Tuesday, June 27, 2017

The amended Arbitration Act: The Power to Nominate and the Choice of the Nominee

The Bombay High Court in DBM Geotechnics v. Bharat Petroleum Corporation Ltd. recently decided a short but important point arising out of the recent Amendments to the Arbitration & Conciliation Act, 1996. In particular, the Court had to consider how the bar on a party’s employees serving as arbitrators had to be construed.

The relevant arbitration clause between the parties before the Bombay High Court was that disputes will be referred:

[t]o the sole arbitration of the Director (Marketing Division) of the Corporation or some officer of the Corporation who may be nominated by the Director (Marketing Division)… In the event of the arbitrator to whom the matter is originally referred being transferred or vacating his office or being unable to act for any reason, the Director (Marketing Division) as aforesaid at the time of such transfer, vacation of office or inability to act may in the discretion of the Director (Marketing Division) designate another person to act as an Arbitrator… It is also the term of this contract that no person other than the Director (Marketing Division) or a person nominated by such Director (Marketing Division) of the Corporation aforesaid shall act as Arbitrator…

Thus, the clause provided: (a) the Director Marketing, or another officer of the corporation nominated by the Director will be sole arbitrator, (b) if the arbitrator to whom the matter is originally referred in unable to act, then another person may be designated, and (c) in any event, the sole arbitrator must be either the Director or a person nominated by the Director.

The question was whether the power to nominate would survive, given that part (a) no longer can be fulfilled due to the bar introduced by the 2016 Amendment on employees serving as arbitrators.  

DBM argued that the power of nomination was unworkable, because part (b) above could come into the picture only if there was indeed a nomination in terms of part (a), and that nominee was unable to act. In circumstances where part (a) was incapable of being complied with (and indeed, BPCL did not at all nominate any employee first), the entire nomination procedure must fall. In other words, the Court could conceivably have held as a matter of interpretation, part (b) of the arbitration clause above remained in place. Textually, that would have been problematic because the application of part (b) contemplates in the first place that there is a nomination under part (a): if that nomination is itself impossible, there can be no question of part (b) applying.

The Court’s answer to this argument is instructive, because the Court does not simply decide the question on an interpretation of this particular (somewhat intricate) clause: rather, the Court draws a conceptual distinction between the power to nominate and the choice of the nominee. It holds:

The parties before me had, as I have pointed out earlier, clearly agreed that the power to nominate would vest in BPCL’s DM alone. It is true too that the clause also said that the DM, in exercising that power, was to draw from a specified class of persons (himself or a BPCL employee). It just so happens that because of the operation of the amended statute combined with a want of consent from DBM, the eligibility of both those sets of persons was rendered impossible. In fact, as Mr Joshi says, the DM’s ‘power to nominate’ cannot be dependent on the DBM’s granting or not granting consent, and this is what the Applicant’s argument amounts to: had DBM consented, there would have been no question of the BPCL’s DM being divested of his power to nominate. I believe Mr Joshi is correct in saying that by withholding consent and then relying on the statutory bar, DBM cannot argue that the power to nominate itself has completely gone. The DM does not, for want of DBM’s consent, stand stripped of all his nominating power. He must exercise that power in the manner that the law requires, i.e., by appointing an independent and neutral Arbitrator. It is perhaps true that as a result of this, the latter portion of clause 19(a) may require to be severed, but there is no difficulty in doing this, nor is this impermissible…

This may well be important in construing other clauses which prescribe a arbitration before an employee of a company/corporation – if the clause provides for nomination by the company/corporation and further prescribes that the choice of a nominee is to be an employee, that clause cannot be considered as ineffective even in light of the amendment, and it cannot be contended that the appointment must now only be by the Court under section 11. The power to nominate itself would survive, notwithstanding the limitations on the choice of the nominee.

[Interestingly, DBM did not argue that the clause itself would be ineffective. It only argued that BPCL’s power to nominate is ineffective; and the nomination must therefore be made by the Court under section 11. This strategic choice may well have saved it from an order as to costs. On costs, the Court indicated, “The amendments to the Code of Civil Procedure, 1908 introduced by the Commercial Courts, Commercial Division and Commercial Appellate Division of High Courts Act, 2015 require that, as a general rules, costs must follow the event, and that reasons must be given if costs are not awarded against the party that fails. I decline to award costs in this case having regard to the fact that the issue raised was limited, and since Mr Doctor very fairly did not suggest that the entire arbitration clause was ousted. No costs.” This, and certain other orders of the Commercial Court, appear to indicate that orders as to costs need not be made if the case set up is reasonable and not frivolous (even if not ultimately successful). With respect, this approach to costs may need further consideration. The new costs provisions do mirror some of the rules in the English CPR. The fact that a case set up is not frivolous or unarguable may be a factor going to the quantum of the costs, rather than to the question of whether to levy costs of not itself.] 

Monday, June 26, 2017

Promoter Exits in India: Reined by the Market Watchdog?

[Guest post by Malek Shipchandler, who practices law with a firm in Mumbai. Views are personal and do not necessarily represent those of the firm.]

It was reported last week that the Securities and Exchange Board of India (SEBI) is likely to relax rules pertaining to promoter reclassification in listed companies. An article co-authored by Gaurav Malhotra and I for the Oxford Business Law Blog in December 2016 on this theme had endeavoured to argue that the requirement of obtaining shareholders’ approval for reclassifying promoters into the public category (pursuant to an open offer or ‘in any other manner’) is counter-intuitive and therefore otiose. The article also touched upon the apparent lacuna in the rules which do not explicitly provide a route for promoters holding minimal (or even nil) shareholding to convert themselves into the public category – except by way of seeking SEBI approval through the informal guidance mechanism or approaching the stock exchanges. It is hoped that SEBI irons out these wrinkles while reviewing the promoter classification rules. For the benefit of readers, we set out below the text of our previous article.


Most Indian listed companies are run by promoters who are a set of persons and/ or families having effective control over a listed company. The Securities and Exchange Board of India (SEBI), the securities market regulator, has historically been wary of investor protection issues that may arise between promoters of listed companies and public shareholders. This is evident by the fact that SEBI, in the past year itself, has restricted promoters from changing the objects of an issue as stated in the issue prospectus (unless shareholder approval is obtained) and barred promoters of companies undergoing compulsory delisting from receiving shareholder benefits and being appointed as directors of other listed companies.

The term ‘promoter’ has been defined under Section 2(69) of the Companies Act, 2013 and Regulation 2(1)(za) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 to broadly mean persons having ‘control’ over a company. The shareholding pattern of listed companies is primarily classified into two categories viz. promoter and public. Entry into the promoter club has never been barred (as anyone who gains control over a listed company, irrespective of shareholding, is categorized as a ‘promoter’) and formal guidelines for exiting the promoter club did not exist until September 2015.

SEBI introduced provisions relating to promoter reclassification into public shareholders under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Norms). Regulation 31A of the Listing Norms deals with disclosures and conditions for reclassification. Regulation 31(A)(5) of the Listing Norms requires a listed company to obtain shareholders’ approval for the reclassification of its exiting/ selling promoter into a public shareholder occurring due to control being established over the listed company by an incoming promoter/ acquirer via (i) an open offer in accordance with the Indian takeover code or (ii) in any other manner. In addition, the exiting/ selling promoter is required to, inter alia, have no more than ten percent shareholding in the listed company, and abandon any special rights vis-à-vis the listed company, established through formal or informal arrangements.

For those who may be less familiar with the concept of an ‘open offer’, it is a procedure required to be undertaken to acquire control over a company by triggering thresholds prescribed under the Indian takeover code. The open offer procedure requires the incoming promoter/ acquirer to provide an exit option to the existing public shareholders of the listed company by offering to buy their shares – after giving numerous disclosures and assurances in the open offer documents under the regulatory scrutiny of SEBI. The expression ‘in any other manner’ would appear to refer to methods such as court-blessed schemes of arrangements and Reserve Bank of India regulated strategic debt restructuring schemes that can facilitate the establishment (and replacement) of control over a listed company. These schemes are exempt from open offer obligations under the Indian takeover code as they already involve regulatory/ judicial oversight and/ or approval of shareholders.

Interestingly, SEBI through its recent informal guidance letters, has allowed existing promoters holding nil or minimal shares to exit without obtaining shareholders’ approval – this appears to be in sync with the Listing Norms (Regulation 31A(5) requires approval of shareholders only when the promoter is being ‘replaced’).

Despite SEBI’s efforts to streamline promoter reclassifications, there appear to be certain lacunae. It appears odd and to an extent, even counter-intuitive, for the law to (a) require shareholders’ approval in relation to reclassification of exiting/ selling promoters into public shareholders pursuant to an open offer, when in fact the law already provides the shareholders with full information/ disclosures about the transaction (triggering such change in control) coupled with a fair option to exit the listed company (in case of ‘open offer’) and an opportunity to approve/ decline such replacement when put to vote (in case of ‘any other manner’) and (b) allow an existing promoter with nil or minimal shareholding to exit the listed company without shareholder blessing.

Delving into this apparent lacuna, a scenario may be envisaged wherein shareholders show reluctance to give their approval for reclassification after the exiting/ selling promoter has transferred the entire stake to the incoming promoter/ acquirer (the earliest this transfer may take effect under law based on the open offer procedure is twenty-five working days after the signing of the acquisition agreement). This would essentially translate into a situation wherein the exiting/ selling promoter may continue having legal obligations as a ‘promoter’ along with the incoming promoter/ acquirer despite not holding any shares.

From a M&A transaction perspective where ‘conditions precedents’ are at the heart of any acquisition agreement, the shareholders’ approval for reclassification being made a condition precedent for the share transfer to occur may not be feasible, as a shareholding of less than ten percent by the exiting/ selling promoter is a prerequisite for seeking reclassification.

An escape from the aforesaid situation can perhaps be found, oddly, through a literal interpretation of Regulation 31A(2)–(3) of the Listing Norms coupled with a reading of the recent SEBI informal guidance letters. Through this route existing promoters can seek reclassification by approaching the stock exchanges – without shareholders’ approval. As such, to obviate the need for obtaining shareholders’ approval under Regulation 31A(5) of the Listing Norms or on being refused such shareholders’ approval, the literal law seemingly allows the exiting/ selling promoter to approach the stock exchanges under Regulation 31A(2)–(3) of the Listing Norms to seek reclassification – without obtaining shareholders’ approval. It should be acknowledged however that this approach ostensibly defeats the spirit of Regulation 31A(5) of the Listing Norms, which requires the exiting/ selling promoter to obtain shareholders’ approval.

On a related note, Regulation 31A(5) of the Listing Norms provides for “re”classification i.e. changing the status of a shareholder from ‘promoter’ to ‘public’ and not “de”classification i.e. a situation where the exiting/ selling promoter sells the entire shareholding to the incoming promoter/ acquirer. However, on perusal of certain recent transactions triggering an open offer, it can be seen that exiting/ selling promoters are adopting the approach of obtaining shareholders’ approval despite having transferred or agreed to transfer their entire shareholding to the incoming promoter/ acquirer. This approach seemingly blessed by SEBI (considering, open offers are overseen by SEBI) and reflecting its “once a promoter, always a promoter” psyche is, respectfully, preposterous and needs correction before a precedent is etched.

Having been established with the task of protecting the interests of public investors and the development of the Indian securities market – has SEBI, in its sincere effort, baked half-hearted guidelines on promoter exits?

- Malek Shipchandler

Frustration in Indian Law

On this blog, we had previously looked at the judgment of the Supreme Court of India in Energy Watchdog v. CERC and connected appeals. An earlier post had examined the decision, and had concluded that the Court “arguably misstated the law when it found that the mere existence of a force majeure clause would prevent the parties from bringing an alternative claim under section 56….” The decision of the Supreme Court presents an interesting opportunity to examine the nature of several legal concepts. In this post, I concentrate on the doctrine of frustration. It seems to this author that the best explanation for the judgment of the Supreme Court is that (as a matter of Indian law) the doctrine of frustration is not at all a free-standing doctrine at all, but is only a question of construction of contracts.

The facts which fell for consideration before the Supreme Court were summed up earlier. The basic issue was whether “force majeure” and “change in law” provisions in PPAs between Adani Power (and other generating companies) and the Gujarat Urja Vikas Nigam were triggered on account of a 2010 Indonesian regulation stipulating benchmark coal prices. Put simply, the contractual question on frustration would be whether the 2010 Indonesian regulations were an event frustrating the PPAs. The underlying contracts for supply of coal were presumably entered into for a long term, with the result that the prices for supply of the coal were agreed at a lower rate. This lower rate would have been in the contemplation of parties at the time of fixing the pricing for the PPAs. Indeed, the coal supply agreements were to be annexed to the PPAs. Did the 2010 Indonesian regulations amount to a frustration of the PPAs?

The Supreme Court noted its earlier precedent around section 56 of the Contract Act – these include Satyabrata Ghose v. Mugneeram Bangur (‘If an untoward event or change of circumstance totally upsets the very foundation upon which the parties entered their agreement, it can be said that the promisor finds it impossible to do the act which he had promised to do…’), and Alopi Parshad v. Union of India (‘[it is only if it is demonstrated that the parties] never agreed to be bound in a fundamentally different situation which had unexpectedly emerged, that the contract ceases to bind… the performance of a contract is never discharged merely because it may become onerous to one of the parties…’)

The Court also referred to English law, including the Suez canal cases (Tsakiroglou v. Noblee [1962] AC 93), where it was held that the closure of the Suez Canal did not amount to frustration (even though the goods would now have to be shipped around the Cape of Good Hope). Tsakiroglou was a case where  a different method of performance (i.e. going around the Cape of Good Hope, rather than through the Suez canal) was not, on facts, sufficiently fundamental. Indeed, Treitel (13th edition) notes, “the seller in the Tsakiroglou case would have made [a profit] if his plea of frustration had been upheld, for the market price of the goods had risen more than the extra cost of carriage via the Cape of Good Hope, and this fact may have had some influence on the decision that the contract remained in force…” There was thus sufficient reason in Tsakiroglou to demonstrate that the method of performance was not intrinsically fundamental, and hence the contract was not frustrated due to events requiring a different method of performance.

Citing the above cases, and English law, the Court concluded that the PPAs could not be considered as being frustrated. It held:
the fundamental basis of the PPAs remains unaltered. Nowhere do the PPAs state that coal is to be procured only from Indonesia at a particular price. In fact, it is clear on a reading of the PPA as a whole that the price payable for the supply of coal is entirely for the person who sets up the power plant to bear. The fact that the fuel supply agreement has to be appended to the PPA is only to indicate that the raw material for the working of the plant is there and is in order. It is clear that an unexpected rise in the price of coal will not absolve the generating companies from performing their part of the contract for the very good reason that when they submitted their bids, this was a risk they knowingly took… the fact that a non-escalable tariff has been paid for, for example, in the Adani case, is a factor which may be taken into account only to show that the risk of supplying electricity at the tariff indicated was upon the generating company.

This is an important passage, because it shows that the enquiry on frustration is – like many other contractual questions –a question of whether the relevant risk was contemplated and allocated. The Court has not really given detailed reasons in this passage for why it concluded that the risk of increased coal prices were on the generating companies. The only reason in the passage above is that the tariff was a non-escalable one. But that is hardly conclusive, especially in a situation where the pricing was based – to the knowledge of both parties – on an underlying supply contract.

Another earlier post noted, “The Court has skirted the issue of protecting the sanctity of the contract by relying on unrelated precedents and not construing the contract itself…” With respect, that is perhaps not taking into account the full reasoning of the Court. The Court’s strongest reason appears later in the judgment, when the Court notes that the question of frustration must be decided in the backdrop of the express contractual provisions in place. There was a detailed force majeure clause in the PPA which in terms excluded “changes in cost… of fuel”. Ultimately, the question of whether a contract is frustrated or not is purely as a question of constructing the contract (rather than as one of applying an external legal rule).

This is also borne out by the further holding of the Court also that “general recourse to section 56 is not available when a contract contains a force majeure clause which on construction by the Court is held attracted to the facts of the case, Section 56 can have no application…” This is, with respect, no misstatement of the law if one accepts the theory that the doctrine of frustration is essentially simply a rule of construction of the contract. If frustration is essentially a question of construction, then a general reliance on the principle will be unavailable when there is indeed an express provision to be construed – it would be quite inconceivable for an implied term to override an express term.

The Court’s reasoning thus seems to situate the doctrine of frustration clearly within the domain of contractual construction. It shows that the enquiry is entirely one of construction of the relevant contract – with express provisions, the task may be simpler; but even otherwise, the Indian doctrine of frustration is best understood as giving effect to parties’ intentions on what counts as a “fundamental” change, without imposing any external legal rule on what does and does not count as a frustrating event.

This reading of the law is however at some tension with Satyabrata: for there, the Court expressly said that the doctrine of frustration is not one based on constructing a contract or finding an implied term, but is really a “rule of positive law”. The Court there rejected the construction theory only on the basis that “there is no question of finding out an implied term agreed  to by the parties embodying a provision for discharge, because the parties did not think about the matter at all…” With respect, this (a) was not a finding essential to the ultimate decision in Satyabrata; and (b) misunderstands the principle of objective construction and the true nature of implication of terms.

In other words, Energy Watchdog is an important recognition of the proposition that the “doctrine” of frustration can best be understood – notwithstanding Satyabrata – as a question of construction of contracts. What tilted the balance in Energy Watchdog was the Court’s approach to the question as one of ascertaining parties’ intents in allocating risks, and of the interpretation of the PPA at issue. The decision must not be therefore read as one laying down a rule of law that economic impracticability can never be a frustrating event.

[Note 1: This post does not independently offer any justification for why the ‘construction’ theory is the best explanation of the doctrine. I only note that if the theory is rejected, then there does not seem to be any basis on which the Courts can ascertain what exactly is a “fundamental” change. For instance, in the absence of a detailed force majeure clause, it is as likely that the change in the cost of fuel would indeed be ‘fundamental’ to long term agreements in the energy sector. The construction theory enables Courts to apply settled principles of interpretation and implication in the task and thereby introduces objectivity into the process.] 

[Note 2: The relevant clause in the exclusions on force majeure said: “Force Majeure shall not include …  (ii) the following conditions, except to the extent that they are consequences of an event of Force Majeure…  changes in cost of the plant, machinery, equipment, materials, spare parts, fuel or consumables…” In other words, changes in fuel price was not itself a force majeure event (and therefore not a frustrating event). But the clause comes with an important rider: changes in cost of fuel will indeed be a force majeure event if that change in the cost is itself a consequence of another force majeure event. We will look at questions of interpretation of these clauses in a subsequent post. For now, it is important to note that the decision of the Court must not be seen as absolutely ruling out pleas of frustration on account of economic hardship or impracticability.]

Sunday, June 25, 2017

Applicability of the Doctrine of Corporate Veil to Societies

[Post by Munmi Phukon and Sagar Batra of Vinod Kothari & Company]

Meaning of Corporation or Body Corporate

Pursuant to Section 2(11) of the Companies Act, 2013 (CA, 2013), “body corporate” or “corporation” includes a company incorporated outside India, but does not include—

(i)        a co-operative society registered under any law relating to co-operative societies; and

(ii)       any other body corporate (not being a company as defined in this Act), which the Central Government may, by notification, specify in this behalf.

However, the definition in CA, 2013 is inclusive and not an exhaustive one. The term has been elaborated under various judgments and has been interpreted with reference to the international scenario. A reference may be drawn to Halsbury's Laws of England, 3rd Edn. Vol.9, page 4, which reads:

A corporation aggregate has been defined as a collection of individuals united into one body under a special denomination, having perpetual succession under an artificial form, and vested by the policy of the law with the capacity of acting in several respects as an individual, particularly of taking and granting property, of contracting obligations and of suing and being sued, of enjoying privileges and immunities in common, and of exercising a variety of political rights, more or less extensive, according to the design of its institution, or the powers conferred upon it, either at the time of its creation or at any subsequent period of its existence. A corporation aggregate has therefore only one capacity, namely, its corporate capacity.

An essential element in the legal conception of a corporation is that its identity is continuous, that is, the original member or members and its or their successors who are composing it are persons wholly different from the corporation itself.  Thus, it has been held that a name is essential to a corporation and that a corporation can, as a general rule, only act or express its will by deed under its common seal.

Whether a Corporation Includes a Society?

A society is united together by mutual consent of its members to deliberate, determine and act jointly for the same common purpose. While on a reading of various provisions of the Societies Registration Act, 1860 (Societies Act), a registered society has the privileges analogous to that of a corporation such as separate legal personality, the power to sue or be sued, holding separate property, it does not however prove the intention of the law to provide for the creation of a corporation. The context holds its authority from the leading case law The Board of Trustees, Ayurvedic and Unani Tibia College v. The State of Delhi, in which the Supreme Court of India deliberated at length whether the nature of society is that of a corporation, and analysed the provisions of the Societies Act. The Court, while interpreting the provisions, held that a society is not a body corporate, by observing:

The most important point to be noticed in this connection is that in the various provisions of the Societies Registration Act, 1860, there are no sufficient words to indicate an intention to incorporate, on the contrary, the provisions show that there all absence of such intention. Section 2 no doubt provides for a name as also for the objects of the society. Section 5, however states that the property belonging to the society, if not vested in trustees, shall be deemed to be vested in the governing body of the society and in all proceedings, civil and criminal, the property will be described as the property of the governing body. The section talks of property belonging to the society; but the property is vested in the trustees or in the governing body for the time being. The expression “property belonging to the society" does not give the society a corporate status in the matter of holding or acquiring property, it merely describes the property which vests in the trustees or governing body for the time being. Section 6 gives the society the right to sue or be sued in the name of the president, chairman etc. and 7 provides that no suit or proceeding in a civil court shall abate by reason of the death etc. of the person by or against whom the suit has been brought. Section 8 again says that any judgment obtained in a suit brought by or against the society shall be enforced against it.

The Supreme Court also placed reliance on extracts from Dennis Lloyd’s ‘Law relating to Unincorporated Association’ (1938 edn.) as follows:

Registration does not result in incorporation, but merely entitles the society so registered to enjoy the privileges conferred by the Act. These privileges are of considerable importance and certain of them go a long way toward giving registered societies a status in many respects analogous to a corporation strictly so- called, but without being technically incorporated. Thus something in the nature of perpetual succession is conceded by the provision that the society's property is to vest in the trustees for the time being of the society for the use and benefit of the societies and its members and of all persons claiming through the members according to the society's rules, and further (and this is the most noteworthy provision) that the property shall pass to succeeding trustees without assignment or transfer. In the same way, though the society, being unincorporated, is unable to sue and be sued in its own name, it is given the statutory privilege of suing and being sued in the name of its trustees. Those provisions undoubtedly give certain privileges to a society registered under that Act and the privileges are of considerable importance and some of those privileges are analogous to the privileges enjoyed by a corporation, but there is really no incorporation in the sense in which that word is legally understood.”

The Supreme Court, in light of the aforesaid judgement, has read the status of the entity as that of a corporation in the light of intention to incorporate with disregard to the fact that it possesses the character of the corporation. Status of being a corporation in the said case was linked to it being incorporated under a statute. Therefore, in simple terms, an entity is a corporation if its incorporated, where incorporation is governed by statute or some express provisions, and an entity is not said to be incorporated merely because it possesses privileges as that of a corporation like separate legal entity. Accordingly, societies, though registered, are not corporation or body corporate.

Status of a Society as a Separate Legal Entity

Even if a society is not registered under the Societies Act and is considered as merely an unincorporated society, yet it has privileges similar to that of a corporation. Hence, for the purpose of calling it incorporated for the purpose of Union and State List under the Constitution, it is not a corporation but it is a separate legal entity, as held by the Bombay High Court in Satyavart Sidhantalankar v. The Arya Samaj:

It is significant to observe that the members of the society are a fluctuating body. A member of the society is a person who having been admitted therein according to the rules and regulations thereof has paid the subscription or signed the roll of the members thereof and has not resigned according to the rules and regulations. The governing body of the society is the governors, council, directors, committees, trustees or other body to whom by the rules and regulations of the society the management of its affairs is entrusted. The members as well as the governing body are not always the same and that is the reason why it has been necessary to provide that no suit or proceeding in any civil Court shall abate or discontinue by reason of the person by or against whom such suit or proceedings may have been brought or continued dying or ceasing to fill the character in the name whereof he shall have sued or been sued, but the same suit or proceedings shall be continued in the name of or against the successor of such person. Even though the members of the society or the governing body fluctuate from time to time, the identity of the society is sought to be made continuous by reason of these provisions. The identity of the original members and their successors is one. The liability or obligation once binding on the society binds the successors even though they may not be expressly named, and in this the society savours of the character of a corporation. The resignation or the death of a member does not make any difference to the legal position of the society. The increase or decrease of the members of the society similarly does not make any difference to the position. A partnership under similar circumstances would come to an end, but not the society. The society continues to exist and to function as such until the dissolution thereof under the provisions of the Societies Registration Act. The properties of the society continue vested in the trustees or in the governing body irrespective of the fact that the members of the society for the time being are not the same as they were before nor will be the same thereafter.

The aforesaid judgement succinctly lays down the existence of separate legal entity of a society from its members and the correctness of the same was not overruled in Board of Trustees case (discussed earlier). But, it was held that even though the society has separate legal existence, it nevertheless cannot be said to be a corporation in the sense of being incorporated, and the decision cannot be interpreted to make it a corporation.

In line with the aforesaid judgement, the Department of Corporate Affairs had also notified that society should not be deemed to be a body corporate, although such a society can be treated as a person having separate legal entity apart from its members constituting it.

Applicability of the Doctrine of Corporate Veil to Societies

In the landmark ruling of Salomon v. Salomon, the House of Lords held:

a corporation is separate from the individuals. Only the corporation held the debt; the individual shareholders did not hold the debt. As part of a legal incorporation, the liability was more minimal than that of a partnership or sole proprietorship, according to Examination Preparation Services. 

The case of Salomon v. Salomon gave rise to the legal fiction of corporate veil, enunciating that a company has a legal personality separate and independent from the identity of its shareholders. Hence, any rights, obligations or liabilities of a company are discrete from those of its shareholders, where the latter are responsible only to the extent of their capital contributions, known as "limited liability.

The doctrine of ‘piercing the corporate veil’ stands as an exception to the principle that a company is a legal entity separate and distinct from its shareholders with its own legal rights and obligations. It seeks to disregard the separate personality of the company and attribute the acts of the company to those who are allegedly in direct control of its operation and impose liability upon the persons exercising real control over the said company. The doctrine rests on the recognised principle of separate legal entity. This forms an important constituent of a body corporate/corporation, where to the contrary, a separate legal entity may or may not be a body corporate (as decided in the cases aforesaid). Hence, the doctrine has applicability where the separate legal entity persists, and in the instant case, society though not being a corporation, yet qualifies for being a separate legal entity.

Most of the cases subsequent to the Salomon case, attributed the doctrine of piercing the veil to various grounds such as that the company was mere a ‘sham’ or a ‘façade’. The law has been crystallized around the six principles formulated by Munby J. in Ben Hashem v. Ali Shayif, [2008] EWHC 2380 (Fam) and the same have been reiterated by the UK Supreme Court by Lord Neuberger in Prest v. Petrodel Resources Limited and others, [2013] UKSC 34

The six principles, as found at paragraphs 159–164 of the Ben Hashem are as follows:

1.         ownership and control of a company were not enough to justify piercing the corporate veil;

2.         the Court cannot pierce the corporate veil, even in the absence of third party interests in the company, merely because it is thought to be necessary in the interests of justice;

3.         the corporate veil can be pierced only if there is some impropriety;

4.         the impropriety in question must be linked to the use of the company structure to avoid or conceal liability;

5.         to justify piercing the corporate veil, there must be both control of the company by the wrongdoer(s) and impropriety, that is use or misuse of the company by them as a device or facade to conceal their wrongdoing; and

6.         the company may be a ‘façade’ even though it was not originally incorporated with any deceptive intent, provided that it is being used for the purpose of deception at the time of the relevant transactions.

The Court would, however, pierce the corporate veil only so far as it was necessary in order to provide a remedy for the particular wrong which those controlling the company had done. As noted in Prest:

35. I conclude that there is a limited principle of English law which applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. The Court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller of the advantage that they would otherwise have obtained by the company's separate legal personality. The principle is properly described as a limited one, because in almost every case where the test is satisfied, the facts will in practice disclose a legal relationship between the company and its controller which will make it unnecessary to pierce the corporate veil.”

In Life Insurance Corporation of India v. Escorts Ltd. & Ors., (1986) 1 SCC 264, while discussing the doctrine of corporate veil, the Supreme Court held that:

Generally and broadly speaking, we may say that the corporate veil may be lifted where a statute itself contemplates lifting the veil, or fraud or improper conduct is intended to be prevented, or a taxing statute or a beneficent statute is sought to be evaded or where 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 etc.

Some of the cases decided, in particular relating to a society, with respect to the piercing of corporate veil are notable. In Harbir Singh vs Shaheed Udham Singh Smarak Shiksha Samiti & Ors, the Delhi High Court held that courts should refrain from interfering in the internal management of a society or a club, as they are governed by their own charter, and that the Court should not sit in appeal over the decisions taken by the management and the majority of the society, as long as the court is prima facie satisfied that the said decisions are taken by the persons authorized to do so and as per the rules and regulations of the said society. However, for adequate reasons made out, the court will ignore the corporate veil to reach out to the true character of the concerned company or, in the relevant case, the society.

In A.V. Krishnan Moosad vs The District Collector, the Kerala High Court held that the corporate veil can be pierced when the corporate personality is found to be opposed to justice, convenience and interest of the revenue or workman or against public interest. If it is seen that the society does not have any asset and there are no persons responsible to settle the liability of the society, it is certainly open for the statutory authorities to pierce the corporate veil of the society and to find out the actual persons who are in management of the society and then take steps according to law.

In Madan Mohan Sen Gupta And Anr. vs State Of West Bengal And Ors, the Calcutta High Court was faced with the question whether a corporate veil or the veil of the society, should be lifted to see what sort of a face, statutory or otherwise, it has and under whose control it remains and whether the affairs are purely private or otherwise.

In the light of aforesaid judgements, it can be concluded that the doctrine of lifting of corporate veil has been applied in a restrictive manner, in the scenario wherein it is evident that the company was a mere camouflage or sham deliberately created by the persons exercising control over the said company for the purpose of avoiding liability. Similarly, in case of a society, the grounds where the corporate veil be lifted to disregard the separate legal entity of the board or the society in itself, shall also be based on the principle as enumerated in the leading cases with the intent to seek a remedy for a wrong done by the persons controlling the company.

The Doctrine of piercing of Corporate Veil has gained clarity on its scope and applicability and the principles were also discussed at stretch in the recent case of Balwant Rai Saluja & Anr v. Air India Ltd. & Ors. (2013). However, the applicability of the doctrine is ultimately within the discretion of the courts and is subjective based on the facts and circumstances of each case.

- Munmi Phukon and Sagar Batra