Is Fraud an exception for arbitrability of a dispute in India?

Arbitration is restricted to only the matters involving the rights of an individual, whereas fraud is an issue that affects only the parties. However, it does not enjoy any exemption from the debate and confusion arising from time to time.

Fraud has enjoyed the blanket exception to the arbitrability of a dispute for several years. However, the scenario has changed a lot of late. There has been a critical development in the legal position on the arbitrability of fraud on the judicial as well as legislative forms.

Arbitration is always a preferred form of alternate dispute resolution as the parties to commercial dispute intent to resolve it expeditiously before it is being taken to a private forum.

The matter was scrutinized by the Supreme Court of India in the case of Avitel Post Studioz vs. HSBC PI Holdings (Mauritius) Ltd., decided on 19.08.2020.

Test for the exemption

The Supreme Court bench of Justices RF Nariman and Navin Sinha held that serious allegation of fraud is a ground for an exemption from arbitral proceedings. This exemption arises only when these two tests are satisfied:

* First Test - When the arbitration clause in an agreement or the agreement itself ceases to exist, the first test is satisfied. It is a clear case where the court finds that the alleged party to the breach cannot be held for agreeing relevant to the arbitration.

* Second Test - When the allegation is raised against the State or its rules regarding arbitrary, fraudulent, or malafide activity, leading to a Court hearing the matter through a writ petition, the second test is satisfied. The allegation or questions raised may not be the predominant questions arising from the contracts or breach of contract under public law.

What initiated the issue?

The Supreme Court bench, while hearing an appellant jurisdiction from the interlocutory judgement and order passed by the Bombay High Court under Section 9 of the Arbitration and Conciliation Act 1996, observed the matter in discussion.

The dispute was between HSBC and Avitel India, where HSBC made an investment in the equity of capital of Avitel India for a consideration of USD 60 million. The investment was made at an initial stage to acquire 7.8 per cent of the paid-up capital. Avitel India informed HSBC that they are at a very progressive stage to finalize the contract with BBC (British Broadcasting Corporation) to the conversion of the film library of BBC to 3D from 2D.

The contract was entered into with an expectation to raise a revenue of USD 300 million in the first phase, leading towards over USD 1 billion, which required the investment of USD 60 million that HSBC had made.

The HSBC later discovered that the contract of Avitel India with BBC does not even exist but was set up to make HSBC invest that amount. The amount was transferred to Avitel Dubai, but the record showed around USD 51 million were not used for the purchase of any equipment for a contract with BBC, rather was liquidated off to the companies which had promoters, including a Jain family, who had a stake.

Constituting a criminal case

From the nature of the case, it was clear that it is not a civil suit that can be regulated under the provision of Sec. 17 of the Contract Act covering the matters of fraud and misrepresentation, rather it is a criminal procedure in nature.

This ceases the scope of arbitration, which could otherwise be implemented if it was a civil suit.

The Court observed that there is a difference between the contract obtained by fraud and if the performance of the contract is breached or spoiled by the action of fraud or cheating. A civil remedy under Sec. 17 of the Contract Act can be passed in the matter of the first situation, but for the latter situation, the contract is void.

What was the Supreme Court decision?

The Apex Court, after analyzing the issues and some material findings in the Foreign Final Award, decided to proceed with a separate criminal proceeding. The Court held that there was a strong prima facie case based on the facts that the contract with HSBC in respect to the BBC transactions, was induced fraudulently and liquidating off of the amount which was supposed to be used in the BBC transaction is the matter under the tort of deceit.

The Supreme Court decided that the fraudulent activity raised a question on the arbitration clause, and this had to be read as an absolutely independent clause. The extent of the arbitration clause was wide and any contract that was void or voidable did not interfere in the non-validity of the clause.

The activities involving impersonification, false representation and diversion of funds are conducted inter-parties does not involve a public matter to be considered as the exception to fraud.