavily emphasised  on the adoption of alternative dispute resolution mechanisms and has endorsed a pro-arbitration regime both in terms of judicial pronouncements and amendments to the Arbitration and Conciliation Act, 1996

With the advent of commercial activities in India, the need for alternative dispute resolution (ADR) is more pressing than ever. The strengthening of the arbitration regime has provided a boost to the commercial market and has replaced the traditional perception from litigation to ADR. Unlike court proceedings, which can take years to resolve conflicts between parties, arbitration in the commercial disputes has established itself as a medium that provides an effective and quick dispute resolution framework. Parties resort to arbitration because it allows for a faster resolution and disposal of issues between the parties and offers little room for dispute extension. As a result, it encourages foreign investors to invest in India and reassures international investors about the Indian legal system’s ability to provide a quick, low-cost, and flexible dispute settlement mechanism.

In the past few months, we have witnessed some critical developments in the legal position on  arbitrability in general and ‘arbitrability of fraud’ in particular, both on the legislative and the judicial front. The present article attempts to briefly examine these developments in the backdrop of earlier judicial pronouncements on this subject. 

Arbitrability refers to whether a specific type of issue may be resolved by arbitration. In practice, arbitrability determines whether the subject matter of a claim is reserved to domestic courts under national law. Arbitrability is the rule in India’s existing legal structure, while non-arbitrability is the exception. The Indian Arbitration Act, 1996, which is substantially based on the UNCITRAL Model Law, takes the universally preferred strategy of limited judicial intervention. Non-arbitrability, on the other hand, is unquestionably a thorn in the side of arbitration.

Section 2(3) of the Indian Arbitration Act specifically states that  Part 1 of the act shall not override any other law whereby certain issues cannot be submitted to arbitration. It also allows Indian courts to overturn an arbitral award if the subject matter of the dispute is determined to be incapable of resolution by arbitration under the current law. Further, if the subject matter of the dispute is not capable of resolution by arbitration under Indian law, enforcement of a foreign decision can be rejected under the Indian Arbitration Act. The impossibility of enforcing a foreign award due to non-arbitrability is not limited to India. In fact, the rules of the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958 (the New York Convention) and the Convention on the Execution of Foreign Arbitral Awards, 1927 form the basis of Indian law on this topic (the Geneva Convention).

As a result, while the Indian Arbitration Act, like the Model Law, makes an implicit reference to non-arbitrability, it neither defines arbitrability nor specifies any group of disputes as non-arbitrable. The law in this area has mostly evolved as a result of judicial decisions. The Supreme Court’s decision in Booz Allen marks a defining moment in arbitration law, emphasizing the significance of establishing the arbitrability of a case before submitting to it. In cases concerning non-arbitrability, Booz Allen’s ratio and list of non-arbitrable disputes are regularly cited. The Supreme Court’s most recent, and possibly most thorough, judgement on the subject is Vidya Drolia. The conjunctive reading of the list provided in Booz Allen and Vidya Drolia, explicitly provides a comprehensive list for subject matters which are non-arbitrable. 

The analysis of arbitrability in India would be incomplete without mentioning the outcome of conflicts involving allegations of fraud. While this has been a difficult issue for many years, with talks beginning with the Supreme Court’s ruling in the case of Abdul Kadir v Madhav Prabhaka, the Supreme Court’s controversial decision in the case of N. Radhakrishnan v Maestro Engineers was seen as a major setback. This decision excluded instances involving significant charges of fraud that needed a thorough investigation and the submission of extensive evidence from the scope of arbitration. Such concerns, according to the Court in Radhakrishnan, are best addressed by a civil court because they cannot be effectively handled by an arbitrator.

However, in line with recent pro-arbitration developments in India, the Supreme Court has clarified and, hopefully, settled, the position on arbitrability of disputes involving allegations of fraud in the last five years, including the most recent decisions in A. Ayyasamy v Paramasivam and others, Rashid Raza v. Sadaf Akhtar, Vidya Drolia and Global Mercantile Private Limited v Indo Unique Flame Limited and others. This article seeks to demystify and analyze the concept of arbitrability and fraud in consonance with the decision rendered by the Hon’ble Supreme Court in Rashid Raza v. Sadaf Akhtar, following the same pro-arbitration spirit.

The Dispute arose from a ‘Partnership Deed’ between the parties dated January 30, 2015. Rashid Raza operated as a partner in S.R. Coating, a partnership firm created in lieu of the abovementioned Partnership Deed. Sadaf Raza, another partner, initiated  criminal proceedings against Rashid in November 2017 by submitting a first information report under Sections 406, 467, 468, 471, 472, and 420 of the Indian Penal Code. The conflict arose from charges of fund syphoning, money laundering, cheating, and making up fake contracts and other business improprieties. On the other hand, the Appellant i.e Rashid filed an applicant pursuant to Section 11 of the Arbitration and Conciliation Act, 1996 in the High Court of Jharkhand in Ranchi, seeking the appointment of an arbitrator under the arbitration clause in clause 15 of the partnership deed between the parties.

The Respondent argued in front of the High Court that the case involved a serious case of fraud that should not be decided through arbitration. The Respondent argued, inter alia, that the Petitioner (Appellant) had used the assets of the partnership firm “S.R. Coating” in another firm run by his father, created a proprietorship firm with the same name “S. R. Coating,” and introduced it to one of the firm’s existing business partners—Reliance Industries Ltd., opened a brand-new bank account based on a fictitious agreement, and transferred cash into the Petitioner’s bank.

The Hon’ble High Court heavily relied on Swiss Timing v. Common-wealth Games, and A. Ayyasamy v. A. Paramasivam, while considering the facts of the case. It outlined the Ayyasamy case’s paragraphs 14, 15, 18, 23, and 25. The court then stated, using paragraph 26 of Ayyasamy, that the simple allegation of fraud is not sufficient to negate the impact of the parties’ arbitration agreement. The court then recorded the circumstances in Ayyasamy’s case, stating that the arbitration clause “may be rejected by the Court” and therefore found that the allegations of fraud are complex and can only be resolved by a civil court based on a thorough examination of the evidence. Furthermore, it was not a case of a simple charge of fraud simpliciter, which could not be used to invalidate the impact of the parties’ arbitration agreement.

Further the court reiterated the principles laid forth in Ayyasamy case by the Apex Court and then separated the facts of this case from those in Ayyasamy’s case, ruling that the current facts “are substantially more complex” and “may require voluminous evidence that can only be legitimately conducted by a civil court of competent jurisdiction.” 

The Appellant, dissatisfied with the High Court’s decision, filed a Special Leave Petition with the Supreme Court.

Issues raised

  1. Whether the allegation of fraud was a valid ground for nullification of an arbitration clause enshrined in a partnership agreement?
  2. Whether the fraud was classified as simple fraud or complex fraud?

The Hon’ble Bench clarified the law governing the arbitrability of disputes involving allegations of fraud and examined the law laid down in Ayyasamy’s case. The division bench in Ayyasamy’s case had asserted that matters involving simple allegations of fraud and pertaining to the internal affairs of the parties would not actually impact the arbitration agreement and the contract under which the parties would be referred to arbitration. Meanwhile, in cases where serious allegations are made, the court should not refer such matters to arbitration because civil courts are better equipped to deal with such matters. The Hon’ble Supreme Court also distinguished between a serious allegation of fraud and a simple allegation of fraud, with the latter not permeating the entire contract and arbitration agreement. The Division Bench clarified this distinction further by illustrating and providing categories of the serious allegation of fraud as provided in the Ayyasamy’s Case:

  • Allegations that would constitute a criminal offence.
  • Allegations of fraud which are so complicated in nature that it is necessary for such complicated issues to be determined only by civil court based on the analysis of copious evidence that requires to be produced before the courts of competent jurisdiction.
  • Serious allegations involving document forgery/fabrication in support of a fraud plea.
  • Where fraud is alleged against the arbitration provision itself or is of such a nature that it vitiates the entire contract, including the agreement to arbitrate, implying that in those cases where fraud goes to the validity of the contract itself or the validity of the arbitration clause itself.

In this case, the Apex Court reaffirmed the above-mentioned law as laid down by the division bench in the Ayyasamy’s Case and held that the controversy between the parties falls within the purview of “simple allegation” and pertains to their internal affairs, and thus the High Court erred in dismissing the appellant’s application. Thus, if allegations of fraud between the two disputing parties do not affect the public at large, the disputes can be settled through arbitration.

In this case, the Supreme Court augmented on the Division Bench decision and structured the approach to be taken in determining the serious allegation of fraud. From the Division Bench decision, the Court derived two working tests:

  1. “Does this plea permeate the entire contract and above all, the agreement of arbitration, rendering it null and void?
  2. Whether the allegations of fraud touch upon the internal affairs of the parties inter se having no implication in the public domain?”

The above-mentioned twin tests now serve as a framework for litigators and arbitrators dealing with issues pertaining to fraud when adjudicating cases. Therefore, as result of the preceding discussion and legal position, it can be concluded that the matters involving allegations of fraud are arbitrable if they fall within one of three categories:

  1. Simple allegations that have no consequence in the public domain.
  2. The allegation does not render the entire contract null and void; and
  3. The allegation does not vitiate the entire arbitration agreement.

Relying on the twin tests and reasoning culled out in this case, the Apex Court held in this matter that the allegations of fraud in the present case neither infringe the partnership deed as a whole nor nullify the arbitration agreement contained within. Moreover, it was also observed that allegations pertaining to siphoning of funds and other alleged business improprieties do not have any impact in the public domain and pertain to the internal affairs of the parties. 

The Supreme Court concluded that the allegations are arbitrable because they fall within the definition of ‘simple allegations’ and can be aptly decided before the Arbitral Tribunal. Thus, it set aside the High Court’s decision and proceeded to appoint Justice Amareshwar Sahay, retired judge of the Jharkhand High Court, as an arbitrator under Section 11 of the Act to resolve the parties’ disputes without affecting the investigation being conducted pursuant to the FIR.

The findings of the Apex Court in the present matter were heavily reliant on the series of landmark judgments rendered by the Supreme Court of India on the matter of Arbitrability of Fraud. The Supreme Court’s decision in Abdul Kadir Shamsuddin Bubere V. Madhav Prabhakar Oak (“Abdul Kadir”) began a line of decisions on the arbitrability of fraud. The three Judge Bench of the Supreme Court observed that, while relying on various English decisions such as Russel v. Russel, where a dispute pertains to fraud of any kind, and it cannot be decided before an arbitral tribunal (even if the accused does not desire to initiate the matter in court of law), because the questions related to  fraud involve complex factual issues, then such an issue must be resolved in a court of law. In such a case, the jurisdiction of the arbitrator would have to be plausible in order to be overturned. Although this case was decided during the regime of the 1940 Act, but the passivity of the erstwhile legislation established it as a  law that continued to be followed in the current regime.

Further, in the case of N. Radhakrishnan v. Maestro Engineers, wherein the dispute pertained to allegations of accounting malpractices and record manipulation by the partnership firm, the Apex Court attempted to depend largely on the decision rendered by it in the Abdul Kadir case, wherein it observed that where circumstances give rise to serious allegations of fraud, such disputes must be mandatorily tried in the open court and while rendering this decision, and rejected the application before it under Section 8 of the 1996 Act. This simple-minded refusal to assign the disputants to arbitration altered the course of this case. 

The Supreme Court not only ignored its own decisions in Hindustan Petroleum Corp. Ltd. v. Pink City Midway Petroleums and P. Anand Gajapathi Raju v. P.V.G. Raju, but it also ignored the issue of a party being able to circumvent the arbitration agreement based on simple allegations of fraud. The Supreme Court in Radhakrishnan also ignored the fact that, in stark comparison to the Arbitration Act of 1940, the framework of reference under Section 8 of the Arbitration Act of 1996 was profoundly different, with reference to arbitration being imperative upon the existence of an arbitration agreement. The Radhakrishnan decision reversed the approach to arbitration in India, rendering arbitration clauses obsolete and increasing the scope for judicial intervention.

The question of arbitrability of a matter simply means whether such a matter can be arbitrated or not but the same has not been explicitly defined in the 1996 Act. Further, the act also fails to provide a conclusive list of the matters which are excluded from the purview of the Arbitration. This issue was endeavored to be resolved by the Hon’ble Supreme Court in Booz Allen Case, wherein the court defined the essence of arbitrability and also threw some light on the disputes that were excluded from the purview of arbitration. The biggest dispute with respect to arbitrability remained in the matters involving allegations of fraud. This question was specifically discussed at length by the Hon’ble Supreme Court in A. Ayyasamy’s case, and this decision proved to be a welcome relief in the domain of fraud pertaining to disputes arising under a contract with an arbitration clause. In the Ayyasamy case, the Supreme Court was dealing with an application brought by the appellants pertaining to Section 8 of the Arbitration Act, which was met with opposition on the grounds that the applicants committed acts of fraud and the dispute could not be arbitrated. The lower courts, relying on the Radhakrishnan case, dismissed the reference to arbitration, citing allegations of fraud. The Supreme Court overturned the lower courts’ findings, holding that a mere allegation of fraud cannot be used to nullify the effect of the parties’ arbitration agreement. Rather than determining whether it has jurisdiction, the Court focused on whether its jurisdiction has been revoked.

It was decided that a request for arbitration should be denied only if the accusations are serious and complicated, necessitating extensive evidence and a court trial. The Supreme Court’s decision was consistent with the principle of kompetenz kompetenz (articulated in Section 16 of the Act), which states that the arbitral tribunal has the authority to decide on its own jurisdiction.

It is worth noting that the Ayyasamy case (decided by a Bench of the same strength as the Radhakrishnan case) did not expressly overrule the Radhakrishnan case, but instead established criteria for distinguishing between cases involving serious allegations of fraud and cases involving simpliciter allegations of fraud, the latter being non–arbitrable.

In order to assess the ‘seriousness’ of fraud, the Supreme Court devised the twin test and thereafter, the twin test so devised in A. Ayyasamy’s case was applied to facts of the present case i.e Rashid Raza and the Supreme Court’s three-judge bench limited and structured the scope of arbitrability pertaining to matters involving fraud by establishing the twin tests and has impliedly overruled the judgment of Radhakrishnan’s case. 

Since the decisions rendered in Ayyasamy’s case and Rashid Raza’s case, the test underlying the determination of arbitrability of fraud has evolved significantly. Nevertheless, the issue arose before the Supreme Court again in the Avitel Post Studioz Ltd. Vs HSBC PI Holdings (Mauritius) Ltd., from an order issued under Section 9 of the 1996 Act for interim measures sought by a foreign party award-holder. In this matter, while entering into a contract with Avitel Group, HSBC claimed fraudulent inducement. The award was rendered in favour of HSBC, supporting its claims. Following that, HSBC sought interim measures in Indian courts, but Avitel argued that there were serious allegations of fraud and other criminal cases pending, and thus no orders should be issued. After careful consideration of the facts, the Supreme Court enforced the twin test established in the A. Ayyasamy’s case and applied in Rashid Raza’s case and determined that the false representation, allegations of impersonation, and diversion of funds were between the parties and lacked “public flavor.” As a result, the Supreme Court rejected the appeal and reaffirmed the orders under Section 9 of the 1996 Act. Further, the Court asserted the legal position on arbitrability of fraud and extended it to when dealing with the application for interim measures.

As a result, in any matter involving ‘fraud’ under Section 17 of the Contract Act of 1872 or tort of deceit, given the fact that criminal proceedings have already been undertaken in relation to the same subject-matter, it does not ultimately mean that an issue that is otherwise arbitrable after applying the twin test, ceases to become so, solely on account of the criminal proceedings.

Furthermore, the Supreme Court ruled in Booz Allen’s case, as well as in Afcons Infrastructure Limited v Cherian Varkey Construction Co (P) Limited, that cases arising from criminal offences were not arbitrable. In this regard, the Apex Court in Avitel stated that the same set of facts can have both criminal and civil consequences. The Court held, after referring to various decisions dealing with the potential overlap of civil and criminal proceedings, as follows:

“In the light of the aforesaid judgments, paragraph 27(vi) of Afcons (supra) and paragraph 36(i) of Booz Allen (supra), must now be read subject to the rider that the same set of facts may lead to civil and criminal proceedings and if it is clear that a civil dispute involves questions of fraud, misrepresentation, etc. which can be the subject matter of such proceeding under section 17 of the Contract Act, and/or the tort of deceit, the mere fact that criminal proceedings can or have been instituted in respect of the same subject matter would not lead to the conclusion that a dispute which is otherwise arbitrable, ceases to be so.” 

The Supreme Court’s decision in Avitel was affirmed in Deccan Paper Mills Co. Ltd. v. Regency Mahavir Properties and Vidya Drolia’s case. Further, the Supreme Court in Vidya Drolia’s case explicitly overturned the law established in Radhakrishan’s case and clearly stated that, as long as the issue is civil in nature, allegations of fraud could be referred to arbitration.

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Further, the Hon’ble Supreme Court in the most recent judgment in Global Mercantile Private Limited v Indo Unique Flame Limited and others, was requested to examine in this case if a dispute involving allegation of fraudulent invocation of a bank guarantee can be submitted to arbitration. After evaluating the legislation and debating judicial precedents, most of which are discussed above, the Court stated unequivocally that the civil facet of fraud is arbitrable in nature. The sole exception is if the accusation is that the arbitration agreement itself is tainted by fraud or fraudulent enticement, or if the fraud affects the validity of the main contract and thus invalidates the arbitration clause. Prominently, the Court observed that in modern arbitration practice, tribunals are accustomed to reviewing large amounts of documentation. This statement was made in the context of the Court’s previous belief that civil courts alone would be best suited to dealing with complex matters involving voluminous evidence. The Court stated unequivocally that using allegations of fraud to affirm non-arbitrability is a “wholly archaic view, which has become obsolete, and deserves to be discarded.”

The Court agreed with previous decisions in noting that the criminal facet of fraud, forgery, or fabrication, which will also result in penal implications and punitive measures, could only be properly investigated by a court of law. These are matters of public law because they may result in a conviction.

On the particular issue of invoking a bank guarantee, the Court determined that the dispute was arbitrable because it arose from disputes between parties inter se and did not fall under the purview of public law.

This decision used a landmark decision to reestablish the importance of arbitration in the present era. Arbitration enables individuals to resolve their differences in a way that preserves personal relationships, and it also reduces the burden on India’s already overburdened courts. Simple allegations of fraud, which can be handled by competent arbitrators, should never be allowed to consume the judiciary’s time. Thus, Justice R.F Nariman was prudent to dismiss the case and place it in the jurisdiction of a sole arbitrator who would just go over the evidence and facts and resolve the disagreements among the parties.

The High Court of Jharkhand overlooked the test established in the A. Ayyasamy case, ruling that the fraud constituted “serious fraud” that could not be resolved through arbitration. The Supreme Court made the correct decision in overturning this decision by granting the petitioner’s request for the referral of the dispute to an arbitrator. The Supreme Court and the legislation have time and again reaffirmed the necessity of a well-developed arbitration regime with minimal judicial interference and to establish this intent a reference can be made to the observation laid down in Para 28 of the Swiss Timing case, wherein it was held that “To shut out arbitration at the initial would destroy the very purpose for which the parties had entered into arbitration.”

The essence of arbitration seems to have been upheld in this case by employing the necessary precedents and legislations. Thereupon, I emphatically concur with the decision and the reasoning employed by the Supreme Court’s while upholding the validity of Application under Section 11 of the 1996 Act referred by the Appellant. Further in my opinion, this case is crucial in determining the position of arbitration in litigation concerning the white-collar crimes. It has also been quoted in N.N. Global Mercantile Pvt. Ltd. vs. Indo Unique Flame Ltd. and Ors, attempting to establish itself as a constructive precedent that reinforces the corporate world’s faith in arbitral proceedings in India.

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