[Aditya is a student at National Law School of India University.]
On 6 December 2023, the Supreme Court upheld the validity of the group of companies doctrine in the review of Cox and Kings v. SAP India Private Limited. The terms of reference for the review in short was that the doctrine interferes with established legal principles such as party autonomy, privity of contract, and separate legal personality.
The court observed that the doctrine’s existence is standalone in arbitration law and application of piercing of corporate veil / alter ego doctrine is not the basis of its invocation. It is rather a fact-based doctrine where the courts deduce the intention of the parties (another company of the group) based on their involvement in the contract. Senior Advocate Ritin Rai’s submission that “complex multi-party contracts are outcomes of detailed negotiations entered into after parties have fully applied their mind. To impute intention to parties in contradiction to the express terms of the agreement would defeat the purpose of the parties…” was of no avail here. It is difficult to reconcile how active intra-group involvement can ever amount to intention to be bound by the arbitration agreement when that is how intra-group operations are generally conducted.
This article intends to analyze how the reasoning that the doctrine operates independent of corporate law is at best evasive. This is because it disregards limited liability protection of two connected corporations by imputing intention from operations, usual within a group especially when the non-impleaded entity was explicitly not a part of the contract. The doctrine in effect goes in the teeth of corporate theory of company being a separate juristic entity. Apart from its intersection with corporate law, the paper will also show how the ramifications of the doctrine are detrimental to the functioning of conglomerate. The test unreasonably penalizes a group for an efficient intra-group modus operandi i.e., active intermingling of technical and financial resources.
Does Corporate Law Really Have No Role?
The Indian jurisprudence, very similar to the test laid down in Dow Chemicals, operates where firstly, there exists a group of companies, and secondly,“the circumstances surrounding negotiation, execution, and termination of the agreement show that the mutual intention of all the parties was to bind the non-signatories.” (reference Dow Chemical v. Isover Saint Gobain, [ICC Case Number 4131, Interim Award dated 23 September 1982], and Cox and Kings Limited v. SAP India Private Limited and Another [2023 INSC 1051 [39-43]]). Hence, the pertinent question which then arises is that how the courts are proceeding without disregarding the separate personality when there is a pre-condition that the companies belong to the same group. The intention is only imputable because the companies are part of the same group. In straight terms, the doctrine is used to impute liability from a subsidiary to a parent/ any other subsidiary of the same group when there is active influence of the non-impleaded company in different facets of the transaction. The fact that the doctrine is not standalone can also be shown through the reasoning exhibited and authorities relied upon by the court itself.
The first point here pertains to the portion of the holding striking down the invocation of the doctrine using the phrase ‘claiming through or under’ given under Sections 8 and 45 of the Arbitration and Conciliation Act 1996. The approach taken in Chloro Controls was that a group company derives interest from the contract and thus is ‘claiming through or under’. The same was struck down for being violative of principles of contract and corporate law. This is because the existence of a group of companies was nearly the sole factor enabling the impleadment of another company and thus wrongfully piercing the veil. What the doctrine in its current form does is potentially extend the liability to a parent/ subsidiary based on their influence and involvement in the transaction. The entry point of both the approaches i.e., the prevailing and the one struck down, is the same. It is just that the former has an additional threshold to be met. While one pierces the corporate veil / construes the party to the arbitration as an alter ego merely because of a tight group structure and interest in the contract, the other has a separate basis, but both of them, in effect, proceed by dissolving the separate legal identities. The fact that it is only for the purposes of an arbitration does not change this as even piercing is carried out for a limited purpose alone. As the court also observes and is well-settled in law, the independent identity and thus the limited liability protection is only breached in extremely limited circumstances with a strong legal basis. These grounds have been affixed in law as protection of public interest, legal invasion after already having incurred the liability/ duty and when a statute states so. The instant case has in effect added a fourth ground to breach the limited liability protection by externally imputing the intention, which is a product of the two entities being part of the same group.
The second reference the author wishes to draw is to the cross-jurisdictional note taken by the court. While the rejection of the doctrine by countries such as the UK and the USA also holds merit, the approach taken by the Singapore High Court is an apt extension to the above-made argument. Even they are placed with the Dow Chemicals test before them in Manchuar Steel v. Star Pacific Line. The court there stops at the first prong i.e., the existence of a single economic reality. It observes that irrespective of the structure and ultimate flow of benefit, the rights of a company can only be exercised by that company and thus its separate legal personality cannot be disregarded.
Proceeding under the idea of companies forming a single economic reality was in itself sufficient for the Singapore High Court to be a wrongful disregard of a company’s separate legal personality. The other referenced jurisdictions such as the UK and the USA also have similar standards (high) of protection for a company’s separate legal personality. The leading case in the UK, i.e., Peterson Farms v. C&M Farming outrightly rejects the existence of the doctrine in English common law. Both this and the seminal cases in the USA i.e., Thomson-CSF v Am. Arbitration Association outrightly rejected the independent existence of the doctrine and ruled that the impleadment can only be using the existing tools of corporate and contract law. These include the application of the doctrine of estoppel, conventional piercing/alter ego, agency, etc. This goes on to show that there is no legal basis for creation of the group of companies doctrine without impinging upon the most fundamental tenets of corporate law.
Unreasonable Imputation of Liability
The judgement places good emphasis on the doctrine being a tool to accommodate contemporary commercial realities. The author believes that while there are considerations of practicality, the judgement misses big when it comes to accommodating modern commercial realities. The test which impleads a company based on its active involvement with its subsidiary is in itself extremely outmoded and goes against the fundamentals of how subsidiaries are made to operate efficiently. As it was held in Prest v. Petrodel and later imbibed in the Indian jurisprudence, there is no fault in limiting the liability in the first place. In fact, this is what incorporation is about. Moving further there are adequate reasons for the law to permit related party transactions, provided there are disclosures of the nature of relationship, financial inflows, and outflows, etc. The Indian Accounting Standard 24 acknowledges that related party transactions, both tangible and intangible, are normal features of commerce. It is thus that the law through various standards prescribes robust disclosures as safeguards to facilitate this essential liability-limiting mechanism of business doing. The relationship between a company and its scattered shareholders is different from the relationship between a parent and its subsidiary. While the former are absentee, the latter is much more active owing to the nature of relation and background of incorporation. The law cannot then expect them to act as absentee shareholders. The doctrine, however, imposes the cost of unlimited liability and shatters the entity shield for active involvement. The purpose of a subsidiary is to execute the performance of a specialized domain while leveraging the technical and financial prowess of the parent and also enabling the parent to undertake more risky ventures. It has been seen through empirical observations that enhanced profitability of a conglomerate is a weighted average of both joint sharing of technical and financial variables. Weak entity shielding may result in a parent delegating more decision-making to its subsidiary along with other organizational and financial restructurings. This, however, will also lead to increased failures. The SGHC in Manchur Steel observed the ramifications of accepting the doctrine on group companies will be that of completely shattering the limited liability protection. It held that the same is unfair keeping in mind that this has been a long-standing practice to limit liability.[1] There is a reason why the law allows such a modus operandi with disclosures and only erodes the division only under grave cases of fraud.
Conclusion
This paper shows how the imputation of intention to bind a non-party in fact flows from disregard of separate legal personality. The test imposes upon the conglomerate the price of unlimited liability for acting like an active shareholder, something which is central to their efficient functioning and profitability. Other legal basis such as doctrine of separability used to buttress the group of companies doctrine also appear to be unsound. At the end, what remains of the essence is the dent that the doctrine creates on a company’s separate legal personality and business doing of a conglomerate.
[1] Manuchar Steel Hong Kong Limited v. Star Pacific Line Pte Ltd, [2014] SGHC 181 [130-133]; The observations were in the context of One Ship Companies, but the holding is relevant as India too has a long-standing practice of operating group companies. In fact, most of our leading business are conglomerates; For overview, see Jayati Sarkar, ‘Business Groups in India’ in Asli Coplan, Takashi Hikino, and James Lincoln (eds) The Oxford Handbook of Business Groups (OUP, 2010).