Enforcement of Award against the Shareholders: The Delhi High Court's Dilution of the Corporate Veil
[Shourya is a student at Jindal Global Law School, and Shruti is a student at Vivekananda Institute of Professional Studies.]
Ensuing the dismissal of DMRC’s application to set aside the arbitral award against them in the matter of DAMEPL v. Delhi Metro Rail Corporation (DMRC), the Delhi High Court vide its order dated 17 March 2023 directed the Union Ministry of Housing and Urban Affairs and the Government of Delhi to take appropriate steps to enable DMRC to meet the obligations arising out of the award. A single-judge bench of Justice Yashwant Varma found both governmental entities to be principal shareholders of the DMRC and further held that public policy and justice demand the lifting of the corporate veil to hold the principal shareholders responsible.
Upon non-satisfactory enforcement of the award, DAMEPL filed the present execution petition against DMRC and its shareholders to obtain the award monies from the shareholders. The ruling, however, pierces the corporate veil in a manner such that it may not be in consonance with precedent. The corporate veil is a fictional veil separating the company and its owners, and the doctrine of piercing the corporate veil provides that the two are to be treated as separate legal entities such that the duties and liabilities of one cannot be imposed on the other, barring certain exceptional circumstances. The emerging principles of law severely dilute the concept of a separate legal entity. The authors would like to shed light on the possible problems in five points.
Injustice: A Complete Sweep
Traditionally, the standards of lifting the veil included ‘sham’, ‘fraud’, ‘public interest/policy’. However, the court in the present case broadened the scope of the doctrine, modifying these well-established standards. The court held that the two governmental entities were promoters of DMRC, and it was merely their “alter ego”, and thus the veil ought to be pierced. This was based on the fact that the two promoters by virtue of their powers over DMRC board, their equity and debt contributions, and capital investments, exercised complete control over the affairs of the DMRC. Therefore, they were liable to be “recognised in law as being in absolute control and the directing mind.”
This alter ego test invoked by the court envisages that the company is a mere instrumentality of its principal shareholders. It has two requirements — that (i) the corporation has such unity with its parents that their separateness has ceased; and that (ii) the facts are such that the treatment of entities as a separate entity would “sanction a fraud” or “promote injustice”.
It is the second prong of this test that the court relied heavily upon while holding that the circumstances in the present case would result in “injustice”, and hence warranted the lifting of the veil. In doing so, the court stretched the boundaries of the doctrine to any situation where there is injustice in not doing so. However, this may be far too sweeping of an element, as what may qualify as “injustice” has been left completely open. This muddles the somewhat solidified jurisprudence on when the corporate veil can be lifted and also takes away certainty in law as to the limits of a “separate legal personality.”
While the court chose not to restrict the ambit of injustice in its own words, it relied on a decision of a US Court, wherein it was specified that injustice must be some wrong beyond the “creditors’ mere inability to collect from the corporate debtor”. Interestingly, however, if this decision were to be applied to the factual matrix at hand, it would preclude it from the ambit of “injustice,” since the dispute at hand involved piercing the veil for collection of a lump sum from the promoters instead of the debtor itself. However, since no explicit clarification has been provided about the objective standard for what constitutes as an “injustice”, its limit remains to be seen.
Controlling and Directing Mind: A Ghost from the Past
The qualifiers of “absolute control and the directing mind” referred to by the court are reflective of the doctrine of identification, which was invoked by the Bombay High Court against Mukesh Ambani in the case of Reliance Industries Limited v. H Block. In that case, the court proceeded to pierce the veil since Mukesh Ambani was “the controlling mind and will” of his company. The judges observed that as per the doctrine of identification, a company is “identified with such key personnel through whom it works.”
These “key personnel” were described to be the alter ego of the company and their actions were deemed to be the actions of the company itself. However, this doctrine was subsequently rejected by the Hon’ble Apex Court because it was typically applicable only in criminal and tortious liability cases. Therefore, the standard of absolute control and directing mind relied on by the Delhi High Court in the present ruling may have been a re-opening of closed doors and a step in the wrong direction.
Public Policy: A Misconceived Ground?
The court also referred to “public policy” as grounds for lifting the veil, since it would allow DMRC to meet its obligations with respect to the award. The court relied on the decision of the Supreme Court in the case of State of UP v. Renusagar Power Co (Renusagar), where it held that the doctrine of corporate veil must be allowed to expand and that the veil can be lifted when public interest requires it. In that case, the entities Renusagar and Hindalco were so inextricably linked that Renusagar had no separate and independent existence apart from Hindalco and was formed for personal use. Further, the state authorities themselves acknowledged the entities cumulatively in their communication. However, DMRC, in this case, is not a company that has been incorporated for the personal use of its two shareholders, nor is there any evidence of any reference to DMRC and its two shareholders in a cumulative fashion during the arbitration proceedings. Therefore, the facts do not reflect such link between DMRC and its shareholders as was the case in Renusagar.
The principle of lifting the veil was also invoked in public interest in the case of State of Rajasthan v. Gotan Limestone Khanij Udyog (Private) Limited. In that case, the corporate entity had been used to conceal a fraudulent transaction involving the transfer of a mining lease to a third party without statutory consent. The doctrine was thus applied to prevent circumvention of statutory provisions. The factual matrix of the present case is different, owing to the fact that DMRC had not been used by its shareholders to conceal any fraudulent transaction. Therefore, using public policy as a ground for lifting the veil here would require more deliberation and clarity from the court.
Dilution of Separate Legal Personality of PSUs and the Government
The court here held that the two “sovereign governments” could not shirk from their liability to abide by binding judgements, decrees and awards. Relying on circumstances like the governmental entities being principal shareholders of the DMRC, their exercise of power over the DMRC by virtue of their position on its board, and their capital infusion and extension of debts to the DMRC, it held that the DMRC was under the absolute control of these shareholders.
The problem with such an application of facts is that a significant number of PSUs exist wherein a government has significant shareholding, sometimes exceeding 90%. The PSUs will therefore be dependent on the approval of their shareholders, including the government, to carry on their operations, whether by way of board meetings or through general meetings. The government will also exercise power derived from the concerned statute. Such powers may also be contained in the charter of the PSU. In either case, the problem that arises from the Delhi High Court’s application of the doctrine is that in many PSUs where the government has a controlling shareholding, the doctrine of separate legal personalities will stand diluted, and all liabilities of the PSU can be directly pinned on the government wherever there is “injustice.”
General Dilution of the Doctrine of Separate Legal Personality
The standard of “absolute control” outlined by the High Court can potentially be stretched to include nearly every corporate body having a concentrated shareholding pattern, which is a commonality in Indian entities. In such scenarios, the promoter/shareholder, by virtue of their shareholding, exercises de facto control over the board, as the appointment and removal of directors is entirely dependent on these controlling shareholders.
Therefore, the question that arises is if a principal shareholder exercising de facto control over the board also engages in extension of debt and capital to the company, will they be considered to be in “absolute control” and be the “directing mind” of the company such that the obligations of the company can be pinned on them in the event of an “injustice”.
The Delhi High Court’s ruling exhaustively analyses the jurisprudence on the doctrine of piercing the corporate veil and rightly comes to the conclusion that the doctrine should be left to develop and evolve. However, the emerging legal principles out of it may be too sweeping and may disbalance the doctrine such that it may invalidate the existence of a separate legal personality. Subjective qualifiers like “injustice” and “inequitable circumstances” require objective tests, clarifications and restrictions so as the prevent arbitrariness. Further, the scope and domain of public interest and public policy as relied on by the court remain ambiguous and prone to erroneous discretion. It raises the question of whether public interest lies in the functioning of the Metro Rail or in the enforcement of the arbitral award at the cost of such functioning. While this determination may be beyond the scope of this piece, it does remain a valid concern.