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Introduction

A Company is an artificial person having a separate legal entity from its members as held in the case of Salomon v. A. Salomon and Co Ltd(1). The concept of separate legal entity gives rise to the concept of ‘corporate veil’ which can be described as a security blanket between the Company and its shareholders as the Shareholders or members of a Company are not liable for the acts of the Company except as provided by law. 

However, this veil often allows the shareholders or the members to commit illegal acts and frauds. Since a Company is an artificial person, incapable of forming mens rea, it is the owners’ of the Company who are responsible for such illegal acts. In such a situation, the Court can order the lifting up of this veil, which is known as ‘piercing of the corporate veil’. On the other hand, reverse piercing can be defined as a tool used by the various Courts to hold the Company legally liable for the wrongful acts of its shareholders and members.

Piercing of Corporate Veil

The piercing of the corporate veil is usually undertaken when a parent Company is in a dominant position to influence the subsidiary Company and has used its power to commit fraud. Similarly, if a sole member of the Company is in a position to control the Company and use its position to do illegal acts then the corporate veil can be pierced.

Some statutory provisions allow the piercing of the corporate veil, however, this is accompanied by judicial precedents as well as facts of each case. In Life Insurance Corporation of India v. Escorts Ltd.(2), the Hon’ble Supreme Court stated, “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 public interest, the effect on parties who may be affected, etc.”

It is pertinent to point out that the following provisions of the Companies Act, 2013 allow the lifting of the corporate veil-

1. Sections 34 and Section 35- Allow lifting of corporate veil for misstatement of prospectus in certain cases.

2. Section 45- When the minimum number of people required for a Company goes below the specified limit, then the Court may pierce the veil.

3. Section 145(4)- Allows making an officer of the Company liable when he uses its name improperly on any negotiable instrument.

4. Section 542- This states that any person of the Company can be made liable without any limit if at the time of liquidation fraudulent conduct of the Company is identified.

However, this act does not provide for the doctrine of reverse piercing of the corporate veil.

Reverse Piercing of Corporate Veil

The emergence of this doctrine can be traced back to the W.G. PLATTS(3) case of the U.S. Supreme Court in 1956. This case related to a dispute where the plaintiff (wife) sought to impose liability on the defendant’s (husband) corporation to get her share of assets as announced in the divorce. It was the first time the court held the corporation be an ‘alter ego’ of the defendant and thus allowing the ‘reverse piercing of corporate veil’. 

Reverse piercing can be defined as a tool used by the Courts to hold the corporation legally liable for the wrongful acts of its shareholders and members. It can be said that if the traditional piercing of the veil is one side of the coin, the reverse piercing is the other side of it. In traditional piercing, liability is imposed on a single shareholder for the wrongful acts committed by him through the Company, whereas in reverse piercing the Company is made liable for the wrongful acts of its members or shareholders.

In Postal Instant Press Inc. v. Kaswa Corporation(4),  the Californian Court introduced two types of reverse piercing and differentiated between them. 

1. Insider reverse piercing: In this, claims are filed by shareholders/members themselves on the assets of the Corporation to make it liable for the illegal acts of one. This is done to impose their liability on the Corporation. This reverse piercing has been disallowed by Courts in many cases as it would be unfair to the innocent parties having an interest in the Corporation.

2. Outsider reverse piercing: In this, claims are filed by third parties on the Corporations for the illegal acts of the shareholders or members. This is also known as ‘third-party piercing’. 

Reverse Piercing in India

Compared to the U.S., Indian Courts have been reluctant in accepting the doctrine of reverse piercing of the corporate veil. Courts were presented with numerous cases where a company was accused of crimes and had to face criminal prosecution. Their reluctance was, however, based on fear of injustice to innocent shareholders, third parties, or creditors. 

The Calcutta High Court initially made the following observation about this doctrine in the case of A.K. Khosla v. T.S. Venkatesan ("A.K. Khosla")(5): First, the accused must be able to establish mens rea, which is a requirement under criminal law. Second, he or she should be able to withstand the imposition of a mandatory prison sentence. In the Court's view, a corporation cannot be deemed to have the required mens rea because it is merely a juristic person and not a natural person. As a result, it neither possesses a mind of its own nor a physical body, therefore it cannot be imprisoned. The Supreme Court upheld this viewpoint in MV Javali v. Mahajan Borewell Co.(6), but with a few minor modifications. As a result, it was established that a firm cannot get a mandatory prison term or fine. A fine would be the only penalty in this situation. The courts were still reluctant to hold a business accountable for the debts or dishonest actions of the people in charge of it, though.

However, this changed in 2005 with the case of Standard Chartered Bank v. Directorate of Enforcement(7) where the Supreme Court of India for the first time applied this doctrine and held that corporations can be held liable for acts of members or shareholders and punished by way of fines. In this case, the Supreme Court diverted from the literal penal provisions and held Standard Chartered Bank guilty under Foreign Exchange Regulation Act, 1973.

This doctrine was applied recently in the case of State Bank of India v. Kingfisher Airlines(8) while recovering debt from Vijay Mallya as he was the chief promoter and handled all the companies alone. The same was held in Punjab and Sindh Bank v. Skippers Builders Pvt. Ltd.(9), where the company was held liable for the actions of a sole person. 

This doctrine has started to grow in India but is still in developing stages as Indian Courts are cryptic to its application due to various reasons like the idea of separate corporate entity, absence of mens rea, inability to give punishment and companies being artificial persons.

• Reverse piercing and Indian Insolvency and Bankruptcy Code

The Insolvency and Bankruptcy Code of India (hereinafter referred to as “IBC”) has not recognized the doctrine of traditional veil piercing and reverse piercing. However, the same has been latently referred to in IBC. In a significant ruling in the case of Arcelor Mittal India Pvt. Ltd. v. Satish Kumar Gupta(10), the Hon’ble Supreme Court recognized that Section 29A of IBC introduces the idea of corporate veil piercing since it allows for the determination of who is in charge of the Company when a resolution plan is submitted. Nonetheless, problems still arise when these doctrines are applied by Indian Courts under IBC. 

Tests to determine the application of the doctrine of reverse piercing

1. Two-prong test

This test was developed in the case of W.G. Platts v. Platts(11). It consists of two elements:

1. Doctrine of an alter-ego or where acts of the members cannot be distinguished from the Company.

2. Act done by the Company alone would result in fraud to a third party.

2. Three-prong test

Established in the case of State v. Easton(12). The first two elements are the same as above. The third element is the quantum of damage to the third party due to the degree of control.

3. Balancing approach

Developed in the case of In re Phillips(13). This doctrine provides that reverse piercing will be done keeping in mind the equitable interests of all interested parties. 

4. Carefully circumscribed reverse piercing rule

In the case of Manichaean v. Exela(14), it was held that three elements were necessary for reverse piercing:

1. Factors of classical veil piercing

2. No other remedy with the third party

3. No harm to innocent shareholders

These tests must be applied in fusion. Any one test alone may not suit a given case. Thus, it is on the Courts to decide which test can be applied to deliver justice.

CONCLUSION

It is neither desirable nor feasible to allow such a tight commitment to maintain a separate legal personality of the corporation and overlook the necessity to use the reverse piercing doctrine in the contemporary corporate climate, where investors and corporation owners are inspired to do business. Therefore, it is said that reverse piercing results in the balance of significant interests, which is crucial to ensuring justice, trust and system stability. To guarantee that justice is served to all the Parties involved, it is essential to analyze and further develop the theory rather than outright reject it. The application of doctrines of veil piercing and reverse piercing has gained importance in today’s world because of the increase in white-collar crimes. In times when bad loans, unpaid debts and the closing of Companies have become an everyday phenomenon, Indian Courts and laws must accept and apply these doctrines. These doctrines are necessary to achieve the greater good and deliver justice fairly. 

REFRENCE

1. (1896) UKHL 1

2. 1986 AIR 1370

3.W.G. Platts Inc. v. Platts, 73 Wn.2nd 434 (1968).

4.162 Cal. App. 4th 1510.

5. (1992) 1 CALLT 77 HC

6. 1997-LL-0926-3

7.AIR 2005 SC 2622

8.OA No. 766 of 2013, decided on January 19, 2017.

9.2016 SCC OnLine DRAT 1

10. MANU/ND/0050/2018

11. W.G. Platts Inc. v. Platts, 73 Wn.2nd 434 (1968).

12.169 2d 282, 647 N.Y.S. 2d 904, 909 (Sup. Ct. Albany Cnty. 1995)

13.139 P. 3d 639 (Colo. 2006)

14. Manichaean (n 34)