Claims against the Fraud under Arbitration

Claims against the Fraud under Arbitration

Arbitration is considered as one of the most preferred modes of dispute resolution in commercial disputes among the parties, being pragmatic, however, the claims for act of fraud  made by the party against the another  in the arbitration proceedings gives rise to a contentious issue– ‘Whether frauds are arbitrable?”

The disputes under fraud are considered to be non-arbitrable under the provisions of Section 34(2) of the Arbitration & Conciliation Act, 1996 ( “ACA”) as the same needs to be settled by the courts through detailed evidence led by both parties and on the ground of public policy.

The issue with respect to “Arbitration of Disputes with Fraud Claims“ have been settled by hon’ble Supreme Court in the matter of Vidya Drolia v. Durga Trading Corporation2020 SCC OnLine SC 1018, where it was been held that – “allegations of fraud are arbitrable, provided, they relate to a civil dispute and exclude only those claims which vitiates and render the arbitration clause invalid.”

Hence, if the matter does not involve serious allegations of fraud, which need not to be dealt by criminal court and does not falls under right in rem but can be dealt as right in personam, the claims involving fraud can be arbitrable by the arbitrator in the arbitration proceedings.

Fraud has been defined under Indian Penal Code, 1860, Companies Act, 2013 and Indian Contract Act, 1872 under the applicable laws of India.

  Criminal Law Companies Act, 2013 Indian Contract Act, 1872
Indian Penal Code, 1860 Bhartiya Nyaya Sanhita 2023 w.e.f July 1st, 2024
Applicable Sections 403, 405, 406, 418, 420, 463, 464, 465, 467, 471, 477A 314, 316, 318, 335, 336, 338, 340, 344 447 17
Punishment Fine & Imprisonment upto 10 years Fine & Imprisonment upto 10 years Upto 10 years and three times the amount involved in the fraud Damages and losses incurred
Legal Recourse Complaint at Criminal Court having jurisdiction Complaint at Criminal Court having jurisdiction Complaint at Special Courts established under Section 435 of the Companies Act, 2013

Civil Suits/Arbitration depending upon the nature of fraud

In our article we have restricted our analyses on the applicability of Section 17 of the Indian Contract Act, 1872 (“ICA”) w.r.t claims against the fraud under the arbitration.

Fraud is committed when one party causes another party to act on a false belief by a representation which he does not himself believe to be true.  Under ICA, the party which suffers damages due to fraud is entitled to bring civil action for the damages incurred.

Fraud has been defined under Section 17 of ICA where fraud includes any of the following acts committed by a party to a contract, or with his connivance, or by his agent, with intent to deceive another party thereto or his agent, or induce him to enter into the contract:

  1. the suggestion, as fact, of that which is not true, by one who does not believe it to be true;
  2. the active concealment of a fact by one having knowledge or belief of the fact;
  3. a promise made without any intention of performing it;
  4. any other act fitted to deceive;
  5. any such act or omission as the law specifically declares to be fraudulent.

The act of “fraud” is been categorized as an exception to the free consent under Section 14 of the ICA. So, any consent to execute any agreement is obtained via fraud shall make it ‘voidable’ under S.19 of the ICA at the option of the person who has been given his consent under the act of fraud.

Under ICA, the fraud is limited to the procurement of the consent to the contract and does not apply for fraudulent acts during the course of performance of the contract. Fraud which vitiates the contract, must have a nexus with the acts of the parties prior to entering into the contract.

A Fraud under ICA is proven when it is shown that a false representation has been made:

  1. knowingly; or
  2. without belief in its truth; or
  3. recklessly, careless whether it be true or false
  4. The (iii) would be applicable on the event (ii) is to be true.

The principles applicable is assessing damages for fraudulent claims   in the arbitration proceedings are as following:

  1. The party who has induced the other party by fraudulent misrepresentation is bound to make reparation for all the damages directly flowing from the transaction;
  2. Although such damage need not have ben foreseeable, it must have been directly caused by the transaction;
  3. In assessing such damage, the party who has been induced by fraudulent misrepresentation is entitled to recover by way of damages the full consideration paid by him, but he must return or adjust any benefits which he has received as result of the transaction;
  4. In addition, damages include the consequential losses cause by the transaction;
  5. The party induced by fraudulent misrepresentation must have taken all reasonable steps to mitigate the loss once he has discovered the fraud.

Damages for Claims against the Fraud under Arbitration:

  1.  The party deceived has the option to affirm the contract and insist that he may rescind the contract to the extent it is not performed. Upon recession, he is liable to restore the benefits received by him and may recover damages. The measures of damages recoverable is all the actual loss directly flowing from the transaction induced by the fraud, including the heads of consequential loss, and not merely the loss which was reasonably foreseeable.
  1. A party can avoid a contract on the ground of fraud which has caused that party to enter into the contract, if the other party has made a fraudulent representation, which may include language or practices, or fraudulent non-disclosure of circumstances which, according to reasonable commercial standards of fair dealing, the latter party should have disclosed.

Where a contract is induced by fraud, the party who is been induced into contract by fraud is entitled to claim rescission, or damages or both, where he could have his remedy by way of  suit, or arbitration even if restutio in integrum is not possible.

This article is for information purpose only and should not be taken as legal advice. To know further details, clarification, assistance or any advice on Arbitration, fraudulent claims under arbitration proceedings or any legal issues on arbitration, you may connect with us at admin@equicorplegal.com  / 08448824659 and visit www.equicorplegal.com