Fraud is a arbitrable except where the arbitration agreement itself is vitiated by fraud : Supreme Court

Allegations of fraudulent invocation of the bank guarantee furnished under a substantive contract would be an arbitrable dispute, irrespective of whether the underlying contract regarding the arbitration was stamped as per the relevant Stamp Act. The Supreme Court bench consisting of J. Dr. Dhananjaya Y Chandrachud, J. Indu Malhotra and J. Indira Banerjee, set aside a High Court order regarding non maintainability of an application for arbitration in the case of M/s N. N. Global Mercantile Pvt. Ltd. v. M/s Indi Unique Flame Ltd. & Ors. [Civil Appeal Nos. 3802 – 3808 / 2020].

The respondent applied for grant of work of beneficiation/washing of coal to the Karnataka Power Corporation Ltd. In an open tender. KPCL awarded the work order via a letter of award to Indo Unique (respondent) in pursuance of which the respondent furnished bank guarantees in favour of KPCL through its bankers. Indo Unique subsequently entered into a sub-contract with the appellant company, M/s N. N. Global Mercantile Pvt. Ltd for the transportation of coal from its washery. Under the principal contract with KPCL, certain disputes and differences arose with Indo Unique which led to the invocation of the Bank Guarantee by KPCL. Indo Unique invoked the Bank Guarantee furnished by Global Mercantile under the work order which led to the present proceedings. Global Mercantile filed a Civil Suit against Indo Unique and prayed for a declaration that Indo Unique was not entitled to encash the bank guarantee as work order had not been acted upon. Indo Unique filed for arbitration which was opposed by Global Mercantile as not being maintainable since the Bank Guarantee was a separate and independent contract and did not contain an arbitration clause. The High Court held that the allegations of fraud were not a criminal offence and hence, arbitration was maintainable. Aggrieved, Global Mercantile filed for a Special Leave Petition before the Supreme Court.

The SC stated that The civil aspect of fraud is considered to be arbitrable in contemporary arbitration jurisprudence, with the only exception being where the allegation is that the arbitration agreement itself is vitiated by fraud or fraudulent inducement, or the fraud goes to the validity of the underlying contract, and impeaches the arbitration clause itself”. Further relying on the case of Swiss Timing Ltd. V. Commonwealth Games 2010 Organising Committee [(2014) 6 SCC 677], the court held that “when a plea is taken to avoid arbitration on the ground of the underlying contract being void, the court is required to ascertain the true nature of the defence. Often, the terms ‘void’ and ‘voidable’ are used loosely and interchangeably. The court ought to examine the plea by keeping in mind the provisions of the Indian Contract Act, 1872. In cases where the court comes to a conclusion that the contract is void without receiving any evidence, it may be justified in declining the reference to arbitration in a few isolated cases. These would be cases where the court can readily conclude that the contract is void upon a meaningful reading of the contract document itself”.

Keeping this in mind, the impugned order passed by the High Court was set aside and it was held that the parties could appoint a sole arbitrator consensually or an application could be filed before the HC for the appointment of the arbitrator.

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