By: Rashi Sharma and Vijpreet Pal
‘Fraud unravels everything’ – Lord Denning
Corporate enterprises were accorded an independent legal status to serve the underlying goals of justice. Although, with time, Benami transactions, frauds, and money transfers into the company’s account were all used to evade accountability. The necessity to govern such malpractices among shareholders and protect the hard-earned money of the investors arose as a result of these fraudulent shareholder transfers, giving rise to the notion of reverse corporate veil piercing, (‘reverse piercing’). The idea refers to a state of affairs when a creditor of a corporation attempts to hold the corporation accountable for the shareholders’ debts. Although new, the idea of reverse piercing is a contentious area of corporate law. For economic progress, a corporation’s independent legal existence must be safeguarded, however, when that form is employed by individuals to avoid existing liabilities, the court may apply classic or reverse piercing of the veil. In India, the notion of reverse piercing is unaccepted, as no cases have been filed in which a court has effectively imposed the personal culpability of a shareholder on the company by reverse piercing.
This article illustrates how this doctrine has emerged and how it can be incorporated into the Indian insolvency regime while delineating the challenges associated with its application in the insolvency resolution process. Furthermore, this article also puts forth recommendations based on the current insolvency regime, while keeping in mind the larger public interest in recovering the economy from the impending crisis. The authors claim that reverse piercing under the Indian insolvency law requires thorough consideration and should not be rejected outright.
EMERGENCE OF THE DOCTRINE OF REVERSE PIERCING IN INDIAN JURISPRUDENCE
In India, the courts have shown an unusual hesitation to accept this doctrine, which can be demonstrated by their approach before 2005. During this time, courts had to deal with a considerable number of cases in which corporations were accused of crimes that required criminal prosecution. It was decided that a company could not be subjected to a mandatory term of imprisonment, consequently, the sole sanction would be fine. Nevertheless, the courts were still skeptical to hold a company accountable for the debts or fraudulent activities of those in charge.
However, for the purposes of this doctrine, the idea of alter-ego was gradually recognized by the courts. While applying the notion of alter ego in Iridium India Telecom Ltd v. Motorola Incorporation and Ors., the court stated that the criminal intent of the corporation’s alter ego could be attributed to the corporation.
Moreover, in the Standard Chartered Bank v. Directorate of Enforcement case, the Supreme Court declared that a corporation can be prosecuted and punished for the transgressions with fines on behalf of its members, independent of the statutory punishment imposed under relevant statutes. Further, this stance was clarified in Aneeta Handa & Ors. v. God-father Travels, a case involving section 141 of the Negotiable Instruments Act, 1881, which gives the inference that individuals’ mens rea can be ascribed to the company to expose the corporate body to criminal culpability. This was the first time the reverse piercing theory was introduced into Indian jurisprudence.
In the recent case involving case Kingfisher Airlines, it was proposed to unite all of the group companies on one platform and use Mallya as the common denominator to impose accountability to settle dues to the Industrial Development Bank of India. A similar plea was brought in the Skippers Builders case when property owned by Tej Properties Pvt. Ltd. was attached to satisfy the debts of Mr. Tejwant Singh, the company’s managing director. Furthermore, even in the Nirav Modi PNB Scam Case, the Debt Recovery Tribunal Mumbai stationing on the principles of this doctrine ordered him and his group of companies to repay the due amount. Even though the court did not use the express term ‘reverse piercing’ in all these cases, the circumstances show that the doctrine was applied.
INCORPORATION OF THE DOCTRINE AND THE INDIAN INSOLVENCY REGIME
The Insolvency and Bankruptcy Code (hereinafter ‘Code’) does not expressly recognise the principle of the reverse corporate veil, however, it is not completely excluded from its ambit. To understand the same, it is relevant to first detail the implication of the corporate veil and its piercing under the Code. In its landmark decision of Arcelor Mittal India Pvt. Ltd. v. Satish Kumar Gupta, the Supreme Court recognized that section 29-A imports the company law concept of corporate veil piercing as it allows to identify who is in control of the entity (at the time of submitting the resolution plan). Furthermore, in cases involving group insolvency, the principle of the corporate legal entity is seen to hold relevance. Although group insolvency is not statutorily identified under the Code, Indian courts recognized its application and have in the past discarded the separate legal entity of the entities involved in the group. For instance, in the Videocon insolvency, the court rejected the separate legal entity of the holding companies to allow consolidation of their assets with the parent company. Thus under the Indian insolvency jurisprudence, corporate veil piercing has been an established practice.
There being a paucity of judicial precedents indicating the Indian courts’ approaches to the reverse corporate piercing of the veil, certain instances can warrant a third party to seek a resolution by stretching the shield of a special leave petition. For instance, creditors seeking to recover their debts from the corporate debtor may attempt to recover the debts from the entities owned and controlled by the management of the corporate debtor.
Presently, under the Indian insolvency law, creditors can move against the corporate debtor or the personal guarantor of the corporate debtor for recovery. In fact, in Lalit Kumar Jain v. Union of India & Ors. held that the personal guarantor is not discharged of the obligation even after the resolution plan is passed by the adjudication authority. Even when the courts have recognised the co-extensive obligation of the personal guarantor to pay off the debts, the National Company Appellate Tribunal in Mr. Nitin Chandrakant Naik v. Sanidhya Industries LLP, refused to include the personal properties of the suspended directors of the corporate debtor. Similarly, it may be possible that the resolution plan includes the assets of the company controlled by the personal guarantors. In such a scenario, by the application of the reverse piercing, courts can consider such assets within the plan’s ambit.
Reverse piercing of the veil will allow courts and resolution professionals to look beyond the corporate debtor to include a larger pool of assets, which may be otherwise evaded due to the separation of the legal entities. For example, Section 18 of the Code is restricted to only those assets where the corporate debtor has ownership rights, whereas the application of the doctrine will result in the assets owned in the name of the personal guarantor being included within the resolution process.
ISSUES ABOUT THE APPLICATION OF THE DOCTRINE IN INSOLVENCY
In the course of implementing this doctrine in insolvency cases, various concerns arise such as the proportional partition of assets or the priority of claims. Whether creditors having reverse piercing claims should be granted priority over all other rank holders as under Section 53, or treated on an equal footing with the highest-ranking creditors. Reverse piercing could be sought not only by the insiders but also by the outsiders of the corporation, which allows corporation owners to pierce the corporate veil at their whim, rendering the Code ambiguous and ineffective.
This can be troublesome when the relevant corporation has several shareholders, and even when there is only one shareholder, it can provide creditors of a shareholder an edge over creditors of the corporation that they would not otherwise have. Furthermore, if the reverse piercing claims succeed, they necessitate the involvement of the adjudicating authority and the application of the judicial mind to ensure that the approval or rejection of the Committee of Creditors’ (hereinafter ‘CoC’) resolution plans is not merely a mechanical process, but a well-thought-out and reasoned decision. As a result, this clause tries to infringe on CoC’s commercial wisdom, which is the supreme authority for adjudicating the resolution plans.
This provision applies only to ‘individuals,’ not to ‘persons’, thereby removing corporate debtors from its scope. As a result, the reverse piercing could only be used in cases of individual insolvency.
Before using the reverse piercing of the corporate veil, it is argued that the claimant must have exhausted all other plausible options, whether provided by law or more commonly accepted. This can be substantiated through the case laws like William G. Schwab vs. Damenti’s Inc. & Ors. wherein the Pennsylvanian Bankruptcy Court has the opportunity to reverse penetrate the corporate veil, making another firm owned by the shareholders accountable for the debts. Although there existed interchangeability of identities between the shareholders and the companies in their activities, the court decided that this was inadequate to indicate that they were single entities. As a result, the legal existence of both firms and their shareholders was preserved. In another case Floyd vs. Internal Revenue Service of the United States, the court found that the outside reverse piercing theory of corporate veil was an aberration, that if used would prejudice innocent creditors of the corporation who engaged with it based on a separate legal entity. As a result, the reverse piercing was denied in this case. Resultantly, this doctrine unfairly hurts the firm’s creditors, who believe that their loans to the company are secured by the company’s assets or otherwise
Indian courts have given recognition to both corporate veil piercing and the principle of alter-ego as common law principles. It is the suggestion of the authors that the same may be considered for reverse corporate veil piercing, a judicially accepted principle applicable in only certain exceptional cases. It is settled in law that there exists a strong presumption against piercing the veil and the court must apply the principle only if all other avenues of the debt resolution are exhausted. In light of the issues highlighted, the authors argue that while reverse corporate piercing of the veil must be judicially recognized it must not be readily implied.
(Rashi and Vijpreet are law undergraduates at National Law Institute University Bhopal. The author(s) may be contacted via mail at email@example.com and/ or firstname.lastname@example.org)
Cite as: Rashi Sharma and Vijpreet Pal, ‘The Curious Case of Reverse Corporate Veil Piercing and the IBC’ (The RMLNLU Law Review Blog, 01 July 2022) < https://rmlnlulawreview.com/2022/07/01/reversecorporateveilpiercing-and-ibc/>date of access
2 thoughts on “The Curious Case of Reverse Corporate Veil Piercing and the IBC”
Fantastic Article. The flow was really amazing.
Also one point to note in case of piercing of reverse corporate veil – The creditors of another entity who was included for recovery may suffer a loss due to this