New Development: Arbitrability of fraud allegations!

The adjudication of claims arising out of private civil or commercial arrangements between parties is ordinarily capable of being referred to arbitration. The underlying principle of arbitration remains that private arrangements between parties give rise to a right in personam (against a particular person), which is exercisable only between the parties to such an arrangement and not against public at large. As a corollary, disputes that are of a public nature are excluded from the purview of arbitration. Indian Courts have also consistently held that disputes which involve questions of public policy or arise out of criminal offences, matrimonial disputes, insolvency and fraud are non-arbitrable in nature[i].

In A. Ayyasamy v. A. Paramasivam & Ors., the Supreme Court of India held that courts may decline to refer a matter to arbitration when the allegations are of a serious and complicated nature, which requires extensive evidence and trial before a court. In this backdrop, the Delhi High Court, in the case of Simran Sodhi v. Sandeep Singh (Sodhi v. Sodhi Judgment), has laid down two critical tests for determining arbitrability of disputes involving serious allegations of fraud.

Facts of the case

Simran Sodhi (“Sodhi”) and Sandeep Singh (“Singh”) formed a partnership firm by entering into a partnership deed for the business of manufacturing and trading electronic items. After certain disputes arose between the partners, both the partners invoked the arbitration clause contained in the partnership deed and filed a petition seeking appointment of an arbitrator before the Delhi High Court.

Sodhi alleged that Singh had attacked him resulting in a First Information Report (FIR[ii]) being filed and criminal proceedings being initiated against Singh in court. Sodhi also alleged that Singh has misappropriated the funds of the partnership firm, in addition to breaching the terms of the partnership deed. On the other hand, Singh alleged that Sodhi had misappropriated funds and goods belonging to the partnership firm to a shell company under control of Sodhi’s relatives by way of a forged rental agreement, and several FIRs were lodged against Sodhi on allegations of fraud and other criminal actions.

One of the issues before the Delhi High Court was whether allegations of fraud and misrepresentation raised by the partners against the other come under the purview of arbitration, especially in view of the fact that FIRs had been lodged.

High Court’s ruling

After analyzing various precedents, the Court laid down the following principles for determining the arbitrability of claims involving criminal offences, such as fraud:

(i)  mere allegations of fraud would not preclude the claims from being arbitrable;

(ii)  serious allegations of fraud may also be arbitrable if the allegations:

(a)  do not directly affect the claims which are sought to be referred to arbitration;

(b)  do not have any bearing on the public at large and only relate to the internal affairs of the parties; and

(c)  do not contain a criminal aspect of fraud, forgery or fabrication, which would result in penal consequences and criminal sanctions to be adjudicated by a Court of law.

The High Court then laid down the following two tests, which serious allegations of fraud need to be subjected to:

(i)   whether the allegations permeate the entire contract, including the arbitration clause; or

(ii)  whether the allegations touch upon affairs having no implications on public domain.

If the answer to the two test is in the affirmative, then the arbitration clause is rendered void and the matter is incapable of arbitration.

On the basis of the above principles, the Court differentiated the claims of the partners in three categories, firstly, it found that the claims which directly arose out of non-performance of the partnership deed came directly under the purview of arbitration. Secondly, the Court found that claims arising out of allegations which involved siphoning off funds and assets of the partnership firm also arose from the contractual relationship between the partners and did not fall into the public realm. Hence, such claims can also be referred to arbitration even if there is a criminal aspect involved to it. Thirdly, the allegations of fraud and forgery of the rental agreement were found to have a serious aspect of criminal wrong to be inspected by the police and decided by a court of law. The High Court, therefore, held that such a claim will be non-arbitrable. The Delhi High Court appointed an arbitrator and referred the disputes to arbitration, insofar as they related to the relationship of the parties as partners.

Our thoughts

The purpose of arbitration is to uphold the principle of party autonomy and therefore, while analyzing the arbitrability of disputes, it is essential to give primacy to the business sense and intention of the commercial transactions between the parties. This purpose would get defeated if every claim colored with an allegation of a criminal offence would become non-arbitrable. The judgment is in line with the jurisprudence on arbitration laid down by various courts as it rightly confers due importance to the true nature of the allegation in order to determine the arbitrability of a dispute. The judgment has cleared Indian courts’ stance over the issue of arbitrability of disputes concerning serious allegations of fraud and its relation to the public policy of India and is definitely a step towards the agenda of a pro-arbitration regime.

Authors: Souvik Ganguly, Renjith Nair, Altamash Qureshi and Shrishti Mishra

The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.

[i] Booz Allen & Hamilton Inc. v. SBI Home Finance Inc., Vidya Drolia & Ors. v. Durga Trading Corporation

[ii] In India, a FIR is a complaint lodged with the police by the victim of a criminal offence or by someone on his or her behalf.