Arbitrability of Fraud and the ‘Public Flavour’ Standard

[Karan Kamath is a 2020 B.A. LL.B. (Hons.) graduate from Symbiosis Law School, Pune.]

On August 19, 2020, a Division Bench of the Supreme Court decided Avitel Post Studioz Ltd. v. HSBC PI Holdings (Mauritius) Ltd., wherein the central question related to arbitrability of fraud, in an appeal arising out of the Bombay High Court’s decision in a petition under section 9 of the Arbitration and Conciliation Act, 1996 (“1996 Act”). The judgment by Nariman J. reviewed incumbent law, synthesised and standardised it, and held that allegations of fraud that have no ‘public flavour’ are indeed arbitrable under Indian law.

Facts in Avitel Post Studioz

Avitel and HSBC entered into two Agreements through which HSBC agreed to purchase a 7.8% stake in Avitel for a consideration of USD 60 million. It was HSBC’s case that Avitel and its promoters had represented that they were about to finalise a contract with the British Broadcasting Corporation, and this was expected to generate profits worth about USD 1.3 billion. Within a year of its investment, HSBC doubted the veracity of Avitel’s representations, and recruited auditors in Dubai to investigate. They returned a finding that the purported contract negotiations did not exist, and Avitel’s promoters had siphoned off the share purchase consideration to their other business interests.

Resultantly, HSBC invoked arbitration proceedings in Singapore as per the Agreements, and the Emergency Arbitrator appointed thereafter ordered Avitel to not dispose of their assets up to USD 50 million. HSBC then filed a section 9 petition before the Bombay High Court, seeking an order compelling Avitel to deposit a security of USD 60 million. Additionally, HSBC filed criminal complaints in India inter alia alleging cheating and criminal conspiracy under the India Penal Code, 1860. Meanwhile, the now-constituted Arbitral Tribunal in Singapore rejected Avitel’s jurisdictional challenge, holding inter alia that issues relating to fraud are arbitrable under Singapore law.

A Single Judge of the High Court froze Avitel’s Indian account, noting that the jurisdictional challenge had been rejected in Singapore and that the arbitration was governed by Singapore law where the fraud was arbitrable. On appeal, a Division Bench of the High Court maintained this position. Additionally, it noted that the allegations raised by HSBC, of fraud and misrepresentation were in terms of sections 17 and 18 of the Indian Contract Act, 1872, and therefore, the dispute had a ‘civil profile’, which was squarely arbitrable. However, it held that even if HSBC succeeds in the arbitral proceedings, the damages awarded may not be the entire loss suffered but ‘the difference between the price paid by [HSBC] in acquiring [Avitel]’s shares and the price [HSBC] would have received had it resold the said shares in the market’. Therefore, it reduced the total deposit to be maintained in the frozen account to USD 30 million. Both Avitel and HSBC appealed this order to the Supreme Court.

Concomitantly, the Arbitral Tribunal gave its final award, holding inter alia that (a) the purported representations were indeed given by Avitel and its promoters, and the same were recorded in the Agreements themselves; (b) the representations were made to induce investment by HSBC, who acted upon those representations; and (c) the said representations were false, and hence, Avitel and its promoters had committed fraudulent misrepresentation. The tribunal awarded damages of USD 60 million and interest thereon. This award was challenged before the High Court vide a section 34 petition and a section 37 appeal, both of which were dismissed. Meanwhile, HSBC applied to the High Court under section 48 for enforcement of the award. This proceeding is pending before the High Court.

Arbitrability of civil fraud

Before the Supreme Court, the sole question was to the extent to which HSBC had a strong prima facie case in the ongoing enforcement proceedings, upon which the decision as to freezing of account would depend. The Court revisited a plethora of case laws that fundamentally maintained a position that although fraud ought to be tried in an open court, every other allegation of fraud cannot oust arbitral proceedings. In Russel v. Russel [(1880) 14 Ch D 471], it was held that an entity accused of fraud had the right to defend itself in an open court of law and therefore, arbitration could not be permitted ‘in cases where the person charged with the fraud desires the inquiry to be public’. This was later interpreted in Charles Osenton & Co. v. Johnston to mean that ‘serious allegations of fraud’ would not be arbitrable, but the rule in Russel could not be extended to every other ‘allegation imputing some kind of dishonesty’.

Under the erstwhile Arbitration Act, 1940 (“1940 Act”), this English standard was substantially reiterated in Abdul Kadir v. Madhav Prabhakar Oak, noting that ‘serious allegations’ were not arbitrable, but mere allegations of wrongdoing between parties themselves do not reach that threshold. Under the 1996 Act, several cases establish sundry standards to identify ‘serious allegations of fraud’. For example, in Afcons Infrastructure v. Cherian Varkey Construction Co. (P) Ltd., the Supreme Court held that ‘cases involving serious and specific allegations of fraud, fabrication of documents, forgery, impersonation, coercion, etc.’ were not ‘normally’ considered ‘suitable for ADR’. Alternatively, Booz Allen Hamilton v. SBI Home Finance Limited, which bases its conclusions on distinguishing in rem and in personam disputes, did not categorically deem fraud to be an exception, but instead carved it out for ‘disputes relating to rights and liabilities which give rise to or arise out of criminal offences’. Thereafter, the Court in Ayyasamy v. Paramasivam held in the context of section 8 that ‘fraud simpliciter’ could not be a hindrance to referring parties to arbitration. On the other hand, when a party alleges fraud to nullify an agreement, and the court is satisfied that the allegations are ‘serious and complicated’ enough to warrant a ‘strict and meticulous inquiry’, then arbitration is not permissible. Although this is not a statutory exception, the Courts have precedentially carved it out to uphold the common law principle that public disputes require adjudication by public fora.

In Avitel Post Studioz, the Court sought to standardise the law, holding that the judgments in Afcons Infrastructure and Booz Allen had to be understood in the light of Ayyasamy. Both hint that a certain level of criminality involved would make a dispute non-arbitrable. However, case law suggests that distinct civil and criminal proceedings can be rooted in the same set of facts – like in the incumbent case, where HSBC invoked arbitration to nullify the underlying agreements on the grounds of fraud, misrepresentation, and the tort of deceit, and simultaneously instituted criminal proceedings. But, deciding the former is distinct from prosecuting the latter. The standards in Afcons Infrastructure and Booz Allen must be read in this light, to hold that mere existence of potential criminality will not thwart an arbitration agreement. Applying this to the facts before it, the Court extensively revisited the final award to conclude that the issues, contentions, and findings were strictly limited to civil law, and therefore, parallel criminal proceedings could not vitiate their arbitrability. In summary, the fraud alleged had no ‘public flavour’ to it.

The judgment in N. Radhakrishnan

Concurrently, the High Court also had to deal with the ratio of N. Radhakrishnan v. Maestro Engineers, which refers to the ‘serious allegations’ threshold in Abdul Kadir but does follow its observations about allegations of wrongdoing inter parties. A section 8 application was dismissed in that matter, because allegations of manipulating accounting books and finances of a partnership firm were alleged. Avitel was challenging the High Court Single Judge’s decision inter alia on the grounds that it had relied on a Single Judge decision of the Supreme Court, which had found N. Radhakrishnan as per incuriam. Single Judge decisions under section 11 have no precedential value and therefore, the High Court could not have relied on Swiss Timings. Additionally, the contention relied on the fact that the Law Commission’s 246th Report suggested amending section 16 to do away with N. Radhakrishnan’s ratio, but in the resultant amending legislation, the Parliament chose not to act upon that recommendation.

The Court accepted that Swiss Timings is not a precedent and therefore could not be relied upon to oust a Division Bench. Nonetheless, it found the reasoning in Swiss Timings persuasive. N. Radhakrishnan had derogated in precedential value because: Firstly, the principle of judicial authorities having an obligation to refer parties to arbitration in section 8 applications was not properly followed. The precedents for this principle – P. Anand Gajapathi Raju v. P.V.G. Raju and Hindustan Petroleum Corporation Ltd. v. Pinkcity Midway Petroleum, were not dealt with by the Court while the former was not even brought to the Court’s notice. Instead, N. Radhakrishnan relied on Abdul Kadir, which was decided under the 1940 Act that granted considerable discretion to courts while referring parties to arbitration. Secondly, even though it relied on Abdul Kadir, it failed to recognise the observations in that case about allegations of civil fraud between parties. It incorrectly concluded that even those cases were not arbitrable. Thirdly, the Court rejected the argument based on Parliament not following Law Commission’s recommendation, as (a) the Parliament’s choice does not necessarily suggest an implied acceptance of N. Radhakrishnan’s ratio, and (b) the law had developed substantially in Hindustan Petroleum, Ayyasamy etc., for the Court to resurrect N. Radhakrishnan.

Therefore, although the High Court Single Judge could not have relied on Swiss Timings to not follow N. Radhakrishnan, the Supreme Court nonetheless justified the precedential devaluation of that judgment. The ‘serious allegation’ threshold now has the same effect as Ayyasamy and Avitel Post Studioz: fraud that has no ‘public flavour’ is arbitrable.

Conclusion

Arbitral tribunals, however desirable, are not public courts. The basic principle that certain kind of fraud should not be arbitrated is not prima facie disagreeable. But the devil is in the details – what is contentious is to identify the kind of fraud that is the courts’ exclusive domain. Avitel Post Studioz carefully standardises the answer to the ‘public flavour’ standard – that as long as the alleged fraud is a matter between parties under civil law that has no public ramifications, it is arbitrable; and that it is not a bar to arbitrability when the same circumstances justify a parallel criminal proceeding.

What is also noteworthy, is that on the same day, a three-judge bench of the Court, delivered the judgment in Deccan Paper Mills Co. Ltd. v. Regency Mahavir Properties. That judgment, also delivered by Nariman, J., adopts and follows the fraud exception in Avitel Post Studioz (Noting ‘public overtones’ as the hindrance to arbitration, instead of ‘public flavour’). This enhances its precedential value vis-à-vis other aforesaid precedents, that are decided by Division Benches. Thus, Avitel Post Studioz and its ‘public flavour’ standard for arbitrability of serious fraud can be considered firmly rooted and substantially important in arbitration law.

– Karan Kamath

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