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It is common practice to use complex corporate structures involving a web of companies as a vehicle to do business. The form of these structures is driven by commercial, regulatory and tax considerations. Given the limitations of the conventional principles of privity and separateness of corporate identity, these complex structures raise a potent challenge to contract enforcement.
It is a basic tenet of company law that the company and its shareholders are treated as distinct personalities. The conventional principle of privity of contract holds only those persons who are parties to an agreement to be liable for its breach. Consequently, asset rich parent companies enter into and execute contracts in the name of shell subsidiary companies to often to avoid liability. It is to redress this asymmetry that the group company doctrine has been deployed. The courts have used the doctrine of piercing the corporate veil and privity by conduct to impose liability on a group of companies in appropriate cases.
Applying the group company doctrine, the Supreme Court recently in Mahanagar Telephone Nigam v. Canara Bank (Civil Appeal Nos. 6202-6205 of 2019) held that subsidiaries to be bound by an arbitration agreement entered into by the parent. No general rule, however, was laid down that would bind all group companies to an arbitration agreement entered into by one of the companies in the group. Common ownership and control by itself therefore was not considered to be adequate to bind non-signatory group companies. The Court instead took into account certain additional elements which when present would bind non-signatory group companies. These elements include a common intention, negotiation or performance of the contract in question by non-signatory group companies. The Court further held that non-signatory group companies benefiting from the contract must also be bound by the arbitration agreement it contains.
The holding in Mahanagar Telephone Nigam, however, expands the composite transaction test postulated in Chloro Controls India v. Severn Trent Water Purification, (2013) 1 SCC 641. Accordingly, non-signatory group companies were held to be bound only in case of composite transactions. The decision in Mahanagar Telephone Nigam makes non-signatory group companies bound by arbitration agreements in an increased number of fact situations, in addition to composite transactions.
The doctrine of piercing the corporate veil is another means by which courts have sought to determine liability in the context of layered corporate structures. In substance, the doctrine, permits a court to disregard the separate character of a company to discover its shareholders and impose liability in appropriate cases. The Supreme Court in Life Insurance Corporation of India v. Escorts, (1986) 1 SCC 264 substantively explained the doctrine of the piercing of the corporate veil. The Court held that the veil of distinct identity between a company and its shareholders may be lifted if it is contemplated by statute or such separateness of corporate identity is employed to perpetuate a fraud. The Court while providing for the aforesaid grounds for lifting the corporate veil held that “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.” The Court therefore contemplated enumeration of further cirucmstances where the lifting of the corporate veil would be justified.
The Supreme Court following the guidance in the Escorts Case enlarged the grounds to lift the corporate veil in Balwant Rai Saluja v. Air India (2014) 9 SCC 407 and Arcelormittal India v. Satish Kumar Gupta, (2019) 2 SCC 1. The holding in these cases crucially diluted the earlier position requiring it to be a case of fraud or statutory requirement for piercing of the veil. It was held as a proposition of law that the corporate veil may be pierced when separate corporate identity is employed to obscure liability for improper conduct.
The Court incorporated the aforesaid expansion by reading into Indian law the principles laid down in Ben Hashem v. Ali Shayif , 2008 EWHC 2380 (Fam) by the High Court of English & Wales which are as thus:
“(i) Ownership and control of a company were not enough to justify piercing the corporate veil;
(ii) 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;
(iii) The corporate veil can be pierced only if there is some impropriety;
(iv) The impropriety in question must be linked to the use of the company structure to avoid or conceal liability;
(v) 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
(vi) 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.”
The inclusion of use of corporate identity as a “façade” to circumvent liability for “improper conduct” by the “wrongdoer” leads to the inescapable conclusion that the breach of contract is also a valid ground to lift the corporate veil and impose liability. In addition, the use of the word “impropriety” clearly indicates lowering of the threshold for lifting the corporate veil from the holding in the Escorts Case. It is trite for centuries that conduct in breach of a binding contract is considered improper and is sanctioned by law. These principles therefore now form the foundational basis of enforcing liability on non-signatory group companies for breach of contract when corporate separateness is used to defeat the very rationale of binding contracts. The use of the doctrine however must be driven by fact specific determinations based on the peculiarities of the underlying commercial transaction. A court must advert to the aforesaid principles in addition to other elements such as those employed by the Court in Mahanagar Telephone Nigam’s Case while adjudicating liability on non-signatory affiliated companies for breach of contract.
Privity imposes liability for breach of contract only on the parties to the contract. This makes imposition of liability on non-signatory group companies. The privity principle has evolved over time to also include privity established by third-parties to a contract by conduct. The Delhi High Court in the case of K.K. Modi Investment & Financial Services v. Apollo International, 2014 SCC OnLine Del 2200 was dealing with a suit seeking enforcement of a non-compete negative covenant against the defendants which were a group of companies. In the said case, only one company of the group was a signatory to the contract under which the Plaintiff claimed. The Single Judge rejected applications for deletion from the array of parties and rejection of the plaint on behalf of the non-signatory defendants on the basis of privity by conduct.
The Single Judge in K.K. Modi applied the holding in the case of Utair Aviation v. Jagson Airlines, (2012) 129 DRJ 630, wherein the Delhi High Court held that privity against a stranger to the contract can be established by admission, awareness, acknowledgment, participation and receipt of benefits. It was held that courts in such circumstances must determine “whether actually the party can be said to be a complete stranger to a contract or where the plea is taken only to defeat the claims of the party. All this can be seen by looking into the attending circumstances after the contract.” The Single Judge in K.K. Modi employed this instrument of privity by conduct to hold that such non-signatory group companies are obliged to follow the terms of the contract.
Privity established by conduct therefore is another route used by courts to fasten contractual liability on non-signatory group companies. This approach is nuanced in the sense that mere relatedness among companies is not be enough for an adjudication of liability. It does require factual enquiry as to whether in fact separate corporate identity was used as a smoke screen. It would also be a material consideration, if the ultimate beneficial owners operated and controlled companies in the group as independently functioning units in relation to the specific contract.
The foregoing precedents provide a different perspective to the group company doctrine in the context of contractual liability. These methods have been used to look beyond the camouflage of separate corporate identity in group companies. While contract enforcement is a key indicator of the efficacy of commercial adjudication in any jurisdiction, this interest must be balanced against the need to preserve distinct corporate identity. The courts therefore must consider facts other than common beneficial ownership and control of companies, relating to the specific agreement and the underlying commercial transaction before enforcing liability against non-signatories. The overarching objective, however, is to impose a significant premium on the abuse of the legal fiction of distinct corporate identity to stymie contract enforcement.
Sidhant Kumar is an Advocate practicing before the High Court of Delhi and the Supreme Court of India with a LL.M. in International Economic Law, Business and Policy from Stanford Law School.