Sunday, November 2, 2008

The grounds for lifting the Corporate Veil

In an earlier post, I looked at a recent judgment of the England and Wales High Court by Justice Munby in Hashem v. Shayif. It appears from the judgment that the only case in which the corporate veil could be lifted was where the company was a façade. In order to support this conclusion, Justice Munby relied on several cases, but most prominently on the decision of the Court of Appeals in Adams v. Cape Industries plc., and on an observation by Lord Keith in the House of Lords decision in Woolfson v. Strathclyde Regional Council that “it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere façade concealing the true facts.

A significant fallout of the decision in Hashem v. Shayif is its refusal to distinguish between various grounds on which the corporate veil can be lifted, specifically ‘agency’ and ‘single economic entity’, and this aspect perhaps merits greater discussion.

In Woolfson, as the judgment itself notes, the line of argument based on agency was not pressed before the Court by the parties. Thus, the Court was not required to consider agency-based arguments at all. That left the Court with the arguments relating to ‘single economic entity’ and ‘façade’. It is in this context that the Court held that a façade was a necessary requirement for lifting the corporate veil.

Woolfson rejected the ‘single economic entity’ argument. However, that does not mean that it negated agency-based arguments also. The distinction between these two kinds of arguments is in fact strengthened by Adams v. Cape Industries, which rejected the ‘single economic entity’ rationale expressly, but rejected the agency arguments only on the grounds that an agency was not established in the facts of the case. Thus, the position arising from Adams is that a group of companies cannot be treated as one on the sole ground that the companies are part of the same economic group. However, if it can be established that a company habitually acts according to the wishes of one shareholder, then a factual agency can very well be established. This would allow the Courts to lift the corporate veil.

A ‘single economic entity’ argument is based on the fact that two or more companies are part of one economic group, while a ‘factual agency’ argument is based on the degree of control over a company by another (legal or natural) person. Rejection of one argument does not mean rejection of the other.

To this extent, then, Hashem v. Shayif does not appear to lay down the correct principle of law.

I now turn to the position in India. In my last post I had stressed that Adams was a judgment in the early 1990s. That was for the specific reason that one of the important Indian cases on the point – State of UP v. Renusagar – was decided in 1988. In Renusagar, therefore, the Court did not have the benefit of the decision in Adams. The Court proceeded, therefore, on the basis of prior English law which had accepted the ‘single economic unit’ argument. Thus, Renusagar seems to support the conclusion that a ‘single economic entity’ argument would succeed in India.

Renusagar cited the (quite controversial) decision in LIC v. Escorts, saying “… the corporate veil should be lifted where the associated companies are inextricably connected as to be, in reality, part of one concern. 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.” Further, the Renusagar decision went on to note, “It is high time to reiterate that in the expanding of horizon of modern jurisprudence, lifting of corporate veil is permissible. Its frontiers are unlimited. It must, however, depend primarily on the realities of the situation. The aim of the legislation is to do justice to all the parties. The horizon of the doctrine of lifting of corporate veil is expanding.

If this was the last word of the Indian judiciary on the point, then one could say that in India the corporate veil could be lifted on grounds of ‘single economic entity’ as well as ‘public interest’; thus signifying a significant difference in the Indian and UK positions. However, Indian Courts have not been entirely unaffected by the changes in British law. In so far as taxation-related ‘veil’ issues are concerned, Azadi Bachao Andolan is often understood as restricting the application of “substance over form” doctrines. This might mean that Courts will tend to be less open to lifting the veil on assessments of hypothetical motive. (An earlier note on this blog has analysed how far Azadi actually goes in this direction.)

Among the Indian decisions which have taken into consideration the developments in British law is the judgment of the Madras High Court in Novartis v. Adarsh Pharma. In this case, an argument was made that the corporate veil could be lifted only in cases where the corporate form was abused leading to unjust and inequitable results. The Court considered several cases and held that “(The Court is) not inclined to agree with the submission … that only when the corporate entity is abused for an unjust and inequitable purpose, the Court should not hesitate to lift the veil … the Court can investigate the relationship between the parent company and the subsidiary company and lifting the corporate veil depends on the facts of each case.”

The Court took this stance after noting Adams. Nonetheless, the Court held that a ‘single economic unit’ argument could work in certain circumstances. These circumstances would depend on the factual control exercised. This view is strengthened by the Supreme Court decision (cited in Novartis) in New Horizons v. Union of India (It is not impermissible to treat) a subsidiary as the agent or the alter ego of its parent, provided the facts of the case justified such a conclusion. However, it would seem that the facts would have to reveal a very high degree of control by the parent over the subsidiary before a Court would conclude that an agency relationship had been established…” This, thus, accepts the Adams position of leaving open the ‘factual agency’ grounds; while recognizing that the factual burden is not an easy one to discharge.

To conclude, the following broad principles can be drawn from the existing case-law:

1. Single economic entity: In England, the mere fact of a two companies constituting a ‘single economic entity’ is not sufficient to lift the corporate veil. In India, Courts are more likely than English Courts to accept this argument, considering that there are Supreme Court judgments which have done so. However, later decisions seem to have noted the change in the English position and have impliedly gone by the Adams trend.

2. In India, the ‘single economic entity’ argument has not been clearly distinguished from ‘agency’ arguments. Perhaps, this is the reason why ‘single economic entity’ arguments have not been rejected outright. It is to be hoped that Indian Courts draw the distinction between these arguments before entirely rejecting the ‘single economic entity’ argument.

3. Factual Agency: In England as well as in India, ‘factual agency’ is a ground to lift the veil. Although on facts this is a difficult ground to establish, there is no authority to reject the argument on law. The test is whether it is reasonable to assume that transactions entered into by the company were entered on behalf of one individual / another company. It must be shown that the company so habitually acts according to the wishes of that other individual / company, that it is justifiable to treat the two as one legal entity.

4. Façade: In light of the existing case-law, Justice Munby’s decision must be confined to “façade” arguments only. On the issue of façade, the decision offers valuable guidance. In order to establish a façade, there must be a showing of impropriety. The impropriety must be linked to the use of the company structure to avoid or conceal liability.

5. Public Interest: In England, public interest – standing alone – is not a ground to lift the veil. It might still be open to argue on the basis of public-interest in India. The Courts will rely on this ground when lifting the veil is the most ‘just’ result, but there are no specific grounds for lifting the veil. Thus, ‘public interest’ may in some cases be used by Indian Courts to lift the veil even when the strict test for establishing a façade is not satisfied.
(I would like to thank Mr. V. Umakanth for his invaluable suggestions regarding this post)


kinnari said...

I am a LLm candidate at the LSE and would like to thank you for your input in this subject.

I am currently researching on the restrictive scope f the corporate veil in the english law.
Hence, your ideas were valuable.

Thanks & regards,

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