[This guest post is authored by Richa Borthakur. She is currently studying in the fourth year at the O. P. Jindal Global University]

Avitel v HSBC: Finally a Uniform Standard on Arbitrability of Fraud?

Indian courts have long held a pessimistic view towards arbitrability of fraud[1]. Due to the lack of statutory direction, vague tests and standards have emerged with every new decision on the issue. Now, in a welcome step, a division bench of the Supreme Court in Avitel Post Studioz Limited v HSBC Pi Holding (Mauritius) has arguably settled and synergised the law on the arbitrability of fraud by using the principles established in the cases of Ayyaswamy and Rashid Raza and converting it into a uniform standard.  

Factual Background

Avitel and HSBC had entered into a share subscription agreement (SSA) through which HSBC invested USD 60 million in Avitel, to acquire 7.80% stake of the company. The parties had agreed to resolve their disputes by arbitration through the Singapore International Arbitration Centre (SIAC). The parties’ shareholders agreement (SHA) also contained an identical arbitration clause.

HSBC argued that Avitel and its promoters had represented that they were at an advanced stage of finalising a contract with the British Broadcasting Corporation, which was expected to generate profits of approximately USD 1.3 billion. Within a year, HSBC began to suspect Avitel’s endorsements. An auditor’s report revealed that no negotiations had commenced between Avitel and BBC. Avitel’s promotors had effectively siphoned off the funds which were obtained from HSBC and had applied them to Avitel’s other business interests.

HSBC initiated three separate proceedings against Avitel. The first was a result of the contractually stipulated arbitration clause. The second was a petition before the Bombay High Court, filed under Section 9 of the Arbitration and Conciliation Act 1996 (Arbitration Act) [Section 9 Petition]. HSBC sought an order to freeze Avitel’s accounts and compel the company to consistently maintain a security deposit of USD 60 million. The third was a criminal complaint in nature and included inter alia allegations of cheating and criminal misappropriation.

Avitel unsuccessfully challenged the jurisdiction of the arbitral tribunal in Singapore. In the Section 9 Petition, the Bombay High Court held that the arbitration proceedings would be governed by the laws of Singapore, under which, disputes related to fraud were arbitrable. On appeal, a Division Bench of the High Court held that disputes related to fraud and misrepresentation were covered under sections 17 and 18 of the Indian Contract Act 1872 (Contract Act) and, thus, assumed a ‘civil profile’. The Court observed that this factor, made the disputes arbitrable. Since the court also reduced the amount that HSBC could claim as damages, both parties appealed to the apex court against the order.

Arbitrability of Fraud

The lack of any statutory authority on the arbitrability of fraud has forced courts to interpret the same. However, in its attempts to uphold common law principles, coupled with different fact situations, the tests propounded by Indian courts have been riddled with ambiguity.

In Avitel, the Supreme Court received a fresh opportunity to assess the arbitrability of fraud. Before looking at the particular facts of the case, the Apex Court traced the jurisprudence of arbitrability of fraud, whilst holding the view that fraud would only be decided in open court if specific tests were satisfied, thereby making the dispute, non-arbitrable.

One of the first common law cases on the arbitrability of fraud was Russel v Russel[2] , where it was held by the Chancery Division that an individual accused of fraud had the right to defend themselves in open court. Thus, arbitration in such cases would not be permitted. The English Court of Appeals in Charles Osenton & Co v Johnston[3] took a slightly different view by holding that although ‘serious allegations of fraud’ would not be arbitrable, this would not extend to every allegation which could impute some amount of dishonesty. This standard was adopted in India through the case of Abdul Kadir v Madhav Praphakar Oak .

The two judge bench in N Radhakrishnan v M/S Maestro Engineers & Ors delivered a vastly criticised decision which held that ‘cases related to allegations of fraud and serious malpractices’ can only be adjudicated in civil courts. The reason provided by the courts was that detailed evidence cannot be ‘properly gone into by the Arbitrator’. Finally, the court also held that the ‘serious allegation standard’ would also apply to inter-party disputes. Thereafter, Indian jurisprudence began to focus on classifying the types of fraud which had to mandatorily be referred to public courts.

In Afcons Infrastructure Ltd & Anr v M/S Cherian Varkey Construction Co Ltd & Ors, the Supreme Court, in its discussion on Section 89 of the Civil Procedure Code, held that certain disputes would not be suitable for ADR due to their ‘nature’. One of the six explicit exclusions was ‘cases involving serious and specific allegations of fraud, fabrication of documents, forgery, impersonation, coercion, etc’.

Following this, in Booz Allen Hamilton Inc v SBI Home Finance Ltd. & Ors, the Supreme Court held that although rights in personam could be arbitrated upon, rights in rem could not. The Supreme Court provided a non-exhaustive list of non-arbitrable disputes. Albeit ‘fraud’ was not explicitly mentioned, it would arguably be covered within the umbrella phrase of ‘disputes relating to rights and liabilities which give rise to or arise out of criminal offences’. Subordinate rights in personam which arise from rights in rem would be arbitrable.

Winds of Change

2014 marked a welcome shift in this position with the Supreme Court’s decisions in Swiss Timing Ltd v Organising Committee, Commonwealth Games 2010, Delhi and World Sport Group (Mauritius) Ltd v SMS Satellite (Singapore) Pte Ltd. In both cases, it was rightly held that Courts cannot refuse to refer parties to arbitration merely on ground that the dispute involved allegations of fraud. However, one must keep in mind that both decisions pertained to foreign seated arbitrations, where the only bar(s) to an arbitral reference is specified in Section 45 of the Arbitration Act. It was categorically held that this principle, in light of the New York Convention, would only apply to foreign seated arbitration and not domestic ones.

Thereafter, in A Ayyaswamy v A Paramasivam, the Apex Court observed – in the context of section 8 of the Arbitration Act –  that ‘fraud simpliciter’ would not oust arbitrability of the underlying dispute. However, if the Court is satisfied that the allegations against a party are ‘serious, complicated’ and is sufficient to warrant ‘meticulous inquiry’, then the dispute cannot be arbitrated.

While it has been established that ‘serious fraud’ or ‘complex fraud’ is non arbitrable, determining the nature of fraud in a given set of facts is at best an ambiguous exercise; mainly because there is no discernible metric. That said, the Supreme Court in Rashid Raza v Sadaf Akhtar has recently laid down a two-step test to distinguish between fraud simpliciter and complex fraud. The first is whether the plea permeates the entire contract and agreement rendering it void. And the second is whether the alleged fraud was related to the internal affairs of the parties, thereby having no impact in the public domain.

Supreme Court in Avitel

In Avitel, the Court attempted to unify the existing jurisprudence. It was observed that both Afcons and Booze Allen must be read with the observations in Ayyaswamy. Even though these cases suggest that certain levels of criminality would cause the dispute to be non-arbitrable, it is settled law that an established point of law that civil and criminal proceedings can be based on the same set of facts. Accordingly, mere existence of potential criminality would not oust arbitral proceedings.

It was also observed that N Radhakrishnan was lacking in precedential value since it did not refer to the ratio in Abdul Kadir. The latter case had held inter alia that ‘serious allegations of fraud are not made out when the allegations of moral or other wrongdoing inter parties are made’.

The court interpreted the tests in Ayyaswamy and Rashid Raza narrowly and held that the fraud exception would apply only if the standard of public flavour is satisfied. This standard is based on the second test propounded by Rashid Raza, of ‘having an implication on public domain’.  For instance, this test would be satisfied if allegations of fraud are made against the State or its instrumentalities – which are enough to invite writ proceedings. This would not predominantly include rights arising out of the contract but questions arising in the public law domain.

The Court held that if the issues, contentions and findings of the tribunal were predominantly civil in nature, the dispute would be arbitrable. Even parallel criminal proceedings would not vitiate arbitrability. Using the public flavour standard, the Court found that the present issues of misrepresentation and siphoning off of funds were inter-party frauds without any ‘public flavour’. The fraud exception was therefore held inapplicable in Avitel.

Conclusion

The Supreme Court’s pro-arbitration approach is indeed a welcome one. It standardises and synergises the jurisprudence related to the arbitrability of fraud. By overcoming vaguely worded standards, as in the case of N Radhakrishnan, the court has laid down a distinct, succinct test.

That said, considering the number of transactions which involves government sectors in India a potential drawback to the new standard is that recalcitrant parties will try to avoid their arbitration clause and flood the already overburdened courts. This can seriously undermine the principle of Kompetanz-Kompetenz and the underlying objective of the Arbitration Act. In the near future, therefore, courts may be required to further clarify and streamline the Avitel standard in the context of public-private transactions.

Interestingly, on the same day as Avitel, the judgement of a three judge bench of the Supreme Court in Deccan Paper Mills v Regency Mahavir Property followed Avitel’s line of reasoning on the fraud exception. Albeit the phrase ‘public overtones’ was used – instead of ‘public flavour’ the effect is the same. Thus, an exception to arbitrability of fraud has been crystallised as a clearly identifiable and easily discernible test.

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[1] Johurmull Parasram v. Louis Dreyfus & Co. Ltd., A.I.R. 1949 Cal 179

[2] (1880) 14 Ch D 471

[3] 1942 A.C. 130