Lifting the Corporate Veil: A Critique of State Trading Corporation v. CTO

*Debarchita Pradhan

Introduction

The amendment to Section 182(3) of the Companies Act, 2013 excluded the requirement for the companies to disclose the specific amount contributed to particular political parties. This change affected the shareholders’ rights to make an informed choice when trading securities with such companies. Regrettably, the Supreme Court did not address this aspect of shareholder rights while delivering its judgement in the electoral bonds scheme case. In many such cases, the principle that a company is separate from its constituents has hindered the court's ability to protect shareholders' rights. 

This trend was concretized in State Trading Corporation of India (STC), Ltd. v. CTO, where the majority opinion concluded that a corporation being a distinct juristic person is not a citizen and hence, cannot assert the rights granted by Article 19. This article will first provide a critical analysis of Justice Sinha’s (majority) opinion in this case. Second, it will argue for the courts to lift the corporate veil while dealing with the issue of granting fundamental rights to a corporation.

A Critical Analysis of Justice Sinha’s Opinion 

A. Reasoning with the Constitution

Justice Sinha mainly relied on Part II of the Constitution and the Citizenship Act, 1955 to conclude that juristic persons are not “citizens”. However, there seem to be multiple flaws in the reasoning of the judgement.

Beyond Textual Interpretation:

This conclusion solely relied on a literal interpretation of Part II of the Constitution and the definition of “person” as given in the Citizenship Act to decide whether a juristic person comes within the definition of citizen. Based on the logic that the provisions seem inapplicable to juristic persons, he concluded that citizenship is limited to only natural persons. However, while interpreting a constitution, especially an important aspect such as citizenship which further affects the “right to some fundamental rights”, it is inadvisable to restrict oneself to a rigid, literal form of interpretation. The Supreme Court has reiterated that mere resort to such a method may reduce the flexibility and defeat the future adaptability of the Constitution.

The provisions governing citizenship can be interpreted using an object-oriented approach, based on the true context and purpose for which they were drafted in the constitution. The concept of citizenship was considered in the context of large-scale violence and homelessness accompanying the partition. As opined by many writers, the constitutional makers were wholly driven by the problems of partition while drafting Part II. The Constituent Assembly debates focused on issues like the exploitation of citizens by aliens, the choice between citizenship by birth and citizenship by blood, confusion regarding the citizenship of children born to foreigners on a casual visit to India, and so on. This demonstrates that the main objective of the drafters was to distinguish between citizens and aliens, rather than to separate citizens/natural persons from juristic persons as concluded by the majority. That might also be the reason behind employing language suitably applicable to natural persons.

Now, if the immediate purpose of the articles that govern citizenship was to solve a historical problem, it is clear that they should not be used in the present to exclude corporations from citizenship. Limiting the meaning of the provisions to the context in which they were written would be against the principle of the Constitution being a “living” document. The drafters would not have made the provisions so rigid as to hinder future application. So, including juristic persons under Part II would thus forward the “living” nature of the Constitution. 

A Closer Look at Article 11

The majority opinion held that Part II of the Constitution and the Citizenship Act, 1955 are exhaustive of the meaning of the word “citizen”. However, Article 11 contradicts such a conclusion. First, this article, which grants the Parliament power to make further provisions regarding citizenship, indicates that the constitutional makers were bound to make only ad-hoc provisions for citizenship. Second, this article was provided with the legislative intent that the Parliament would address the difficulties of citizenship for people travelling or born outside of India, among other instances. Therefore, the purpose of this article, as intended by the legislature, was to resolve the issues regarding citizens and foreigners, not to distinguish between citizens and juristic persons. Even though Section 2(1)(f) of the Citizenship Act, 1955 says that “person” would not include companies, the Act was solely concerned with solving the problems of the natural persons that it was assigned to and it left untouched the position about the citizenship of corporations. 

So, the majority opinion erred in excluding corporations from the scope of “citizen” merely on the basis of the text in Part II of the Constitution and the definition of “person” in the Citizenship Act, 1955.

B. Ignored Precedents 

The majority opinion didn’t give due importance to all the precedents that have held in favour of granting fundamental rights (which are exclusively for citizens) to corporations. In fact, the textual interpretation was itself inadequate. In T.D. Kumar and Bros. Private Ltd. Vs. Iron and Steel Controller and Ors., the court reasoned that under the General Clauses Act, 1897, a person included a company, and from Section 6(3) of the Income Tax Act, 1961, it can be inferred that a company can also be a resident under appropriate conditions. Hence, the court opined that under Article 5(c) of the Constitution, a company can be a citizen if it “has been ordinarily resident in the territory of India for not less than five years immediately preceding such commencement”. This reasoning was not addressed by the majority in the STC case. Similarly, in the Maharaja Kishangarh Mills case, the court adopted a liberal interpretation of Article 5 and observed that the definition of citizen should be comprehensive enough to include corporations.

In Reserve Bank of India Vs. Palai Central Bank Ltd., the High Court of Kerala went even a step further. Referrto some English cases and literature, the court observed that a company can also have a place of birth. Thus, the court held that a corporation can be a citizen not only under Article 5(c) but also under Article 5(b) by “birth”. It also opined that just because these articles are inapplicable to juristic persons, they should not be removed from the scope of Article 5. The court presented another unique argument that hinted towards lifting the corporate veil. This is addressed in the latter half of the article.

Similarly, other precedents have supported companies claiming fundamental rights under Article 19(1). However, they were not analysed by the majority in the STC case.

C. Arguments Overlooked

There were two strong arguments put up by Mr. Setalvad for the petitioners that were not adequately considered by the majority. 

First, he argued that neither the Constitution nor the Citizenship Act deals with the totality of “citizenship”. Justice Sinha himself admitted that neither the Constitution nor the Act defines the term “citizen” anywhere. In fact, ordinarily, constitutions do not define citizenship because a fixed definition results in a lot of problems in the future. This creates a silence regarding the position of juristic persons as citizens and hence, paves the way for the application of the doctrine of “constitutional silence”. This doctrine has been effectively utilised by courts to fill gaps in crucial areas of justice and public interest. For instance, the Supreme Court applied this doctrine to recognize a "no-confidence motion" despite its absence in the Constitution keeping in mind the democratic principles of the 73rd Amendment.

Denying a group of Indian citizens access to fundamental rights, which are essential for safeguarding corporations from undue state intervention, would be grossly unfair. The Kerala High Court correctly observed that this could not have been the intention of the constitutional makers. Indeed, Mr. R. K. Sidhwa, during the constitutional assembly debates, pushed for bringing trade, commerce, and economics under the ambit of justiciable fundamental rights. It is imperative for promoting the seamless functioning of corporations and ensuring the overall economic well-being of the country. Hence, it is vital to include juristic persons within the scope of Article 19(1) by employing the doctrine of “constitutional silence”.  However, the majority in the STC case didn’t leave any scope for the application of this doctrine as they ruled out the petitioners’ argument by saying that the meaning of “citizens” mentioned in Part III should be consistent with that of Part II. Hence, the inapplicability of Part II to juristic persons meant that the same is not covered under Article 19, as well. 

Second, the petitioners argued that a group of citizens should not “by mere incorporation, lose the benefits of the guarantee in Article 19”. This argument proposes lifting the corporate veil to reveal a group of citizens who deserve the same protection as any individual citizen under Article 19. However, this was not mentioned in the majority judgement. The importance and the viability of this argument will be discussed in the next portion of the article.

A Move Towards Lifting of the Corporate Veil

The separate personality of the company was established in Salomon v. Salomon & Co Ltd. Similarly, in India, the Supreme Court has declared that the shareholder may participate in the profits of the company but the company, as a juristic person, is a distinct entity from the shareholder. However, while the principle of separate corporate personality has been widely recognized, it is important to note that it is not an absolute concept that can never be challenged. In certain situations, it may be necessary to restrict the application of this principle to ensure that the law serves its intended purpose.

In the Daimler case, the court looked at the character of the company’s members to ascertain the enemy character of the company. In another case, the Court of Appeal found it necessary to lift the veil of the defendant’s company because the company was just used as a sham to do what was prohibited. Similarly, in India, the courts have recognized this exception. In the TELCO case, the court summarised the conditions laid down by Palmer and Gower where the court would be justified in lifting the corporate veil for the interest of justice in exceptional circumstances. Similarly, in the LIC case, the Supreme Court recognized that in certain exceptional circumstances, the court may disregard the corporate personality to reveal the members behind it for who they really are.

However, even though courts have mainly used the doctrine of lifting the corporate veil to hold members accountable, there are no fixed rules for when it can be applied.  So, when justice demands it, the court should be able to lift the corporate veil to protect the rights of shareholders. Indeed, in the Palai Central Bank case, the Kerala High Court observed that the denial of fundamental rights to all corporate bodies wholly constituted by Indian citizens would be a denial of the same to the Indian citizens who constitute such bodies. This hinted towards lifting the corporate veil. Instead of delving into the question of whether a corporation is a citizen or not, it went behind the corporate veil to argue that a violation of a fundamental right of the corporation is a violation of the fundamental right of the citizens that constitute it. This particularly makes sense when we consider the "symbolist" theory of corporations, which suggests that the rights actually belong to the individuals behind the corporation, not the corporation itself. Moreover, the corporate veil protects shareholders by limiting their financial liabilities in a corporation. So, if it's meant to protect them, why can't it be lifted to safeguard them? It would be unfair to lift the veil only to pin liability on them when it is primarily used for their protection.

The TELCO case presented the possibility of lifting the corporate veil, but the court denied it due to the ruling in the STC case. Despite the fact that a corporation is constituted by its members who are natural, right-bearing citizens, the majority opinion, in this case, argued that a corporation is a separate juristic person that cannot claim fundamental rights exclusively available to citizens. It missed the point that citizens should not lose their constitutional rights to form any association, as highlighted by the Kerala High Court. In the end, the fact remains that the Constitution doesn’t differentiate between a citizen and a group of citizens. 

Alternative to the proposal of lifting the veil

Justice Hidayatullah, in his concurring opinion, had provided an alternative to the argument for lifting the corporate veil by saying that the members who are citizens by enforcing their personal rights can effectively benefit the corporation. This was also implied in later cases. In the Bank Nationalization case, the court entitled the petitioner to move a petition for the infringement of the fundamental rights of the company. Nevertheless, this is a limited advantage. It implied that a shareholder can move to the court only when, along with the fundamental rights of the company, his fundamental rights are also infringed. This limitation was also seen in the Bennett Coleman case. So, even though these two cases went a step ahead of the STC case and the TELCO case, they burdened the shareholders to prove an infringement of their own fundamental rights. This is because the principle of a corporation being a separate juristic person was not compromised. This burden on the shareholders was partly lightened by an obiter in a later case where the Supreme Court opined that the rights of a shareholder and the company are “co-extensive” and hence, an infringement of fundamental rights of one would be a denial of the same to the other. Nevertheless, except the Palai Central Bank case, none of these cases have materially declared that infringement of the fundamental rights of a company inevitably translates to infringement of the same of the constituent citizens. This can be achieved only by lifting the corporate veil.

Conclusion

In sum, the majority opinion in the STC case could have avoided the narrow solution that they employed. Instead, they could have adopted any of the two alternative paths suggested in this article. Firstly, they could have interpreted the Constitution in a broad and purposive manner, taking guidance from the earlier cases, to include the corporations under the definition of citizen. Secondly, if they were constrained by the text of the Constitution to exclude the corporations from citizenship, they could have lifted the corporate veil and recognized the rights of the shareholders behind it who were full-fledged citizens of India and rightly deserved their fundamental rights to be protected. 

*Debarchita Pradhan is a third year student at National Law School of India University, Bangalore.

The views expressed above are the author's alone and do not represent the beliefs of Pith & Substance: The CCAL Blog.