The Road Not Taken: Solving The Bad Loan Crisis Through Reverse Piercing

[By Anushka Juneja]

The author is a student at the Gujarat National Law University. 

The Indian economy has long been sitting on a ticking time bomb which is the mountain of bad loans held by its banks. The rapidly increasing non-performing assets pose a systematic risk to the banking system which consequently affects the economy as a whole. Several steps including the enforcement of the Insolvency And Bankruptcy Code, setting up of bad banks, amendments to the Banking Regulation Act 1949, have been taken to tackle this chronic crisis. It is believed that these steps need to be supplemented with the application of the doctrine namely reverse piercing of the corporate veil. The doctrine would enable the creditor to utilise the assets of the debtor’s corporation to discharge the liabilities of the individual defaulter.

The broad aim of this article is to propose adoption of the doctrine as a solution to the plaguing bad loan problem. To that end, I will discuss the judicial approach undertaken in India and foreign jurisdictions. Further, the adoption of the doctrine for debt resolution in India would cause disruption in the priority of claims matrix which can be resolved as I would explain later in the article.

 GROWING INCLINATION TOWARDS THE DOCTRINE IN INDIA

The equitable doctrine of Reverse piercing is antithetical to the traditional doctrine of corporate veil piercing. Unlike the latter, where a shareholder is held liable for the default of the corporation, in the former, the liability of the shareholder is imposed upon the corporation.

In India, a divergence of opinion has been observed by the judicial fora on the application of the doctrine. Initially the courts were reluctant in their approach, the appellate tribunal in NEPC India Ltd. v. SEBI termed the doctrine to be inconceivable and outlandish.

However, with changing economic realities and commercial growth, a judicial inclination can be observed. In Punjab and Sind Bank v. Skippers Builders (P) Ltd. ,the “reverse piercing” jargon was not explicitly used, however, the facts of the case clearly point towards its application. The doctrine has been applied to fix criminal liability in numerous cases. It was held in Iridium India Telecom Ltd. v Motorola Incorporation and Others that guilty intent of a person should be attributed to the corporation in case it is found that they are the alter-ego of the corporation. Further, in Aneeta Hada v. Godfather Travels, the court confirmed that the criminal act of an individual can be attributed to his company.

JUDICIAL STANCE OUTSIDE INDIA

Globally, the doctrine is not yet well recognised, however, the nature of remedy that it offers has often compelled the courts to consider its applicability in appropriate situations. The High Court of Singapore in Koh Kim Teck v. Credit Suisse Ag held that the doctrine demands full consideration and cannot be dismissed straight away. Numerous courts worldwide have allowed the application of the doctrine in debt recovery cases. The Supreme court of Colorado, in the case of Re Phillips, held the claims of an outsider against the corporation for the default of the debtor to be legit. Under Pennsylvanian law, even an allegation of fraud or misconduct against the debtor-shareholders is not imperative for the sustainment of a reverse piercing claim.

Analogously, in various tax recovery cases like Towe Antique Ford Foundation v. IRS, Zahra Spiritual Trust v. United States, Shades Ridge Holding Co. v. United States, the tax recovery agency was treated as the creditor, their claims were placed over the other creditor-stakeholders and outside reverse piercing claim was allowed for the satisfaction of the dues.

ADOPTION OF THE DOCTRINE IN THE INDIAN JURISPRUDENCE FOR DEBT RESOLUTION

Application of the doctrine in debt related cases would amount to giving more powers in the hands of the creditors. This is in consonance to what the legislature intended while enforcing the insolvency and bankruptcy code. However, it is quite understandable that this application would give rise to a clash of priority of claims between the corporation’s existing creditors and the ones having reverse piercing claims against it.

In Alfred Booth v. Jeremiah Bunce, the controllers of an insolvent corporation transferred their assets to a new company to defraud the creditors of the former corporation. When a clash of priority of claims arose between the creditors of the former cooperation and the existing creditors, the court observed: “though the new corporation was a valid legal entity for its own creditors, the principle of qui prior est tempore, potiore est jure would enable the old creditors to make their claims against the new corporation, owing to the fact that the controllers of the corporation were same and that the transfers were fraudulent.

As has been noted above and considering the principle of “qui prior est tempore, potiore est jure” meaning “he who is earlier in time is stronger in law”, it is hence contended that the reverse piercing claims of the creditors ought to be placed either at the top in the hierarchy list which has been specified in Section 53 or 178 of the code or should at least be considered at par with the claims of the other highest ranked creditors and distribution of assets should hence be done accordingly.

Further, in light of the principles of equity, justice and good conscience, the Adjudicating Authority might help in resolving the conflict. The application of judicial mind would warrant a rational decision rather than a mechanical one.

CONCLUSION

Undeniably, the courts are yet irresolute to adopt the doctrine. This is perhaps because of their tendency to adhere to the ancient principle of a separate legal entity. However, this approach needs to be altered because corporate veil is often used as a façade to escape liability and commit fraudulent acts.

Several changes were made to the Companies Act in line with the Insolvency and Bankruptcy Code. The substantial shift made from the current priority of claims under the Act was solely done to promote the interests of the creditors. Empowering the creditors through the application of reverse piercing doctrine would further bolster their position and would play a huge role in resolving the bad loan crisis.

The author does not propose a blind application of the doctrine, however, where the creditor makes a credible claim supported by corroboration in favour of reverse piercing doctrine, the Adjudicating Authority should act proactively and must not be hesitant in taking the “the road not taken”.

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