Monday, December 5, 2016

Arbitrability of Fraud: Is Every Fraud Arbitrable?

[The following guest post is contributed by Bhushan Shah & Jogan Punjabi from Mansukhlal Hiralal & Company. The views expressed in the post are personal]

Arbitrability of fraud has been a highly contested issue in the field of alternative dispute resolution. The Supreme Court in N Radhakrishnan v Maestro Engineers and Ors  ("Radhakrishnan Case") held that cases where fraud and serious malpractices are alleged can only be settled by judicial proceedings and cannot be subject to arbitration. However, recently the apex court in A Ayyasamy vs A Paramasivam & Ors ("Ayyasamy Case") held that simple fraud is subject to arbitration, provided an arbitration agreement exists between the parties. However, serious frauds such as criminal offences will continue to be adjudicated by courts.

The Ayyasamy Case

Five brothers and their father entered into a partnership deed for running a hotel in Tamil Nadu. The partnership deed contained an arbitration clause. The business was being managed and administered by the father and, after his death, the same was entrusted to the eldest brother, i.e. Mr Ayyasamy. Disputes arose between the parties, and Ayyasamy fraudulently signed a cheque to transfer money to his son from the hotel account, without the knowledge and consent of the remaining brothers, instead of depositing the same into the common bank account of the partnership firm. He also refused to show the account books of the hotel to his brothers.

The brothers were therefore forced to file a declaratory suit seeking a declaration that they were entitled to participate in the administration of the hotel, and for a permanent injunction restraining Ayyasamy from interfering with the same. Ayyasamy meanwhile filed an application under section 8 of the Arbitration and Conciliation Act, 1996 ("Arbitration Act") to refer the dispute to arbitration. The Trial Court, however, dismissed the aforesaid application, relying on the Radhakrishnan Case wherein the Supreme Court laid down that serious offences such as allegations of criminal acts, malpractices and serious allegation of fraud are required to be determined by the Courts. Thereafter, the High Court upheld the decision of the trial court and Ayyasamy, being aggrieved by the said order, filed an appeal before the Supreme Court.

The Supreme Court has clearly stated in this judgment that the Arbitration Act does not make a provision excluding any category of disputes by treating them as non-arbitrable. When an agreement has an arbitration clause, in such cases judicial intervention would be minimal. Under the Arbitration Act, an Arbitral Tribunal has the power to rule on its own jurisdiction. The Supreme Court has held where there are mere allegations of fraud simpliciter, such issues can be determined by the Arbitral Tribunal.

In the Ayyasamy Case, the Supreme Court also laid down well-recognised examples of non-arbitrable disputes, which are:

- disputes relating to rights and liabilities which give rise to or arise out of criminal offences;

- matrimonial disputes relating to divorce, judicial separation, restitution of conjugal rights, child custody;

- guardianship matters;

- insolvency and winding-up matters;

- testamentary matters (grant of probate, letters of administration and succession certificate); and

- eviction or tenancy matters governed by special statutes where the tenant enjoys statutory protection against eviction and only the specified courts are conferred jurisdiction to grant eviction or decide the disputes.

Fraud is one such category spelled out by the decisions of this Court where disputes would be considered as non-arbitrable.

The Supreme Court has further held that rights in personam (right exercisable against specific individuals) are considered to be amenable to arbitration; and all disputes relating to rights in rem (rights exercisable against the world) are required to be adjudicated by courts and public tribunals.

The Supreme Court has held that (i) when there is a serious allegation of fraud which makes it a criminal offence, or (ii) when the allegation of fraud becomes so complicated that it becomes necessary to consider complex issues wherein extensive evidence is required to be produced by the parties for the determination of the offence by the court, or (iii) where fraud is alleged against the arbitration provision itself or is of such a nature that permeates the entire contract, including the agreement to arbitrate, meaning thereby in those cases where fraud goes to the validity of the contract itself of the entire contract which contains the arbitration clause or the validity of the arbitration clause itself, then the Court can dismiss an application under section 8 of the Arbitration Act and proceed with the suits on merit.

Therefore, the Supreme Court has made it clear that simple fraud is arbitrable, whereas instances of serious fraud are to be determined by courts. However, the Supreme Court has not provided any definition of `serious fraud` and interpretation of the same shall be interpreted on a case-to-case basis. The Arbitral Tribunal may not be competent to deal with such matters which involve an elaborate production of evidence to establish the claims relating to fraud and criminal misappropriation. Also, Supreme Court laid down in the Ayyasamy case that disputes which give rise to or arise out of criminal offences are non-arbitrable; therefore, serious frauds need to be determined by the Courts.

Impact of the Decision

In our view, the Ayyasamy Case will prevent parties from delaying arbitral proceedings on the grounds that fraud is not arbitrable. This is also in line with the recent amendments to the Arbitration Act. The basic principle of the Arbitration Act is that arbitration is essentially a voluntary assumption of an obligation by contracting parties to resolve their disputes through a private tribunal. The intent of the parties is expressed in the terms of their agreement. Where commercial entities and persons of business enter into such dealings, they do so with knowledge of the efficacy of the arbitral process. In view of the aforesaid, the parties are bound to submit the dispute to arbitration unless it involves serious issues which are non-arbitrable.

- Bhushan Shah & Jogan Punjabi

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