Supreme Court on Arbitrability and Serious Fraud.


Published 06 October 2025 Civil Appeals >> Civil & Consumer Law  

In a recent decision, the Supreme Court of India addressed the complex relationship between arbitration agreements and allegations of serious fraud, providing a clear framework for how courts should handle such cases. The judgment, delivered on August 5, 2025, by Justices Pamidighantam Sri Narasimha and Manoj Misra, arose from a civil appeal involving The Managing Director Bihar State Food & Civil Supply Corporation Limited and others versus Sanjay Kumar.

The case centered on a series of appeals stemming from a High Court of Judicature at Patna judgment that had appointed arbitrators under Section 11 of the Arbitration and Conciliation Act, 1996. The core of the dispute revolved around the arbitrability of cases involving significant allegations of fraud.

 

 

Background of the Case:

The Bihar State Food and Civil Supplies Corporation (the Corporation) had agreements with various rice millers to convert paddy into rice for distribution under a Food Corporation of India scheme. The agreements included a clause for arbitration (Clause 16) if mutual discussions failed to resolve disputes.

Allegations of a "massive fraud" amounting to over a thousand crores led to the Corporation initiating criminal proceedings, filing nearly 1,200 First Information Reports (FIRs) against the rice millers. In one such FIR, it was alleged that a rice miller, Sanjay Kumar, had defalcated over Rs. 83 lakhs after failing to deposit the agreed-upon quantity of rice. The respondents were subsequently charged under Sections 420 and 409 of the Indian Penal Code (IPC).

Despite the ongoing criminal proceedings and the initiation of recovery proceedings under the Bihar and Orissa Public Demands Recovery Act, 1914, the High Court allowed applications from the rice millers to appoint arbitrators, a decision the Corporation challenged in the Supreme Court.

The Supreme Court's Analysis:

The Court meticulously examined the issues, including whether the disputes had become non-arbitrable due to the pending criminal cases, if the invocation of the Recovery Act barred arbitration, and the scope of a court's inquiry under Section 11(6A) of the Arbitration Act.

The Court revisited the principles governing arbitrability in cases of serious fraud, acknowledging that while disputes involving "fraud simpliciter" can be arbitrated, "serious fraud" may render a matter non-arbitrable for policy considerations. The Court also noted that the mere fact that criminal proceedings have been or can be initiated does not automatically make an otherwise arbitrable dispute non-arbitrable.

Drawing on precedents such as Ayyasamy v. Paramasivam and Avitel Post Studioz Limited v. HSBC PI Holdings, the Court restated two key tests for determining serious fraud. The first test applies when a party alleges they never entered into the arbitration agreement at all. The second test applies to cases where a party alleges arbitrary, fraudulent, or mala fide conduct by the State or its instrumentalities, requiring a hearing in a writ court because the issues extend into the public law domain.

The Court's Final Ruling:

The Supreme Court ultimately held that its scope of inquiry was limited by Section 11(6A) of the Arbitration and Conciliation Act, which confines a referral court's examination to "the existence of an arbitration agreement". The Court clarified that this examination is not a laborious or contested inquiry but a scrutiny of whether an agreement exists based on Section 7 of the Act.

Given the existence of an arbitration agreement in the contracts between the parties, the Court concluded that its role ended there. It dismissed the appeals and directed that all issues, including the jurisdictional ones regarding the arbitrability of the dispute due to fraud, should be raised and contested before the arbitral tribunal. The Court's decision emphasized that it is the arbitral tribunal, under Section 16 of the Act, that is empowered to rule on its own jurisdiction and the substantive validity of the arbitration agreement after admitting evidence.


Section 7, Arbitration and Conciliation Act - 1996  

Section 11, Arbitration and Conciliation Act - 1996  

Arbitration and Conciliation Act, 1996  

Section 409., Indian Penal Code - 1860  

Section 420., Indian Penal Code - 1860  

Indian Penal Code, 1860