Contributed by Divyam Desai and Shravin Relan

Introduction

The Corporate Veil Theory is a legal notion that separates a company’s identity from its members. As a result, the members are protected against obligations resulting from the company’s acts. The concept of corporate veil and independent existence of an company was introduced in 1897 by the House of Lords in the case of Saloman v. Saloman [1897] AC 22. In a series of judgement, the hon’ble apex court has taken a consistent view that a corporate veil of a company should be respected as veil is the rule and the piercing of veil is an exception.

The law as it stands today based on jurisprudence in this regard has carved out the following exceptional circumstances when a veil can be lifted by the courts. First (statutory lifting) is when there are violations of the provisions of the companies act. Second (judicial lifting) is on account of fraudulent acts, evasion of taxes through shell companies and when the company is acting as an agent [2]. The courts also have the authority to lift the veil to uphold public policy and prevent transactions that are detrimental to public policy. When raising the veil is the most ‘just’ consequence, the Courts will rely on this reason, but there are no precise grounds for doing so. As a result, when there is a contradiction with public policy, the Courts disregard the form and consider the substance.

The Insolvency and Bankruptcy Code (IBC), 2016 was enacted by the legislature to revive the companies under financial distress and if such revival is not feasible, then to liquidate the companies and repay the creditors.  At the same time, the object of the statute is also to protect the creditors. IBC, 2016 does not explicitly provide for piercing of veil but NCLT and courts have done it to meet the ends of justice.This article aims to critically analyse the circumstances under which the corporate veil has been lifted by NCLT under Insolvency and Bankruptcy proceedings of IBC, 2016. Further based on the analysis there are certain suggestions which should be adopted as a matter of practice to lift the veil when the stakeholders are trying to abuse the process of law.                                  

1. Piercing the veil between subsidiaries and group insolvency

Explanation to Section 18 of the IBC, 2016 stipulates that the assets of the subsidiary companies cannot be included in the assets of the corporate debtor who is subjected to CIRP or liquidation, whatever the case may be. The thumb rule is that the subsidiary companies are distinct and separate legal entities from the corporate debtor. Now let’s consider one situation and try to answer whether it would be apt for the NCLT/courts to not deviate from the thumb rule. Suppose X, a parent company has 5 subsidiary companies who are closely related to each other in terms of operations and the management. Now, Y, a subsidiary, procures a huge loan and fraudulently transfers the loan amount or the profits generated from the amount to Z, another subsidiary company. Y is now under CIRP as it is unable to repay the creditors. Under such circumstances where companies try to misuse the veil, deviation from this thumb rule becomes very important and NCLT should not hesitate to lift the veil at the threshold between such subsidiaries. Report of Insolvency Law Committee, 2018 has also highlighted certain concern in this regard as the subsidiary goes into CIRP or liquidation with little to no assets making it very difficult for creditors to recover their monies. 

In the case ofSBI v. Videocon Industries Ltd, NCLT bench at Mumbai lifted the corporate veil between 13 subsidiary companies of Videocon as they were closely interlinked in their operations and management because of common directors, assets etc. and it would have been very difficult for the consortium of banks to recover their monies if the tribunal had tried to respect the veil. For the first time NCLT introduced the doctrine of ‘substantial consolidation’ in the Indian jurisprudence from the US bankruptcy laws. This doctrine has expanded the scope of lifting the veil between the companies by allowing initiation of CIRP against all the subsidiaries at the same time if it the adjudicating authority finds that the companies are closely interconnected with each other, and the corporate structure is being misused.

In the case of Walnut Packaging Pvt. Ltd. v. The Sirpur Paper Mills ltd, court has held that when a subsidiary company is acting as an agent to a holding company, NCLT has the power to lift the veil between the subsidiary and the holding company if the application for CIRP is filed against the subsidiary company.

2. Piercing the Corporate Veil for The Protection of Homebuyers

IBC, 2016 under Section 7 grants financial creditors the power to initiate the Corporate Insolvency Resolution Process (CIRP) as a measure of recovery mechanism. NCLTs have recognized the rights of homebuyers as financial creditors and disregard the established principle of separate legal entity. The Supreme Court affirmed the constitutional validity of the amendment to the IBC, 2016 in 2019 in the case of Pioneer Urban Land and Infrastructure Limited & Anr v. Union of India & Ors, which held that the homebuyers would be considered as financial creditors and therefore are in a position to initiate CIRP under Section  7 of the IBC, 2016. In Yadubir Singh Sajwan & Ors. v Som Resorts Private Limited National Company Law Tribunal (NCLT), Delhi recently ruled that the developer/builder cannot be allowed to take advantage of the homebuyers and defraud them. Tribunal ordered the liquidation of Cosmic Structures due to its failure to deliver promised properties and issue refunds to homebuyers, who were financial creditors. It was believed that the real estate project was owned by Cosmic Structures. Subsequently, the corporate debtor also failed to complete the project, leading to financial creditors initiating Corporate Insolvency Resolution Proceedings (CIRP) against it. Both entities i.e., Som resorts and Cosmic structures shared the same owner and were under his exclusive control.  

3. Other instances of piercing the veil by NCLT:

Although a company is a separate legal entity from its promoters/directors, in many cases understanding the role of directors becomes very crucial in companies’ default because a company is an artificial person who is managed by a living person. In the case of Ayan Mallick and Another v. State Bank of India and Others, petitioners (erstwhile directors) and the company who were the erstwhile directors of the company in CIRP were served with the notice by the Reserve Bank of India as to why the RBI should not proceed against them by adding them to wilful defaulters list. Court lifted the veil by rejecting the arguments of the petitioner that they are protected under moratorium as the application for the CIRP has been admitted. Court took the view that the corporate veil should be lifted to closely examine the role of the directors (petitioners) in the management of the corporate debtor which led to the default. Therefore, by lifting the veil, the court also allowed the RBI to proceed against the company and the directors in spite of there being protection under Section 14, IBC. 

To check the bonafides and the intention of the parties, NCLT has in various cases has lifted the corporate veil and even declined to admit the application for initiating the CIRP where it is found to be perverse. In the case of Ishap Sharma Versus SMID Infrastructure Pvt. Ltd (2023 SCC OnLine NCLAT 432). NCLAT decided to lift the corporate veil as the promoter Ishap Sharma had the controlling power over the company because he had 50% shares of the corporate debtor. He infused the money from his pocket into the company at did not return it. At the same time other creditors were also defrauded by him and thus, the initiation to initiate CIRP was with an ill-intention.

Conclusion and suggestions:

The adjudicating authorities have pierced the corporate veil during the proceedings going on under IBC, 2016 in the above cases.  Although there is no express provision regarding piercing of veil under the Code, but the adjudicating authorities have rightly done so to meet the ends of justice. The above-mentioned jurisprudence shows that piercing of veil can be done at any stage by the judicial forum if it found that corporate structure is used to defraud the creditors, to understand the role of mischievous directors in a company, to defraud the homebuyers, to create alter egos and fetch more funds from creditors like in the case of substantial consolidation doctrine etc.

The paper concludes with the following suggestions:

One, when a corporate debtor himself, goes to NCLT to initiate the CIRP, a preliminary inquiry should be conducted to ascertain whether it is trying to condone its own wrong by initiating CIRP. Court should satisfy itself on why the corporate debtor is in more hurry than its creditors to subject itself to CIRP.

Two, when an NCLT is entertaining an application under Section 7, 9 and 10 i.e. by corporate debtor, financial creditors or by operational creditors, it should compulsorily read these provisions with Section 65 of IBC, 2016 in order to ascertain whether the parties have come to the court with clean hand and if there is a requirement to pierce the veil.

Third, legislation should incorporate amendments in the legislation or should come out with policy changes or rules highlighting that when can a veil be pierced during the IBC.

Fourth, the real estate developers should not be allowed to shield themselves behind the corporate veil as a separate legal entity because promoters of such companies misuse the corporate structure and siphon off the funds of investors.