The Corporate Veil and Arbitration Clauses

With the rapid growth of group companies in India over the past decade, it has become commonplace for a commercial transaction to be routed through several entities in one group. In cases where some of those entities have entered into agreements containing an arbitration clause, and others have not, the question arises as to whether the non-signatories are bound by the arbitration clause.

In answering this question, two considerations are relevant. The first is one of arbitration law, and in particular, s. 7 of the Indian Arbitration and Conciliation Act. The second, however, is the contention that is often made in these circumstances that the corporate veil may be lifted in cases where one of the companies has a limited economic role in the transaction. This contention has met with varying degrees of success in the United States and England, but has been accepted on occasion in France. On April 27, the Supreme Court had an opportunity to consider these questions, in Indowind Energy Ltd. v. Wescare Ltd., available here. A two-judge Bench of the Supreme Court, comprising Justices Raveendran and Radhakrishnan, decided the matter.

Indowind and Wescare, the Respondent, are companies incorporated under the Companies Act, 1956. Subuthi Finance Ltd., another incorporated company, is the promoter of Indowind. In February 2006, Subuthi and Wescare entered into an agreement by which Wescare agreed to sell certain Wind Electric Generators to Subuthi for Rs. 98 crores, part of which was to be paid through the issue of shares. While Indowind was not a party to this Agreement, the Agreement provided that it was “subject” to the approval of the Board of Directors of Wescare, Subuthi and Indowind, and that the Agreement would be null and void in the absence of approval. This Agreement contained an arbitration clause, which Wescare invoked when disputes arose, following the failure of the Indowind Board to approve the Agreement. Wescare filed an injunction application under s. 9 of the Arbitration Act, requesting the High Court to restrain Indowind from proceeding with its IPO, and from using the assets sold by Wescare. That application was dismissed by a single judge on the basis, inter alia, that Indowind was not a party to the Agreement, and had not signed or ratified the Agreement. Subsequently, Wescare once again approached the High Court, under s. 11(6) of the Act, seeking the appointment of an arbitrator. The Chief Justice allowed the application, holding that the case was a fit one for lifting the corporate veil, and that Subuthi and Indowind are “one and the same party”. In addition, the Chief Justice relied on several factual circumstances that established a close connection between Subuthi and Indowind.

The Supreme Court rejected this approach, and made several important observations on the sanctity of the corporate form. It began by noting that s. 7 of the Act requires that the arbitration clause is contained in a document “signed by the parties”, or in an exchange of letters, telex etc. Alternatively, the clause must be “incorporated by reference”. The Court firmly rejected the possibility of lifting the corporate veil, in the following terms:

It is not in dispute that Subuthi and Indowind are two independent companies incorporated under the Companies Act, 1956. Each company is a separate and distinct legal entity and the mere fact that two companies have common shareholders or common Board of Directors, will not make the two companies a single entity. Nor will existence of common shareholders or Directors lead to an inference that one company will be bound by the acts of the other. If the Director who signed on behalf of Subuthi was also a Director of Indowind and if the intention of the parties was that Indowind should be bound by the agreement, nothing prevented Wescare insisting that Indowind should be made a party to the agreement and requesting the Director who signed for Subuthi also to sign on behalf of Indowind. The very fact that parties carefully avoided making Indowind a party and the fact that the Director of Subuthi though a Director of Indowind, was careful not to sign the agreement as on behalf of Indowind, shows that the parties did not intend that Indowind should be a party to the agreement.

The Court rejected the contention that a non-signatory may be bound by an arbitration clause by virtue of its “conduct”, holding that the requirement in s. 7 that the agreement be in “writing” is mandatory. In addition, the Court held that the Chief Justice or his designate under s. 11(6) is not the appropriate forum to inquire into the conduct of the parties, and must merely consider whether there is an arbitration agreement or not.

The Court did not entirely foreclose the possibility that a non-signatory in India may bind himself to an arbitration clause through conduct, but noted that this would have to be through “incorporation by reference” or under the provisions of s. 7(4)(b) of the Arbitration Act. It declined to follow American decisions binding non-signatories for the reason that the underlying statutory provision in question was substantially different to s. 7.

It will be interesting to observe whether the Supreme Court confines its observations on the corporate form to the particular context of arbitration agreements, or chooses to apply it more generally.