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Abstract

One of the fundamental concepts of corporate law is the principle of limited liability. It enables business owners to limit their personal liability for the debts and obligations of their company to the amount of their investment in the company. The principle of separate legal entity as established in the Solomon case[1] states that a company is both legally and financially separate from its owner. However, there are situations where the corporate veil can be pierced, which allows the owners to be held personally liable for the company’s debts. This is referred to as forward piercing of the corporate veil. In recent years, there has been increasing interest in a different form of veil piercing called reverse piercing or backward piercing, where a creditor of an individual seeks to collect from assets that are held within a corporation. This paper aims to evaluate the position of reverse piercing as a mechanism for corporate accountability.

Introduction

The concept of reverse piercing of corporate veil is derived from the equitable doctrine of ‘piercing the corporate veil’ which has been applied in cases where a shareholder has attempted to shield his or her personal assets from liability for the debts of the corporation. Under the doctrine, courts may disregard the separate legal entity of a corporation and hold the shareholders personally liable for the debts and obligations of the corporation if the shareholders have abused the corporate form as per section 339, Section 464 etc. of the Companies Act, 2013. The concept of reverse piercing of corporate veil is similar in that it involves disregarding the separate legal entity of a corporation, but it is applied in a different context. The doctrine of reverse piercing of the corporate veil holds the corporation liable for the actions of an individual member.

Reverse piercing of corporate veil is relatively uncommon, and there is no clear legal framework for determining when it is appropriate. The legal framework for reverse piercing of corporate veil is still evolving, and courts have taken a variety of approaches and applications to this issue. Some courts have held that reverse piercing of corporate veil is not permitted under any circumstances, while others have allowed it in limited circumstances. The main challenge in determining whether reverse piercing of corporate veil is appropriate is the tension between the principles of limited liability and the ability of creditors to collect on their judgments.

The Position of Law in UK and USA

All companies incorporated in accordance with the UK Companies Acts and Codes, as well as laws in other European countries, North American states, like India have complete entity shielding and is an important characteristic of a body corporate. The reverse piercing doctrine has been recognized and well developed in the US, where a further demarcation is made between ‘inside reverse piercing’ and ‘outside reverse piercing’. When a shareholder attempts to pierce the veil in order to collect debts owed by the company’s owner, it is said that inside reverse piercing has taken place. Whereas, outside reverse piecing occurs when a third-party creditor seeks to recover the debts of the company controller from the company.

In the Prest v Petrodel Resources Ltd[2] the court was asked to determine whether the corporate veil could be pierced, allowing the assets of the companies to be considered as Mr. Prest’s personal assets for the purpose of the divorce settlement. One important case referred for the development of reverse piercing in the US is Kingston Dry Dock Co. v. Lake Champlain Transportation Co[3], where the court expressed doubts on the appropriateness of reverse piercing stating that it would be appropriate only in rare circumstances, if ever. However, reverse piercing was permitted in W.G. Platts, Inc. v Platts[4] in which, as in Prest, the claimant sought to impose liability on her husband’s company in order to satisfy a divorce settlement. Unlike, Prest, the US court held that the company was the alter ego of the husband and permitted piercing in order to satisfy the divorce decree.

There are broadly two approaches used by US courts, ‘inverse method of reverse piercing’ and ‘equitable results approach.’[5] The court simply applies the traditional veil-piercing requirements in the context of reverse piercing in accordance with the inverse method, However, according to the equitable results approach, the courts impose additional requirements to better protect the diverse interests affected by reverse piercing. Such additional requirements include questions like whether reverse piercing would cause any injury to the company’s innocent shareholders and creditors. In Phillips v Englewood Post No.322 Veterans of Foreign Wars of the U.S. Inc.[6] the court found that no injury would be caused to the company’s creditors since they were identical to the controlling shareholder’s personal creditors. In the case of Floyd v. Internal Revenue Services[7] the court held that as there is a possibility of prejudice against the third party (third party shareholder) the reverse piercing doctrine would not be applied. In State v. Easton[8] the court stated that fraud is one of the major requirements for the application of this doctrine.

Legal Framework of Reverse Piercing in India

Even though the Indian courts showed reluctance to use this doctrine forthrightly, the idea of alter ego is gradually being accepted. In the case of Iridium India Telecom Ltd v. Motorola Incorporation and others[9], the court stated that the criminal intent of the corporation’s alter ego could be attributed to the corporation. The Supreme Court ruled in Standard Chartered Bank v. Directorate of Enforcement[10] that a corporation can be prosecuted and fined for transgressions on behalf of its members, regardless of the statutory punishment imposed under relevant statutes. The first application of reverse piercing theory can be witnessed in Aneeta Handa & Ors. v. God-father Travels[11], a case involving section 141 of the Negotiable Instruments Act, 1881, which gives the inference that individuals mens rea can be ascribed to the company to expose the corporate body to criminal culpability. This doctrine in India is primarily used in tax recovery which is owed by individuals. In the Nirav Modi PNB Scam Case, the Debt Recovery Tribunal Mumbai ordered him and his group of companies to repay the due amount according to the tenets of this doctrine. The degree of the shareholder’s relationship with the corporation is an important caveat for the application of this principle. Reliance on facts and circumstances is a must and hence no straight jacketed formula can be used by the court in the same.

Challenges and Limitations

One of the main challenges in reverse piercing of corporate veil cases is determining the appropriate legal standard to apply. Some courts have held that the standard for reverse piercing should be the same as for forward piercing, which requires a showing of fraud or other wrongful conduct. Other courts have applied a more flexible standard that considers the unique circumstances of each case.

The potential impact of reverse piercing on the business community in another challenge. Allowing creditors to use reverse piercing to collect on judgments may discourage entrepreneurs from forming corporations and have a chilling effect on the economy. On the other hand, if reverse piercing is not allowed, it could lead to unjust results in cases where individuals have used the corporate form to shield their personal assets from creditors. If creditors are allowed to use reverse piercing to go after assets held within a corporation, it could create uncertainty and undermine the basic principles of corporate law. Furthermore, there is a risk that reverse piercing could be used as a tool for harassment and intimidation. Creditors could use the threat of reverse piercing to force individuals to settle debts or agree to unfavourable terms, even when they are not legally obligated to do so.

Future Directions: Suggestions

It is argued that before using reverse piercing of the corporate veil, the claimant must have exhausted all other plausible options, whether provided by law or more commonly accepted. This is supported by case laws such as William G. Schwab vs. Damenti’s Inc. & Ors.[12], in which the Pennsylvanian Bankruptcy Court has the ability to reverse penetrate the corporate veil, holding another firm owned by the shareholders liable for the debts. Although the identities of the shareholders and the companies were interchangeable in their activities, the court determined that this was insufficient to establish that they were single entities. As a result, both firms’ and shareholders’ legal existence was preserved. Ultimately, the development of a clear legal framework for reverse piercing of corporate veil in India will require a careful balancing of competing interests and a nuanced understanding of the role of corporations in modern business. It is important for policymakers, legal practitioners, and other stakeholders to engage in a constructive dialogue about this issue to ensure that the principles of corporate law are upheld while also protecting the rights of creditors and entrepreneurs. A similar, related claim is that liberal approaches to veil piercing generate increased borrowing costs for an organisation.[13]

A common criticism of this doctrine  is that it is unprincipled, unpredictable and arbitrary in its application. It can be argued that the ascription of discretionary license to the judiciary is economically inefficient in that it increases transaction costs whilst securing no social benefit.[14] However, this might be true but there is a need for the judiciary to intervene and use this doctrine as an exception to protect against economic frauds. It will not only act as a measure of deterrence but will also make people accountable. To ensure that the use of the doctrine is limited and applied only in exceptional circumstances, it may be appropriate to introduce a minimal financial threshold, which would qualify a case for application of reverse piercing. This would help to ensure that the doctrine is used only in large financial scandals, where there is a clear and significant harm to the public interest.

It is important to note that there is a strong presumption against piercing the veil, and the court must apply the principle only if all other avenues of debt resolution have been exhausted. The doctrine should be seen as a measure of last resort, to be used only when there is no other way to hold those responsible for financial wrongdoing accountable.

Conclusion

In conclusion, the legal framework for reverse piercing of corporate veil in India is still evolving, and the courts have adopted different approaches to this issue. The key factors that the courts consider include the degree of control that the individual has over the corporation, the existence of fraudulent or wrongful intent, and the potential harm to other creditors. Despite the challenges and limitations associated with reverse piercing, there may be situations where it is necessary to prevent injustice and hold individuals accountable for their actions. However, any decision to allow reverse piercing should be made carefully and based on a clear legal framework that balances the interests of creditors and entrepreneurs.

[1] Solomon v. Solomon & Co Ltd. 1897 AC 22 (HL)

[2] 2013 UKSC 34

[3] 31 F.2d 265

[4] 49 Wn.2d 203 (1956)

[5] N. B. Allen, ‘Reverse Piercing of the Corporate Veil: A straightforward Path to justice’ (2011) St. John’s Law Review

[6] 138 P.3d 639

[7]151 F.3d 1295 (10th Cir. 1998)

[8] 169 Misc. 2d 282, 647 N.Y.S.2d 904 (N.Y. Sup. Ct. 1995)

[9] (2011) 1 SCC 74

[10] AIR 2005 SC 2622

[11] (2012) 5 SCC 661

[12] 405 B.R. 555 (Bkrtcy M.D, Pa.2009)

[13] E. Ferran, ‘Principles of Corporate Finance Law’ (2008) 2 Oxford, OUP 34

[14] SM Bainbridge, ‘Abolishing Veil Piercing’ (2001) 26 Journal of Corporation Law 479

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