Fraud simpliciter is not enough to vitiate arbitration agreements

Asmita Kuvalekar | Government Law College, Mumbai | 12^th April 2020. 

RASHID RAZA V SADAF AKHTAR (CIVIL APPEAL NO 7005 OF 2019 ARISING OUT OF SLP (C) NO 4061 OF 2019) 

FACTS OF THE CASE: 

This judgement becomes important because of the crucial distinction it makes between simple and complex fraud. The appellant in this case seeks to refer his partnership dispute with the respondent to Arbitration under Section 11 of the Arbitration and Conciliation Act, 1996 (hereinafter referred to as the 1996 Act). 

The Supreme Court entertains the interesting question of Arbitral prowess in dealing with fraud. 

ISSUE: 

1. Whether fraud is an arbitrable subject under the 1996 Act? 

JUDGEMENT: 

First and foremost, the Court noted the existence of an ongoing investigation into fraud against one of the parties, based on a subsisting FIR. An application under Section 11 of the 1996 Act was made thereafter and therefore, the question of fraud being an arbitrable issue arose. In coming to its decision, the Court relied upon its decision in A. Ayyasamy v A. Paramasivam and Ors¹. It was held in that case that fraud can essentially be categorized into two types. 

One is simple fraud, limited to a partnership/ internal dispute, not having a ripple effect in the public domain. Such a type is superficial and does not affect the legal tenability of the contract/partnership deed/arbitration agreement itself. It pertains to internal matters between the parties. 

On the other hand, complex fraud is one which is so multi-layered and so intrinsically woven into the fabric of the contract/partnership deed/arbitration agreement that its existence threatens their legality and continuity. Fraud may also be of a criminal nature and therefore, not arbitrable. 

Additionally, the Court observed that complex fraud may necessitate voluminous evidence and unlike Arbitrators, Courts are well-equipped to deal with such scenarios. Moreover, any fraud that has a bearing in the public domain is complex in nature and it is the Court that is best suited to hear such a case. Serious allegations that question the validity of the contract itself fall in this group. 

Furthermore, this judgement highlighted the absence of a list of non-arbitrable subjects in the 1996 Act. It logically follows therefore that prima facie, nothing is non-arbitrable unless the Courts determine it to be so. It is up to the Courts to decide what matters require public fora and what can be effectively dealt with through alternate dispute resolution. In its evaluation thereby, Courts have to be cognizant of cases that effectively oust their jurisdiction. Such subjects must not be allowed to proceed to arbitration. 

Moreover, with respect to applications under Section 11, it is the duty of the Courts to carefully investigate the intention of parties and the particularities of each case. Such an investigation will permit conclusions either respecting the arbitration agreement or setting it aside. 

Thus, based on the Ayyasamy ruling, two tests can be made out to aid Courts in deciding whether fraud in a particular circumstance is subject to arbitration or not: 

1. Fraud permeates the entire contract  including the arbitration agreement, thereby rendering it null and void (Non arbitrable); or
2. Fraud is merely an internal dispute between the parties, having no influence in the                       public  domain (Arbitrable)

Consequently, the present dispute was held to be arbitrable and an Arbitrator was duly appointed. It was seen that the alleged fraud was of a private nature and did not in any way affect the legality of the arbitration agreement. The Court clarified that investigation under the FIR would continue and this judgement would not obstruct the same. 

1. (2016) 10 SCC 386