Supreme Court on Piercing the Corporate Veil in Public Interest

Background
The
separate legal personality of a company is a feature that has made that
business form the most popular by a mile. However, the separate legal
personality is not sacrosanct and is subject to limitations, as courts use the
legal tool of piercing the corporate veil to disregard the separation between
the company as a legal entity on the one hand and its shareholders and
directors on the other. Although this basic concept goes to the heart of company
law, it has also been one of the more controversial areas with differing and
sometimes unprincipled piercing of the corporate veil by courts. Part of this
can be attributed to the fact that veil piercing tends to be largely a judicial
function than a legislative function, which therefore gives rise to
uncertainties from a business perspective.
Facts
In
this light, it is useful to consider a recent decision of the Supreme Court of
India in State
of Rajasthan v. Gotan Lime Stone Khanji Udyog Pvt. Ltd.
[1] wherein the judicial tool of veil
piercing was deployed (Hat-tip: LiveLaw). The case involved the treatment of a mining lease for
limestone in Rajasthan. M/s. Gotan Limestone Khanji Udhyog (GKLU) was a partnership
firm that held a mining lease from the Government. After obtaining the
necessary consent from the Government, GLKU transferred the lease to a private
limited company Gotan Limestone Khanji Udhyog Pvt. Ltd. (GLKUPL), which came
into existence as a result of a conversion of the partnership firm into a
private limited company. The partners of the firm became the directors of the
company, and the transfer of the lease from the firm to the company did not involve
any price or premium. Thus far, there seems nothing extraordinary. But, it is
the step that followed that gave rise to the dispute. The shareholders of
GLKUPL then sold all of their shares in the company to a subsidiary of Ultra
Tech Cement Company Limited (UTCL) for Rs. 160 crores, effectively giving rise
to a sale of the mining lease. No separate formalities were followed as it only
involved a transfer of shares and not a transfer of the lease, which continued
to be held by the company. Several parties, including the State Government, challenged
the transaction before the High Court of Rajasthan. Both a single judge as well
as (on appeal) a division bench of the High Court upheld the transactions and
refused to intervene on the ground that the company is a separate legal
personality and that a transfer of shares among shareholders does not affect
the existence or character of the mining lease with the company. It is the
decision of the division bench that has been challenged before the Supreme
Court.
Decision
The
Supreme Court disagreed with the views of the High Court and decided to quash
the transaction. In doing so, it placed reliance on an earlier decision of the
Supreme Court in Victorian Granites (P)
Ltd. v. P. Rama Rao
, (1996) 10 SCC 665. The Court essentially saw through
the entire transaction by disregarding the corporate veil of GLKUPL. It noted:
22. In the present case there are two
transactions. Viewed separately, there may be nothing wrong with either or both
but if real nature of transaction is seen, the illegality is patent. In first
transaction of transfer of lease from the firm to the company, with the
permission of the competent authority, only disclosure made while seeking
permission for transfer is of transforming partnership business into a private
limited company with same partners as directors without there being any
financial consideration for the transfer and without there being any third
party. There is perhaps nothing wrong in such transfer by itself. In the second
transaction, the entire shareholding is transferred for share price and control
of mining lease is acquired by the holding company without any apparent price
for lease. Technically lease rights are not sold, only shares are sold. No
permission for transfer of lease hold rights may be required. Let us now see
the combined effect and real substance of the two transactions. The partnership
firm holding lease hold rights has successfully transferred the said rights to
a third party for consideration in the form of share price which is nothing but
price for sale of mining lease which is not allowed and for which no permission
has been granted.
On
the specific legal principle of piercing the corporate veil, the Court found
that the ground of “public interest” is an important one. Moreover, this is to
be seen in the light of the purpose of the legislation which is sought to be
affected by the transaction. Given that this involved mining lease, which is a
public good, it was treated as welfare legislation thereby affecting public
interest. As the Court observed:
23. The principle of lifting the
corporate veil as an exception to the distinct corporate personality of a
company or its members is well recognized not only to unravel tax evasion but
also where protection of public interest is of paramount importance and the
corporate entity is an attempt to evade legal obligations and lifting of veil
is necessary to prevent a device to avoid welfare legislation. It is neither
necessary nor desirable to enumerate the classes of cases where lifting the
veil is permissible, since that must necessarily depend on the relevant
statutory or other provisions, the object sought to be achieved, the impugned
conduct, the involvement of the element of the public interest, the effect on
parties who may be affected etc.
For
this reason, the Supreme Court allowed the appeal of the State of Rajasthan.
Analysis
Through
this judgment, the Supreme Court of India continues its trend of adopting an
expansive set of grounds for piercing the corporate veil, particularly the one
relating to “public interest”. This is evidence of the Court’s concern to
prevent misuse of the corporate form, which partakes a rather “public” nature
in the Indian context compared to other jurisdictions. On the contrary, in the
UK there has been an effort to narrow the scope of veil piercing to more
specific and distinct grounds as seen in 2013 in the case of Prest
v. Petrodel Resources Ltd
.
To that extent, the Supreme Court in India has deliberately chosen a different
path, and sought to set out its own jurisprudence on veil piercing. Although Prest is generally considered an
important decision in the Commonwealth, it did not find a mention at all in the
Supreme Court’s analysis.
The
present decision appears to be consistent with some trends I had set out in a paper last year:
Corporate law stipulates that a company
that has been incorporated in accordance with the law is a legal personality
that is separate from its shareholders, directors, creditors and other
constituencies. This principle forms the foundation of the limited liability
protection offered to shareholders that encourages entrepreneurs to establish
business and carry out trade that benefits the economy as a whole. However, the
law pertaining to “piercing the corporate veil” steps in to create a balance
whereby the limited liability doctrine is not abused to adversely affect the
interests of third parties (particularly creditors). My comparison suggests
that English law is rather circumspect about the idea of piercing the corporate
veil, thereby treating the principles of separately legal personality and
limited liability as sacrosanct. More recent evidence from the English courts
considerably narrow the situations where the veil can be pierced. Contrast this
with the position in India where courts have been more liberal in piercing the
veil. The differing treatments are indicative of the variance in the
philosophy, whereby England continues to follow a market-oriented approach
wherein incorporation is considered a facilitative process for advancing the
business needs of entrepreneurs, whereas the courts in India tend to adopt a
broader view taking into account the interests of all stakeholders whose
interests are affected by the actions of companies.



[1]
The judgment dated January 20, 2016 by Anil R. Dave, J. and Adarsh Kumar Goel,
J. can be accessed via Judis.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

3 comments

  • In my opinion tax avoidance should that too sparingly be the reason to lift corpoate veil. The legislature when it enacted company law has not created any provision for lifting and legislative intention should be held sacrosanct by courts

  • Surely this could have been justified on the ground of fraud . There was clearly an intention to transfer the mining lease without permission of government to a third party using the separate corporate personality. This is fraud at the inception i.e. at the time of incorporation. This would satisfy the English law requirements also, in my opinion.

  • I believe we are concerned here with a public ground for piering the corporate veil. The moment it formed itself in a Pvt Ltd company, I suppose it had the intent of transferring the company for pecuniary gain.
    This clearly embarks the false legal facade hat a company uses to hide their frivolous ativities.

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