Ftil-Nsel Limited Liability Ends Merger
By : Madhavi G
Update: 2018-02-12 06:01 GMT
story
The fundamental principle which Indian courts have recognized and applied is that upon incorporation, a company becomes a distinct legal and juristic person, separable from its members by a ‘corporate veil’. Well-known cases, including that of Vodafone, have set out stringent parameters for ignoring the legal fiction to see what, or rather who, lies beneath and may be held accountable. This corporate veil may be pierced only where it is used as a shield to mask illegal ends, or used to conceal or defend the persons in actual control, or where a company has been constituted with the sole intention of acting as a façade to perpetrate a fraud. The fraud, however, must necessarily be a fact that is proved and cannot be something that is merely stated to be believed or accepted.
Section 396 was introduced as a social welfare legislation to amalgamate companies in situations where the Central Government was satisfied that the amalgamation was ‘essential in public interest’, providing a simplified mechanism that does not have to be driven through the court process and under its supervision.
The judgment that paves the way for the merger of NSEL with its promoter company FTIL effectively creates a path for the summary lifting of the corporate veil without establishing stringent parameters for doing so. This is not because Section 396 on its own creates another ground on which the veil may be lifted, but if interpreted in a manner where such a summary procedure is used to tear the veil between two companies, the well-established pre-conditions to lifting the veil are made redundant. The route of a possible forced amalgamation may result in a precipitous mechanism for creditors/claimants to insist that a parent company be held responsible for the acts/omissions/debts (even if unproven) of its subsidiary.
The implications are far-reaching. If Section 396 is permitted to be used in this manner, it would circumvent the longestablished legal fiction and conditions which must be fulfilled before the curtain is drawn to permit a claimant to seek recovery of dues or reliefs from the members/holding company of the actually contracting subsidiary. There is no need to establish that the subsidiary was formed for the purpose of committing a fraud, or that the members/parent are in actual control, or that the subsidiary is nothing but the alter ego of the parent. Proof and detailed adjudication are dispensed with so that the two companies can be amalgamated ostensibly in public interest. Section 396 then becomes a sui generis equivalent of compulsory acquisition power, which is usually only found in the domain of welfare legislation and property rights, such as the Land Acquisition Act.
A natural corollary of state action in such a manner is to set at naught the basic premise of limited-recourse finance and bankruptcy remoteness, which is the essence of project finance. These principles will no longer be legally sound if a cash-rich parent can be held responsible for the debts of its subsidiary. It is difficult to see how such action could be said to be ‘essential’ or in ‘public interest’ when it is tantamount to bringing down two entities instead of liquidating one which has no hope of restructuring or survival.
Should the present action taken by the government be treated as a precedent for similar future actions, it does not bode well for the incumbent government’s avowed efforts to attract foreign investment. Certainly, such potential action against global players in the future does not suggest a greater ease of doing business in India and will instead be seen as a further risk, potentially creating investorstate disputes, instead of inviting greater foreign investment into the country.
MCA order merging holding company FTIL with its subsidiary NSEL which dilutes established principles for lifting the corporate veil and goes to the heart of limited liability and the High Court’s ratification of the sameSanjay AsherSenior Partner, Crawford BayleyWhat would be the impact on the corporate landscape of the country if two private companies were to be forcibly merged by lifting...
MCA order merging holding company FTIL with its subsidiary NSEL which dilutes established principles for lifting the corporate veil and goes to the heart of limited liability and the High Court’s ratification of the same
Sanjay Asher
Senior Partner, Crawford Bayley
What would be the impact on the corporate landscape of the country if two private companies were to be forcibly merged by lifting the corporate veil and abolishing the limited liability concept?
If two private companies are forcibly merged by lifting the corporate veil, then it will have an atrocious effect. I would describe such an action as killing a corporate entity and abolishing the very fabric of the limited liability concept of corporate entity.
Do you think it will set a dangerous precedent if the corporate veil is lifted between a parent and its subsidiary without any trial?
It will surely set, in my view, an incorrect dangerous precedent if the corporate veil is lifted between a parent and subsidiary without any trial.
On October 21, 2014, the Ministry of Corporate Affairs (MCA) issued a draft order amalgamating promoting company Financial Technologies India Ltd. (FTIL)—now known as “63 Moons Technologies Limited”—with its subsidiary National Spot Exchange Ltd. (NSEL). The MCA called upon the powers under Section 396 of the Companies Act, 1956 and issued the amalgamation order allegedly on grounds of “public interest”, i.e., that FTIL was responsible for the recovery of the default sum with respect to contracts traded on NSEL. The order was triggered by the Forward Markets Commission’s (FMC’s) recommendations and not by an independent probe carried out by the MCA. While “public interest” as a reason is irrelevant when it comes to provisions under Section 396 of the Companies Act, 1956, the Bombay High Court, too, upheld the MCA’s order in writ petition number 2743 of 2014. Ever since, investors have been worried about the extent of protection available to the principle of limited liability (when the liability of an owner of a company is limited to the amount invested by him/her in the company and does not include debts incurred by the company) in India.
In keeping with Section 396 of the Companies Act, 1956, the MCA issued a copy of the draft order. Soon after, NSEL, FTIL, and FTIL’s shareholders and creditors filed writ petitions in the Bombay High Court on grounds that a company with negative net worth such as NSEL cannot be amalgamated with a company with positive net worth such as FTIL as the amalgamated entity will be unable to restore stakeholders’ rights to the original level as envisioned in Section 396 (3) of the Companies Act, 1956. If NSEL’s supposed liability is '5600 crore, it becomes a negative net-worth company, and as such, it cannot be merged with FTIL, which has '2600 crore positive net worth.
In my view, the judgment will undoubtedly have an adverse impact on corporate India. In my view, the amalgamation order has been passed by the MCA as a punitive measure, which is not the public interest envisaged under Section 396. Undoubtedly, this will set a dangerous precedent and upset the fundamental principle underlying the incorporation of companies with limited liability
Tushad Cooper
Senior Legal Counsel
Tushad Cooper
Senior Legal Counsel
Stakeholders were assured that they could raise objections before the MCA and the MCA would consider their objections in a fair manner, and after giving them a personal hearing, it would possibly even decide against the merger. Most stakeholders, including FTIL’s shareholders, creditors, employees, and vendors, did file writ petitions against the proposed amalgamation. But while the HC’s interim order required that the MCA give a personal hearing to all stakeholders, only NSEL and FTIL were given a personal hearing. Ultimately, the MCA went ahead and issued the final order amalgamating FTIL and NSEL on February 12, 2016.
If NSEL was deemed to pay traders the supposed '5600-crore liability, FTIL’s entire net worth would be erased, putting its shareholders at risk. However, the MCA issued a compensation order under sub-section (3) of Section 396 of the Companies Act, 1956 without providing any compensation to FTIL’s shareholders. In its final order, the MCA added two more reasons, i.e., that it was necessary to restore people’s confidence in forward contracts and exchanges and that it was also necessary to reinforce the ground reality that NSEL and FTIL were one and the same.
The MCA moved to amalgamate FTIL and NSEL based on an FMC order that the promoters of NSEL were not fit and proper. While the FMC order has been challenged before the High Court through a writ petition which has been admitted but is yet to be adjudicated, the findings in the FMC order were erroneously treated as “objective facts” and neither FTIL nor NSEL seriously disputed them. Further, the legitimacy of most of these “objective facts” is still to be established in civil and criminal suits pending in various courts.
TAKING ACTION UNDER SECTION 396
IS IT A GO-BY TO THE CONCEPT OF THE CORPORATE VEIL?
The fundamental principle which Indian courts have recognized and applied is that upon incorporation, a company becomes a distinct legal and juristic person, separable from its members by a ‘corporate veil’. Well-known cases, including that of Vodafone, have set out stringent parameters for ignoring the legal fiction to see what, or rather who, lies beneath and may be held accountable. This corporate veil may be pierced only where it is used as a shield to mask illegal ends, or used to conceal or defend the persons in actual control, or where a company has been constituted with the sole intention of acting as a façade to perpetrate a fraud. The fraud, however, must necessarily be a fact that is proved and cannot be something that is merely stated to be believed or accepted.
Section 396 was introduced as a social welfare legislation to amalgamate companies in situations where the Central Government was satisfied that the amalgamation was ‘essential in public interest’, providing a simplified mechanism that does not have to be driven through the court process and under its supervision.
The judgment that paves the way for the merger of NSEL with its promoter company FTIL effectively creates a path for the summary lifting of the corporate veil without establishing stringent parameters for doing so. This is not because Section 396 on its own creates another ground on which the veil may be lifted, but if interpreted in a manner where such a summary procedure is used to tear the veil between two companies, the well-established pre-conditions to lifting the veil are made redundant. The route of a possible forced amalgamation may result in a precipitous mechanism for creditors/claimants to insist that a parent company be held responsible for the acts/omissions/debts (even if unproven) of its subsidiary.
The implications are far-reaching. If Section 396 is permitted to be used in this manner, it would circumvent the longestablished legal fiction and conditions which must be fulfilled before the curtain is drawn to permit a claimant to seek recovery of dues or reliefs from the members/holding company of the actually contracting subsidiary. There is no need to establish that the subsidiary was formed for the purpose of committing a fraud, or that the members/parent are in actual control, or that the subsidiary is nothing but the alter ego of the parent. Proof and detailed adjudication are dispensed with so that the two companies can be amalgamated ostensibly in public interest. Section 396 then becomes a sui generis equivalent of compulsory acquisition power, which is usually only found in the domain of welfare legislation and property rights, such as the Land Acquisition Act.
A natural corollary of state action in such a manner is to set at naught the basic premise of limited-recourse finance and bankruptcy remoteness, which is the essence of project finance. These principles will no longer be legally sound if a cash-rich parent can be held responsible for the debts of its subsidiary. It is difficult to see how such action could be said to be ‘essential’ or in ‘public interest’ when it is tantamount to bringing down two entities instead of liquidating one which has no hope of restructuring or survival.
Should the present action taken by the government be treated as a precedent for similar future actions, it does not bode well for the incumbent government’s avowed efforts to attract foreign investment. Certainly, such potential action against global players in the future does not suggest a greater ease of doing business in India and will instead be seen as a further risk, potentially creating investorstate disputes, instead of inviting greater foreign investment into the country.
With a forced merger between FTIL and NSEL, FTIL’s shareholders automatically became responsible for any liability that may befall NSEL. Without the merger, however, circumstances would have had to be established to justify “lifting of the corporate veil” (legal decision to treat the rights or duties of a company as the rights or duties of its shareholders) before imposing obligations of a
subsidiary (NSEL) on the holding company (FTIL). As such, the MCA order set a precedent that the lifting of the corporate veil can be accomplished merely through an executive order under Section 396 of the Companies Act, 1956.
In a capitalist economy, the principles of limited liability and corporate legal entity separate from the promoting/holding company constitute the very foundation of corporate growth.
Bombay High Court issues notice to Ministry of Corporate Affairs to consider forced merger of bank loan defaulting companies with respective group & holding Cos
Recently, in response to a Public Interest Litigation (PIL) seeking merger of bank loan defaulting companies with their group companies, the Bombay High Court issued notice to the MCA to consider forced merger of bank loan defaulting companies with their respective group and holding companies under Section 396 of the Companies Act, 1956 (U/s 237 of the new Companies Act). The HC notice to the MCA implies that the corporate veil can now be lifted without running a trial. Accordingly, bank loan defaulting companies, the likes of Kingfisher Airlines; Essar Steel; Lavasa Corporation Limited; etc., are all set to be merged with their respective group and holding companies.
Effectively, the government can now first invoke Section 396 of the Companies Act to merge bank loan defaulting companies with their group companies, thereby passing on the burden to group companies. Then again, by ignoring the concept of independent corporate entity, judicial proceedings, different shareholder classes, and the nature of business of holding/group companies, the government may completely disregard the interests of stakeholders of holding/group companies. It wouldn’t come as a surprise then if local and global investors started pulling out of companies that have subsidiaries, which includes group companies. Not only would this prove bad for business, but also one may start seeing random PILs being used (rather misused) to hold India Incorporated at ransom.
Disclaimer – The views expressed here are solely those of the author. The content in the article is purely informative in nature.