22 November 2016

ARBITRABILITY OF FRAUD | IS EVERY FRAUD ARBITRABLE?

Fraud is broadly understood as a concealment of material facts or a false representation through statements or actions that injure the person who relies upon them. Arbitrability of fraud, has been a highly contested issue in the field of alternate 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, the matter can only be settled by court and are not 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, shall continue to be adjudicated by courts.

FACTS OF THE AYYSAMY CASE:

• Five brothers and their father, entered into a partnership deed for the running of a hotel in Tamil Nadu, that contained an arbitration clause.

• The business was being managed and administered by the father and after his death, the same was entrusted to the Appellant, the eldest brother.

• Disputes arose between the parties and the Appellant fraudulently signed a cheque to transfer money to his son from the hotel account, without the knowledge and consent of the Respondents instead of depositing the same into the common bank account of the partnership firm. He also refused to show accounts books of the hotel to the Respondents.

• The Respondents therefore were forced to file a declaratory suit, proclaiming that they were entitled to participate in the administration of the hotel and seeking a permanent injunction restraining the Appellant from interfering with the same.

• The Appellant 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 and when the matter is complicated and requires the parties to adduce evidence for the determination of the offence, then the judicial authority i.e. the Court can refuse to refer the dispute to arbitration and adjudicate the same, despite the subsistence of an arbitration agreement between the parties.

Thereafter, the Appellant filed a revision petition in the High Court contending that the trial court committed a jurisdictional error. However, High Court dismissed the Petition, also relying upon the Radhakrishnan Case. Being aggrieved by the same, the Appellant preferred an appeal before the Supreme Court.

The Supreme Court in this judgement has clearly stated 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 the judicial intervention would be minimal. Under the Arbitration Act, an Arbitral Tribunal has the power to rule its own jurisdiction and the civil court does not possess jurisdiction to decide the same. The Supreme Court has held where there are mere allegations of fraud simpliciter, such issues can be determined by the Arbitral Tribunal.

Well-recognised examples of Non-Arbitrable disputes: In the Ayyasamy Case, the Supreme Court has also laid down the 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.

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 that such complex issues wherein extensive evidence is required to be produced by the parties for the determination of the offence by the civil 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, 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.

MHCO COMMENTS:

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 relegate the dispute to arbitration unless it involves serious issues which are non-arbitrable.

This article was released on 22 November 2016.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.