Arbitration in Loan Disputes: Limited Jurisdiction of Courts and Fraud Allegations Do Not Bar Reference Unless Arbitration Clause Is Vitiated

The High Court held that arbitration in loan disputes is not barred by fraud allegations or the limited jurisdiction of courts unless the arbitration clause itself is vitiated.

The Calcutta High Court, Single-judge Bench of Justice Shampa Sarkar, reviewed an application and observed that a referral court’s jurisdiction under Section 11 is limited to a prima facie examination of the existence and invocation of an arbitration agreement, and that mere allegations of fraud, unless they vitiate the entire contract including the arbitration clause, cannot preclude reference to arbitration or the appointment of an arbitrator.

The High Court considered an application for the appointment of an arbitrator under Clause 17 of a loan agreement dated July 1, 2019, which empowered the lender to unilaterally appoint the arbitrator. While the petitioner’s counsel sought to enforce this clause for arbitration, the Court noted that recent legal developments and Supreme Court rulings had restricted the lender’s ability to unilaterally appoint an arbitrator. The petitioner had filed the application after the respondents failed to respond to an arbitration notice dated May 25, 2023, despite the respondents disputing the nature of the dispute altogether.

The respondents challenged the application on multiple grounds, asserting that the loan transaction was induced by fraud and thus fell outside the scope of arbitration, urging that such fraud allegations be adjudicated by civil courts. They also pointed to procedural defects in the arbitration notice and questioned the certification of the arbitration agreement. The respondents relied on key Supreme Court precedents, including Rashid Raza v. Sadaf Akhtar and A. Ayyasamy v. A. Paramasivam, to support their arguments. Further, they highlighted pending allegations of fraud made by the Reserve Bank of India before the National Company Law Tribunal and contended that the loan and mortgage transactions were illegal, particularly in relation to properties within a Special Economic Zone.

The Court, however, emphasised its limited jurisdiction under Section 11 of the Arbitration and Conciliation Act, which restricts its role to examining the existence of an arbitration agreement and whether it has been properly invoked. While the existence of the arbitration clause was not disputed, the Court found that the serious fraud allegations required detailed evidence and could not be decided at the interlocutory stage. The Court noted the petitioner’s corporate insolvency resolution process and subsequent change in management but reiterated that these matters did not affect the limited scope of its enquiry.

Referring to the Supreme Court’s judgment in A. Ayyasamy, the Court held that an arbitration application could only be dismissed if it was clear that fraud tainted the entire contract, including the arbitration clause, thereby rendering it void or inoperative. Mere allegations of internal fraud between the parties did not preclude reference to arbitration. Issues regarding the alleged fraudulent use of the loan, round-tripping, or impacts on public interest were factual matters for the arbitrator to decide and not within the competence of the referral Court at this stage.

The Court also relied on the recent Supreme Court decision in SBI General Insurance Co. Ltd. v. Krish Spinning, affirming that the Court’s jurisdiction under Section 11 is narrowly confined to the existence and invocation of the arbitration agreement, with prima facie scrutiny of arbitrability only in exceptional cases. The principle of competence-competence was upheld, entrusting substantive arbitrability issues to the arbitral tribunal. Consistent with Supreme Court precedents, the Court found that allegations of fraud, stamping, and registration issues, as well as procedural objections relating to the arbitration notice, were matters for the arbitrator’s determination.

Consequently, the Court allowed the application and appointed Hon’ble Justice Girish Chandra Gupta, former Chief Justice of the Calcutta High Court, as the sole arbitrator, directing compliance with Section 12 of the Act and permitting him to fix his remuneration. The Court clarified that its observations were tentative and made solely for the purpose of disposing of the Section 11 application, without prejudicing the merits of the dispute to be adjudicated by the arbitrator.

Mr. Jishnu Saha, Sr. Advocate, Mr. Swatarup Banerjee, Advocate and Mr. Shaunak Ghosh, Advocate, Mr. Rajib Mullick, Advocate, represented the Appellant.

Mr. Anubhav Sinha, Advocate, Mr. Subhasis Dey, Advocate, Mr. Saswat Acharya, Advocate, Mr. Abhijit Agarwal, Advocate and Ms. Shruti Shaw, Advocate, appeared for the Respondents.

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