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.

Source : indiacorplaw.blogspot.com