Disputes Involving Allegations Of Serious Fraud Need More Clarity: Supreme Court Summarises Principles Governing Arbitrability

The Supreme Court in its recent Judgment, has summarised the principles governing arbitrability in cases involving allegations of serious fraud.

The Court was deciding a batch of various Civil Appeals arising out of the Judgment of the Patna High Court which allowed the Applications under Section 11 of A&C Act and appointed Arbitrators in several cases.

The two-Judge Bench comprising Justice P.S. Narasimha and Justice Manoj Misra restated the following principles –

I. Access to justice for enforcement of rights and obligations is assured by the usual proceedings in the ordinary tribunals. It is for this reason that Section 28 of the Indian Contract Act, 1872 while prohibiting agreements in restraint of legal proceedings saves resolution of disputes through contract, i.e., by arbitration. The conduct of arbitration is governed by the Arbitration and Conciliation Act, 1996.

II. The limits of dispute resolution through arbitration are statutorily incorporated in the Arbitration Act itself. Section 2(3) provides that, “This part shall not affect any other law for the time being in force by virtue of which certain disputes may not be submitted to arbitration.”

III. Same set of facts may lead to civil and criminal proceedings. A civil dispute could involve questions of coercion (section 15 of Contract Act), undue influence (section 16 of Contract Act), fraud (section 17 of Contract Act), misrepresentation (section 18 of Contract Act) for example, and such disputes can be adjudicated as civil proceedings for determination of civil or contractual liabilities between the parties. The same set of facts could have their co-relatives in criminal law. The mere fact that criminal proceedings can or have been instituted in respect of the same incident(s) would not per se lead to the conclusion that the dispute which is otherwise arbitrable ceases to be so.

IV. The reason for permitting submission of such disputes to arbitration is well explained in Swiss Timing as, “To shut out arbitration at the initial stage would destroy the very purpose for which the parties had entered into arbitration. Furthermore, there is no inherent risk of prejudice to any of the parties in permitting arbitration to proceed simultaneously to the criminal proceedings.

V. For an important policy consideration, Court has drawn a distinction between “serious fraud” and “fraud simpliciter” to segregate and exclude disputes involving serious fraud from arbitrability. Disputes involving serious fraud may not be submitted to arbitration.

VI. “Serious allegations of fraud” is to be understood in the context of facts. The first test is satisfied only when it can be said that the arbitration clause or agreement itself cannot be said to exist in a clear case in which the court finds that the party against whom breach is alleged cannot be said to have entered into the agreement relating to arbitration at all. The second test can be said to have been met in cases in which allegations are made against the State or its instrumentalities of arbitrary, fraudulent, or mala fide conduct, thus necessitating the hearing of the case by a Writ Court in which questions are raised which are not predominantly questions arising from the contract itself or breach thereof, but questions arising in the public law domain.

VII. Disputes involving allegations of serious fraud need more clarity so that there is certainty about the availability of the remedy. At least one instance of serious fraud will be where disputes involving allegations having criminal law implications transcend inter se disputes between the contracting parties and attain public implications, where the ramifications could directly or indirectly affect non-parties and impact, integrity in governance, accountability in public service, distribution of essential commodities, safety and security of the nation for example. Consideration of such disputes have public law implications and shall “not be submitted to arbitration”.

VIII. Arbitral Tribunal will be within its jurisdiction to consider allegations of fraud even with respect to the specific terms or clauses in the contract as an arbitration agreement stands independent of the contract and continue to bind and govern the parties even if the contract is terminated or challenged and this question is no more res integra. There is however an exception, the following is its articulation.

IX. However, the allegations of fraud with respect to the arbitration agreement itself stand on a different footing. This position is generally recognized as a dispute which is in the realm of non-arbitrability. In such cases, the arbitral tribunal will not examine the allegation of fraud but will consider the submission only for the purpose of examining exclusion of jurisdiction.

X. The burden of proof is on the party who raises the plea.

XI. When a plea of non-arbitrability is raised, the Court will examine it as a jurisdictional issue only to enquire if the dispute has become non-arbitrable due to one or the other reason as indicated hereinabove.

Senior Advocate Ranjit Kumar appeared for the Appellant while Senior Advocate Amit Sibal appeared for the Respondents.

The Court kept open all the issues raised by senior counsel for the Appellants for being raised and contested before the Arbitral Tribunal.

“The issues that we have not taken up and left it to the arbitral tribunal are jurisdictional issues, involving barring of the arbitral proceedings due to limitation or for the reason that they are non-arbitrable. These issues shall be taken up as preliminary issues and the arbitral tribunal will consider them after giving opportunity to all the parties”, it concluded.

Accordingly, the Apex Court dismissed the Appeals.

Cause Title- The Managing Director Bihar State Food and Civil Supply Corporation Limited & Anr. v. Sanjay Kumar (Neutral Citation: 2025 INSC 933)

Click here to read/download the Judgment