Revisiting “Sham” as a Ground for Piercing the Corporate Veil

[Ashwin Murthy and Sathvik Chandrasekhar are 4th year students from NALSAR University of Law]

The doctrine of piercing the corporate veil was clarified in India with the landmark case of Balwant Rai Saluja v Air India (2013), recognising that the veil should rarely be lifted. Balwant directly relied upon the UK case of Prest v Petrodel which similarly narrowed the scope of such piercing (read more here), however with key differences in the language. While in Prestit was held that the corporate veil could be pierced when “a person is under an existing legal  obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control” (para 35), in Balwant such piercing could only be allowed when “it is evident that the company was a mere camouflage or sham deliberately created by the persons exercising control over  the said company for the purpose of avoiding liability”. While “avoiding liability”is similar to the holding of Prest, the addition of “mere camouflage or sham” is notably distinct and carries with it an ambiguity counterproductive to Prest’s goal of limiting the scope of piercing the corporate veil.

The question thus arises as to what the term ‘sham’ constitutes. In an earlier post by V. Niranjan on Balwant, it was argued that sham constitutes one of two possibilities: either an ‘economic reality’ (the structuring and functioning of the company; a substance over form approach) or impropriety (which in effect is avoidance of liability). Interestingly however, there has been a different argument in the context of piercing the corporate veil due to tax evasion, where ‘sham’ transactions are treated as separate from ‘fraud and impropriety’ and ‘colourable devices’. Here fraud and impropriety are argued to be the usage of a company as a device to subvert the interests of shareholders and other stakeholders. However, following the earlier UK case of Snook v London & West Riding Investments (1967), sham was held as acts that give third parties the appearance of legal rights and obligations different from the actual rights. Thus, the post argues that fraud is the subversion of an existing liability, while sham questions the existence of the liability itself. Thus, sham here would create the appearance of rights and obligations that do not in fact exist.

While the second argument is certainly convincing, subsequent Supreme Court case law must be analysed so as to determine whether such a distinction is in fact adopted in Indian jurisprudence or whether it remains solely a creature of UK law, thereby clarifying the scope of ‘sham’ transactions.

Before proceeding with subsequent cases however, reference must be made to the Supreme Court’s holding in Vodafone International Holdings v. Union of India (2012), where the concept of sham was discussed in the context of tax evasion. The Court, when first using the term, referred to the transaction rather than any particular entity. It held :“Once the transaction is shown to be fraudulent, sham, circuitous or a device designed to defeat the interests of the shareholders, investors, parties to the contract and also for tax evasion, the Court can always lift the corporate veil and examine the substance of the transaction.”. While the Court did not go on to define the term, the outcome of a sham transaction was clearly outlined, i.e., the interests of the shareholders, investors and parties to the transaction were defeated and the transaction was a means to avoid tax. However, the Court in the same judgment also used sham to describe an entity rather than a transaction, while discussing when the actions of a wholly owned subsidiary can be imputed to a holding company. It held that “the Parent company of a Wholly Owned Subsidiary is not responsible legally for the unlawful activities of the subsidiary save in exceptional circumstances, such as a company is a sham or the agent of the shareholder, the parent company is regarded as a shareholder” (emphasis added). Therefore, Vodafonecannot be solely relied on to determine the contours of ‘sham’ due to its usage of the same term in two different contexts.

Balwantfollowed Vodafoneand, as previously mentioned, applied sham in a different sense from in Vodafone.Interestingly, there are very few Supreme Court cases following Balwant dealing with the question of piercing the corporate veil, and even fewer directly citing or following its interpretation, including on the question of ‘sham’.

Two cases follow the ‘economic realities’ understanding of sham in order to pierce the corporate veil. The first is Commissioner of Central Excise v Detergents India Limited (2015) relating to ‘related persons’ under the Excise Act. The Court here allowed for holding the companies as related persons so as to lift the corporate veil and ascertain the economic realities. By examining the economic realities, the Court would see behind the ‘legal façade’ to observe for evasion or avoidance of tax. Similar lines were adopted in Commissioner of Central Excise v J Foundation (2015), directly citing the aforementioned case. The phrase ‘sham’ is not mentioned in the judgment.

While the corporate veil in State of Rajasthan v Gotan Lime (2015) was pierced on the basis of public interest, the Court cited Palmer’s understanding of piercing the corporate veil:

The courts have further shown themselves willing to ‘lifting the veil’ where the device of incorporation is used for some illegal or improper purpose…. Where a vendor of land sought to avoid the action for specific performance by transferring the land in breach of contract to a company he had formed for the purpose, the court treated the company as a mere ‘sham’ and made an order for specific performance against both the vendor and the company

In Estate Officer v Esys Information (2016),the Supreme Court cited Juggilal Kamlapat v Commissioner of Income Tax (1969) in stating that the Court could lift the mask of the corporate veil when the corporate structure is used to perpetrate fraud, tax evasion or other fraudulent design. Interestingly, the case cited LIC v Escorts (1985) and State of UP v Renusagar Power Company (1988) but notBalwantin its application of the principle of corporate veil. S. Sukumar v Institute of Chartered Accountants of India (2018) noted that the veil may be pierced when the corporate personality is used as a cloak for fraud or in improper conduct, as well as in the protection of public interest. Crucially, it states that the veil may be lifted when “the corporate personality is used to evade obligations imposed by law” (para 50). The legal obligations already existed; they were merely subverted through the application of the corporate personality. These cases, along with Gotan Lime, therefore hearken to the earlier definition of fraud rather than sham as per the Snook understanding, as there is a subversion of an existing right and not the creation of rights on the basis of a fact that does not exist. Thus, it would be an impropriety that leads to the avoidance of a liability.

When reading the aforementioned cases, two interesting conclusions could be reached. The foremost is that clearly the case of Balwant isless influential than believed or hoped, as the subsequent Supreme Court cases seemed to have completely ignored its existence and have not hesitated to pierce the veil. Thus, the limited approach of lifting the corporate veil as per Prest is still not in effect in India.

Secondly, and perhaps a moot point considering the ignorance of Balwant, there is no explicit reference to the concept of sham in these cases. Given the absence of any explicit mentioning of sham, it cannot be considered a ground in such concrete terms – the mere reference of ‘sham’ cannot be a ground to piercing the corporate veil. However, one could argue that in mentioning the term ‘sham’ the Court intends to refer to one of two divergent strands.

The first strand is when sham is to be considered as ‘economic realities’ of the company at hand. However, the previous cases that have referred to economic realities are limited only to specifically the evasion of tax liabilities by subsidiaries. The second strand is when it refers to a mere impropriety or fraud which subverts the existing liabilities (instead of the creation of rights and liabilities on non-existent facts). This, however, is already an established ground to pierce the veil and therefore is redundant. The understanding laid down in Snook– the creation of an appearance of rights and obligations that do not in fact exist – has not been addressed by courts, either due to a lack of prior cases involving the same or simply a lack of judicial clarity when analysing corporate structures.

Thus interestingly, both of Niranjan’s understandings of sham have come forward, in different contexts. In the specific understanding of avoiding tax liability, sham would be equated to economic realities, and in other cases it would merely be a redundant reference to impropriety and fraud.

Unfortunately, this level of clarity appears to be lacking at the Supreme Court when dealing with issues of corporate personality. An approach guided by careful deliberation of the language used, and restraint from judicial flourishes, would prevent this very confusion from arising as to whether a special meaning was purported by the usage of specific words or phrases by the Court. Such an approach would go a long way in maintaining clarity when dealing with technical issues such as piercing the corporate veil.

Ashwin Murthy & Sathvik Chandrasekhar

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