Allegation of fraud cannot be used to defraud an arbitration agreement – Indian Supreme Court's ruling on arbitrability

The background

Prior to Avitel the position of Indian courts regarding arbitrability of matters where an allegation of fraud was raised was, arguably, in a state of flux. In an earlier decision, in the case of Maestro Engineers,^[2] the Indian Supreme Court had held that in cases of "serious allegations of fraud", where there was an arbitration agreement, the case should still be tried in a court of law. However, subsequent decisions of various Indian courts had sought to rationalize this judgment and had added further gloss to this test. The result of this? A convoluted position in India regarding arbitrality of matters where 'fraud' was alleged by a party. Fortunately though, in an arbitration friendly decision, the Indian Supreme Court has now clarified the true construct of "serious allegation of fraud", through the Avitel judgement.

The facts at hand

HSBC had entered into a Share Subscription Agreement ("SSA") and Shareholders' Agreement ("SHA") with the Appellants. Both the SSA and SHA contained an arbitration clause which provided for a Singapore-seated arbitration. 

HSBC subsequently claimed that it entered into the SSA and SHA in reliance on fraudulent representations by Avitel. HSBC also alleged that monies had been siphoned off by the Appellants to related companies. HSBC thus commenced arbitration in Singapore and subsequently obtained an award in its favour which it then sought to enforce in India. Pending arbitration, HSBC had also sought injunctive relief – under section 9 of the Arbitration and Conciliation Act, 1996 (the "Act").

The appeal before the Supreme Court concerned the judgment and order of the Division Bench of the High Court of Judicature at Bombay in relation to HSBC's section 9 proceeding. In the section 9 proceeding, it was held, inter alia, that it could not be said that the dispute was not arbitrable because of an allegation of fraud made by HSBC, since the allegations of fraud and misrepresentation were in the contractual context, and thus had an inter-partes civil profile – and not an issue of Indian public policy.

The issue before the Supreme Court was whether for the purposes of the section 9 proceeding (i.e. interim measures in aid of arbitration), HSBC could be said to have a strong prima facie case in the enforcement proceedings. This, in turn, depended on the substantive law in India qua arbitrability when allegations of fraud are raised by one of the parties to the arbitration agreement.

The Supreme Court's ruling

After a comprehensive analysis of the jurisprudence, the India Supreme Court held that only "serious allegations of fraud" would remove a dispute from the ambit of an arbitration clause.

In this regard, the Indian Supreme Court clarified that the "serious allegation of fraud" threshold is only met if one of the following two tests is satisfied, and not otherwise.

• First, where it can be said that the arbitration clause or agreement itself cannot exist, due to inability of the party to enter into the arbitration agreement – either due to fraud or other specified reasons in the Contract Act, 1872 (the "Contract Act").
  
  
• Second, where allegations of fraud are made against the State or its instrumentalities, thus necessitating the hearing of the case by a writ court. In such cases the questions raised are not predominantly questions arising from the contract itself or breach thereof, but rather questions arising in the domain of public law and policy.

Further, the court observed that the fact that a criminal proceeding can, or has been, instituted in respect of the same (civil) subject matter would not itself vitiate a party's ability to follow arbitration as a commercial or civil remedy.

The court also drew a distinction between a contract which was obtained by fraud and performance of an otherwise valid contract being vitiated by fraud. The court held that the latter scenario falls outside section 17 and 19 of the Contract Act – making a contract voidable at the option of the defrauded party. As such, where fraud is involved in the performance of the contract – as opposed to the formation of the contract – damages would be available, but the innocent party is not entitled to rescind the contract. However, both kinds of fraud are subsumed within the expression of "fraud" when it comes to arbitrability of an agreement containing an arbitration clause.

On the facts, the court also held that in Avitel there was no fraud that would vitiate the arbitration clause itself, which in any event, was separate and distinct from the underlying contract(s). Crucially, the false representations made and diversions of funds were inter parties and had no "public flavor", so as to attract the fraud exception. Prima facie, the contracts were induced by fraud and thus voidable under section 17 and 19 of the Contract Act whilst the siphoning of money amounted to a tort of deceit for which damages would be available.

How does this benefit you?

This case is important in that it clarifies the law regarding the arbitrability of disputes in the face of allegations of fraud. In this regard, the pro-arbitration approach taken by the Indian Supreme Court is much welcomed.

From a practical perspective, the decision also limits the extent to which an award can be challenged on the basis of arbitrability and public policy (i.e. the allegation of fraud must go beyond fraud simpliciter, and must be "serious" enough that one of the two tests above is satisfied). With the ever shrinking remit of public policy defense in India - international parties can certainly build more confidence around enforcement of their foreign awards in India.

This article is produced by our Singapore office, Bird & Bird ATMD LLP, and does not constitute legal advice. It is intended to provide general information only. Please contact our lawyers if you have any specific queries.

[1] Judgement of the Supreme Court of India, dated 19 August 2020, in Civil Appeal Nos. 5145, 5158 and 9820 of 2016

[2] (2010) 1 SCC 72