Tuesday, October 8, 2013

NSEL: A Fit Case For Lifting The Corporate Veil?

Business Standard has reported that the NSEL Investors Forum, a body that represents investors of the National Spot Exchange Limited (NSEL), have  written to the Securities and Exchange Board of India (SEBI) and the Forward Markets Commission (FMC) seeking liquidation of foreign assets of Financial Technologies (India) Limited (FTIL) to pay investor dues. It argues that investment by FTIL in businesses that are making losses is against prudent business practices.


FTIL owns 99.99 percent stake in NSEL. In law FTIL is the promoter-shareholder of NSEL. In Salomon Vs. Salomon & Company Limited, in 1897, the House of Lords established the fundamental principle that a limited liability company must be treated like any other independent person with its right and liabilities appropriate to itself. Therefore, the company is an entity different from the shareholder who owns all the shares of the company. According to this fundamental principle, FTIL is not liable to pay to the creditors of NSEL. The liability of a shareholder of a company is limited to the amount unpaid on shares that the shareholder owns.

Courts some time disregard this fundamental principle. This is known as 'lifting the corporate veil'. There is no bright line for deciding situations in which courts pierce through the corporate veil and make shareholders accountable for the omissions and commissions of the company. Therefore, courts take a view depending on the facts of the case.

Generally, courts lift the corporate veil if the company is a sham and is created to perpetrate fraud or the company is an agent of the shareholder. Sometime, the courts consider group which consists of the holding company and its subsidiaries, as a single entity. For example, if we consider FTIL group companies as a single entity, FTIL will be held liable to pay NSEL's creditors. 

Courts pierce the corporate veil of subsidiaries only in special circumstances. They consider the Group as a single entity only if the separate entity is a facade, that is, the outer appearance is maintained to conceal facts.

Section 542 of the Companies Act 1956 provides that if in the course of winding up of a company, it appears that any business of the company has been carried on with intent to defraud the creditors of the company or any other person or for any fraudulent purpose, the persons who are knowingly parties to the carrying on of the business, in the manner aforesaid, shall be personally responsible, without any limitation of liability for all or any of the debts or other liabilities of the company, as the court may direct.

Let us examine if NSEL is a fit case for lifting the corporate veil. My view is that it is not a fit case for lifting the corporate veil. It was not created for a fraudulent purpose. Its intent was not to defraud creditors. It was not an agent of FTIL. On the face of it the company was created as subsidiary of FTIL because of the totally different nature of business and not to conceal the reality. In order to apply the provisions of section 542, investors have to establish that the business was carried on to defraud creditors and FTIL was a party to that.

The deciding factor will be whether the amount collected from investors was tunneled to FTIL to support its investments. On the basis of the available information, it appears that the money collected from investors did not flow to FTIL. Borrowers used it to create assets or for working capital.

In conclusion, FTIL can not be held liable to NSEL's creditors unless it is established that funds collected from investors were used by FTIL for investments in different businesses.

I am also not sure whether investors are NSEL's creditors. If the contract is between investors and borrowers, investors are not NSEL's creditors unless NSEL has guaranteed payment to investors by borrowers.

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