The Supreme Court of Appeal (SCA) recently provided clarity concerning arbitration clauses found in contracts which have been entered into fraudulently.

The judgment in North East Finance (Pty) Ltd vs Standard Bank of South Africa Ltd is important because the question of whether a party is obliged to submit a dispute to arbitration by virtue of an arbitration clause found in a voidable agreement - is one that is relevant to any contracting party.

The legal issues

The question put before the SCA in North East Finance (Pty) Ltd vs Standard Bank of South Africa Ltd can be stated succinctly: if a third party to a contract enters the contract on fraudulent grounds (ie is fraudulently induced into entering such a contract), are the parties bound by an arbitration clause which forms part of the contract?

In this matter a settlement agreement was entered into. It contained an arbitration clause which referred, inter alia, to "including any question as to the enforceability of this contract". It was by virtue of this clause that the appellant argued that the respondent was bound to refer the matter to arbitration, thereby including the question of whether the contract was fraudulently induced.

The respondent, having won already in the court a quo, argued that the contract was void ab initio because the fraud was substantial and the respondent had exercised its election to cancel the contract and to claim restitution.

The appellant, in the court a quo, had sought a court order which would in effect compel the respondent to submit the issue (being whether or not the contract was void) to the arbitrator appointed in terms of the agreement, so that a decision could be taken as to whether the contract was fraudulently induced.

The appellant argued that the issue of whether the contract was binding on the respondent was to be decided by an arbitrator in terms of a clause in that very same contract. It is trite in South African law that if a contract is voidable, an election is available to the innocent party. Should the party elect to void the contract, the contract is considered void ab initio, as if it had never occurred. On this basis, therefore, the respondent argued that it could not be bound to a clause in a contract which it would never have entered into but for the fraud.

The obvious question then is: to what extent can questions relating to the validity of the fraudulent contract be decided according to a clause contained in that very contract? The SCA discussed a number of authorities and resources, including many English authorities, which discuss the issue in some depth.

The court was tasked with deciding whether the arbitration clause could compel submission to arbitration and, if so, whether the allegations of fraud appeared to be "wholly unfounded".

The second issue is both interesting and important. The court a quo found that the allegations of fraud did not appear to be 'wholly unfounded' and that the respondent could therefore rely on the fraud to declare the contract void ab initio. It appears that the court a quo exercised its discretion in arriving at this decision. However, if a court were to find that the allegations of fraud were wholly unfounded then presumably the dispute could be referred to arbitration as the election to void the contract would not be available to the innocent party. This was not canvassed in the judgement.

The judgement

The court referred to a Constitutional Court judgment in which Cameron JA said that an arbitration clause embedded in a fraud tainted agreement could not stand.

He or she thereby denies that he or she ever joined in the submission relating to arbitration. The fact that the arbitration clause included the words "including any question as to the enforceability of this contract" was not enough to convince the SCA that the dispute should have been placed before an arbitrator.

That being said, the court referred to English authorities where Lord Porter was quoted as saying "…equally, I see no reason why, if at the time when they purport to merge the contract they foresee the possibility of such a dispute arising… it may require very clear language to effect this result and it may be true to say that such a contract is very collateral to the agreement supposed to have been made, but I do not see why it should not be done".

It follows that the court was bound to consider the context in which the agreement was concluded and to read the clause with reference to the rest of the agreement. Thus, if the parties foresee the possibility of a particular dispute arising as to the validity of a contract, they may provide that it be referred to an arbitrator for resolution.

It was the opinion of the SCA that the respondent had not foreseen that there might have been fraudulent conduct on the part of the appellant at the time of concluding the agreement. There was thus no intention that the arbitrator would be expected to resolve issues relating to fraud. It had been envisaged that the arbitrator's role would be to determine disputes in respect of accounting issues.

The appeal was accordingly dismissed with costs.

By Luke Choate, associate, Webber Wentzel