Simple Fraud Allegations No Bar to Arbitration, Rules Supreme Court

This case arose from the multi-crore Bihar Public Distribution System (PDS) scam. The Bihar State Food and Supply Corporation (BSFSC), as a result of an award made in favour of the claimants by an arbitrator in accordance with the Indian arbitration law, questioned the order suggesting that an arbitrator be appointed. BSFSC argued that it was unable to refer the dispute to arbitration because there were pending criminal proceedings involving allegations of offences consisting of cheating under Section 420 IPC, and criminal breach of trust under Section 409 IPC. The dispute arose out of a contractual relationship where a valid arbitration agreement as signed with the parties.

Issue

• Does the pendency of criminal proceedings alleging “simple fraud” (like cheating or breach of trust) in respect to the same transaction bar reference of a contractual dispute to arbitration?

• Is a dispute based merely on fraud arbitrable or must it be dealt exclusively by a court?

Judgement

A coram of Justices PS Narasimha and Manoj Misra has affirmed the High Court’s decision in BSFSC’s appeals, and directed arbitration to take place. The Supreme Court unequivocally held that where valid arbitration agreements exist, courts should not refuse to refer parties to arbitration simply because there were pending criminal cases alleging simple fraud. The Court noted that the referral court can only look at the agreement to see if a valid arbitration agreement exists. No investigations into the issues that led to the dispute can be made at this stage.

Rationale

The Court set out an important distinction between two kinds of fraud:

• Serious Fraud: Certain types of fraud or criminal conduct that, due to their natures (e.g., forgery, the public interest involved, or in the case where fraud relates to an arbitration clause), would not give rise to an arbitration award (i.e., Jurisdictional issues) and thus are non-arbitrable.

• Simple (Simpliciter) Fraud: These actions refer to misrepresentations, cheating, breaches of trust, perjurty, etc. which arise from the contractual obligations through contractual defenses, and such matters are arbitrable. In its decision, the bench hinged on the case Avitel Post Studioz Ltd. v. HSBC PI Holdings (Mauritius) Ltd. (2021), wherein the following was held:

1. Where the fraud destroys the arbitration clause/agreement itself (e.g., failed to keep originals for forged contract), there is no arbitration clause at all.

2. Where public law applies or government corruption exists, this matter may be barred from arbitration. If neither of these tests applied, and the matter was purely contractual, and even if there were still criminal cases on-going that alleged simpliciter fraud, this would still comprise a dispute that could be referred.

In this particular situation, as the allegations of fraud did not nullify the arbitration agreement nor engage any public law issues, the case was not non-arbitrable. The Court made it very clear that fraud must relate to the arbitration agreement itself or involve a “public law” aspect, to render the matter non-arbitrable.

Significance

• Reiterates Arbitrability Principle: this case confirms that a parallel criminal action for “simple” or contractual fraud does not act as an automatic bar to arbitration.

• Clarifies Jurisdiction: at this referral stage, the role of the court is simply to confirm the validity of the arbitration agreement, they are not to consider any merits of the fraud allegations.

• Distinguishes the types of fraud: provides clear legal guidance on the types of fraud that render arbitration impossible and preserves arbitration’s goal of an effective system to resolve disputes in an expeditious manner.

• Sets Forth A Basis For Future Cases: the decision will provide the necessary guidance to referral courts dealing with cases containing both contractual disputes and criminal complaints for fraud and prevent the use of criminal allegations to unduly delay, obstruct or prevent arbitration.

This ruling provides a clear and practical direction: except for the rare case where fraud is of a nature to go directly to the root of the arbitration agreement or engages public law, arbitration must proceed notwithstanding simple fraud and even if a criminal matter was ongoing.