Doctrine of ‘Reverse’ Piercing and the Jurisprudence of Indian Courts

[Debarshi Chakraborty is a 3rd year B.A., LL.B. student at National Law University Odisha.]

The doctrine of ‘reverse’ piercing, although relatively new, is a controversial area of corporate law. This doctrine could be problematic given the situations where a body corporate has multiple shareholders. Conversely, there have been times even in relation to companies with one shareholder where it has given creditors of a shareholder an advantage that they would not normally have in relation to the creditors of the corporation. Consequently, the doctrine of ‘reverse’ piercing is less universally recognized as compared with traditional veil piercing.

The ‘reverse’ piercing of corporate veil refers to the concept where a creditor of the shareholder of a corporation attempts to hold the corporation liable for debts of the shareholders. Opposed to this, in traditional piercing, a creditor of the corporation usually attempts to hold the shareholder personally liable for the debts of the corporation. Like fraudulent conveyance, ‘reverse’ piercing acts as an equitable remedy for executing civil judgment. Consequently, under both these concepts, a creditor can sue a corporation that received the owner’s personal assets to help the owner evade personal liability.

Emergence of the Doctrine of ‘Reverse’ Piercing

The doctrine witnessed its full-fledged emergence and acceptance in the US through the Supreme Court’s decision in 1956 – W. G. Platts case. This case concerned a marital (property) dispute in which the plaintiff sought to impose liability on her husband’s corporation for satisfying her share of the assets pronounced in the divorce decree. The Court held the corporation to be an ‘alter ego’ of the husband, i.e. secondary/alternative personality of the husband, thereby permitting ‘reverse’ piercing in order to satisfy the decree.

Two years later, a district court in Colorado inShamrock Oil & Gas v. Ethridge confirmed this doctrine by adopting an all-encompassing definition. Arra J, District Judge observed that “the [mere]abstraction of the corporate entity should never be allowed to bar out and pervert the real and obvious truth.”This etched the doctrine clearly in the US legal system. Thereafter, ‘reverse’ piercing came to be invoked in a slew of cases. For the government, especially it became a convenient tool to obtain taxes. G. M. Leasing Corporation v. US is one of the leading cases in this direction.

Evolution of the Doctrine in India

The doctrine of ‘reverse’ piercing was virtually unheard of in India as it was in UK. The Indian courts demonstrated inordinate reluctance in bluntly accepting this jurisprudence. This is evident from the behaviour of the courts, especially before 2005. During this time, courts had to grapple with large volumes of cases where corporations had been charged with offences demanding criminal prosecution. It was first pointed out by the Calcutta High Court in A.K. Khosla v. T.S. Venkatesan (“A.K. Khosla”) that there were two pre-requisites, as criminal law demands, in order to prosecute a person– First, the accused should be capable of generating mens reaand second, s/he should be able to bear the imposition of mandatory sentence of imprisonment. A corporation, in the opinion of the Court, could not be said to have the necessary mens rea, as it is merely a juristic person and not a natural person. Therefore, neither does it have a mind of its own nor can it be sentenced to imprisonment as it has no physical body. This view was confirmed in MV Javali v. Mahajan Borewell Co by the Supreme Court (“SC”), but with slight modification. Consequently, it was laid down that mandatory sentence of imprisonment and fine cannot be imposed on a company. In such a case, fine would be the only punishment. However, the courts were still averse to hold a corporation liable for the debts or fraudulent acts of the ones managing it.

Finally, in the landmark Standard Chartered Bank v. Directorate of Enforcement (“Standard Chartered Bank”) decision, SC held that a corporation can be prosecuted and punished for an offence with fines, regardless of the mandatory punishment required under respective statues. In this case, Standard Chartered Bank was being prosecuted for violation of certain provisions of Foreign Exchange Regulation Act, 1973 (“FERA”). The SC digressed from the literal and strict rule of interpretation, as is required for penal statutes, and sought to deliver complete justice by imposing fine on the corporate. [FERA does not distinguish between a natural person and juristic person, consequently, the bank was vulnerable to criminal prosecution under the statute.] This marked the induction of the ‘reverse’ piercing doctrine into the jurisprudence of Indian courts.

‘Reverse’ piercing in the UK

The characterization that the Indian courts sought after 2005 had already been espoused by the English courts even before the first case of this kind in India. MacNaghten, J. in the 1972 appeal case of D.P.P. v. Kent and Sussex Contractors Ltd.observed body corporates to be “persons”, to whom a mind capable of knowing and forming an intention (including criminal intention) should be attributed/attributable. In other words, English courts emphatically supported what is now termed ‘reverse’ piercing as the doctrine of ‘attribution and imputation’. Therefore, this marked the percolation of the jurisprudence that the criminal intent or the “alter-ego” of the corporation is that of the person or group of persons that guide the business of the corporation.

MacNaghten, J.made this observation in 1972, and the first case in India to reach the court bearing identical question(s) was only in 1991 with A.K. Khosla. But the view was contrary to what was laid down by the English court of appeals. It only came to be accepted to some extent in the year 2005 with the Standard Chartered Bank decision. Hence, indeed it is much too late in the day to suggest the contrary. As a matter of fact, the body corporate can form an intention only through its human agents, but circumstances may be such that the knowledge of the agent must be imputed to the body corporate. This opinion came to be reiterated in other decisions, as well. Presently, it stands as a steady jurisprudence in the English courts.  

Reluctance of Indian Courts and Vicarious Liability

The principle of “alter-ego” has always seen reverse application. Although the general principle is that the acts of the individual, who is in control of the affairs of a corporation and is a directing mind, are attributed to the corporation, nonetheless, whenever s/he is made an accused, on the application of the principle of “alter-ego”, the corporation shall also be implicated as accused person.

It is imperative to acknowledge the well-recognized principle, by virtue of which the Indian courts had initially resisted ‘reverse’ piercing. According to the Indian courts, a corporation does not act on its own but through its directors/officers. When such director/officer acts on behalf of the corporation, the corporation ought to be held responsible for their acts on the application of “principal-agent” principle, and there is no requirement of a separate doctrine to bring the same into existence. Therefore, the popularly held principle was that of vicarious liability.

Consonant with the elementary concept of corporate law, a company is a separate legal entity from its directors/controllers. It is only under certain exceptional circumstances that this distinction can be done away with in the interest of justice. Broadening the horizons by bringing into existence the principle of ‘vicarious liability’ would merely dilute the elementary constructions of the Company Act, 2013. Therefore, the practice of ‘reverse’ veil piercing is certainly not guided by the principle of vicarious liability, but, like traditional veil piercing is a pragmatic exception to the doctrine of separate legal entity. In other words, it is based on the broader interests of public policy and justice.

Nonetheless, it is significant to note that imputing the conduct of the directors of a company is not automatic. It requires an existing statutory provision to make such imputation possible. This position is further clarified by SC in Aneeta Handa & Ors. v. Godfather Travels. A glaring example would be section 141of theNegotiable Instruments Act, 1881. This provision notes that where a person or a group of persons guiding the business of a company do so with a criminal intention, the same shall be imputed to the body corporate [and not vice-versa]. Consequently, the principle of “alter ego” was applied in one direction here as well.

Conclusion

The doctrine of ‘reverse’ piercing, although at a nascent stage has nonetheless percolated into the jurisprudence in India. But the hurdle that no corporate criminal liability can be fixed on a company unless there is a statutory provision mandating the same continues to this day. Consequently, ‘reverse’ piercing is not applicable in all circumstances. It should be noted that public policy coupled with justice and stability with time cannot be forsaken. The courts must more actively allow the ‘reverse’ piercing concept, even if not as the first resort but definitely in circumstances that allow for it. Strict adherence to the separate legal entity doctrine does not address the problem of economic complexities.     

– Debarshi Chakraborty