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Arbitrator Cannot Lift The Corporate Veil – Delhi High Court

The law with respect to lifting of the corporate veil is well established in India. The courts have time and again held that corporate veil can be pierced only in rare cases where the court concludes that the conduct of the shareholder is abusive and the corporate facade is used for an improper purpose, for perpetuating a fraud, or for circumventing a statute. At the same time, the courts have also taken a view that corporate veil cannot be lifted by an arbitrator in an arbitration proceeding. While discussing the law on the subject in detail, the Delhi High Court (“DHC”) has recently in a judgment passed in the matter of Sudhir Gopi vs. Indira Gandhi National Open University and Another reinforced the said legal position.

Background & Rival Contentions:

The DHC has decided a petition under section 34 of the Arbitration & Conciliation Act, 1996 (“Act”) filed by the Chairman and Managing Director of Universal Empire Institute of Technology (“UEIT”), a limited liability company incorporated under the laws of Dubai, challenging the arbitral award passed by the sole arbitrator holding the petitioner (principal shareholder) and UEIT jointly and severally liable to pay the amount awarded in favour of Indira Gandhi National Open University (“IGNOU”).

The award was challenged by the petitioner before the DHC on the limited aspect that “whether the arbitral award holding the petitioner and UEIT jointly and severally liable is legally sustainable in view of the fact that the petitioner was not a signatory to the arbitration agreement?

Contentions of the Petitioner:

The petitioner primarily contended that:

  • he is not a signatory to the arbitration agreement;
  • though he is a principal shareholder as well as the Chairman and Managing Director of UEIT, he is not personally liable for the contractual liability of UEIT;
  • the arbitral award to the extent holding him liable to pay the awarded amount to IGNOU is without jurisdiction;
  • the reply to the statement of claims was filed under the signatures of the petitioner on behalf of UEIT in his capacity as a Managing Director of UEIT and not in his personal capacity;
  • the statement of claims arraying the petitioner as a respondent in the arbitration proceedings by IGNOU was bad for mis-joinder of parties as the petitioner was not a party to arbitration agreement.

Contentions of IGNOU:

IGNOU countered the petitioner’s contentions, inter alia, as under:

  • the petitioner was running the business under the facade of UEIT and essentially there was no difference between the petitioner and UEIT;
  • the petitioner held 99 shares out of 100 shares of UEIT and was the sole in-charge of running the business and affairs of UEIT;
  • conduct of the petitioner showed that he made no distinction between himself and UEIT such as cheques issued to IGNOU in discharge of UEIT’s obligations under the agreement were issued by the petitioner, the petitioner replied to the legal notice issued by IGNOU upon UEIT without raising any objections as to the notice being sent/addressed to him; common reply to the statement of claims and joint counter claims were filed by the petitioner and UEIT in the arbitration proceedings;
  • the petitioner having participated in the arbitration proceedings, was precluded from challenging the jurisdiction of the arbitral tribunal at a subsequent stage;
  • arbitral tribunal can lift the corporate veil;
  • intent of the legislature under the Act is minimum interference of/by the courts. Thus, in a petition under section 34 of the Act the court shall not interfere with the view of the arbitrator even if it is considered erroneous by the court.

The Court’s View:

It is settled law that the arbitral tribunal derives its jurisdiction from the consent of parties. In absence of such consent, the arbitral tribunal would have no jurisdiction to make an award and the award so rendered would, plainly, be of no value. As per section 7 of the Act, an arbitration agreement must be in writing. In the present case, admittedly, the arbitration agreement was not signed by the petitioner. The instances to show conduct of the petitioner portraying himself and UEIT as one, have also been rejected by the DHC for the reason that both the petitioner and UEIT had resisted the claims of IGNOU in the arbitration proceedings on the ground of mis-joinder of parties. Further, both UEIT and petitioner had clarified in the arbitration proceedings that the petitioner is contesting the proceedings on behalf of UEIT being its Managing Director and not in his personal capacity. On the said basis, the argument of IGNOU that having participated in the arbitration proceedings the petitioner is now precluded from objecting to the jurisdiction of arbitrator, has also been rejected by the DHC.

Non-signatories not liable in arbitration: 

Having concluded that the petitioner was not a party/signatory to the arbitration agreement, the DHC discussed the jurisdiction/power of the arbitrator to pass the award against the petitioner (a non-signatory). The DHC observed that jurisdiction of the arbitrator is circumscribed by the agreement between the parties and it is thus obvious that such limited jurisdiction cannot be used by the arbitrator(s) to bring within its ambit, persons that are outside the circle of consent. The arbitral tribunal, being a creature of limited jurisdiction, has no power to extend the scope of the arbitral proceedings to include persons who have not consented to arbitrate. Thus, the DHC concluded that an arbitrator would not have the power to bind other parties who have not agreed to arbitrate.

Arbitrator cannot lift the corporate veil:

The DHC further discussed in detail the legal proposition that under certain circumstances courts can lift the corporate veil. In the cases where a corporate form is used to perpetuate a fraud, to circumvent a statute or for other misdeeds, the courts can disregard the corporate facade and hold the shareholders accountable for the obligations of the corporate entity by lifting the corporate veil.

The DHC thus concluded that the courts, undoubtedly, have the power to determine if in a particular case the corporate veil should be pierced and the persons behind the corporate facade be held accountable for the obligations of the corporate entity. However, an arbitral tribunal has no jurisdiction to lift the corporate veil. More so, when there is no foundation that the corporate façade was used to perpetuate a fraud.

Interference by the courts in arbitral awards: 

The DHC agreed with the contention of IGNOU that the legislative policy in arbitration is one of non-interference by the courts and observed that the settled position of law is that “even if the view of the arbitral tribunal is erroneous, the same cannot be set aside unless it is found that the same is perverse, patently illegal or otherwise in conflict with the fundamental policy of Indian Law. It further stated that there is a distinction between the errors which are within the jurisdiction of the arbitral tribunal and those that are not. While the arbitral tribunal is the final authority on determining the questions of fact and no interference is warranted unless the findings are perverse or fail the test of reasonableness, there is no ground for sustaining an award which suffers from a jurisdictional error.

The DHC held that the legislative policy of non-interference does not extend to errors of jurisdiction. Therefore, a party which challenges an arbitral award on the ground that it is without jurisdiction will have full right to make contentions in this regard and the view of the arbitral tribunal would at best be considered as a prima facie view which would be subject to full examination in proceedings under section 34 of the Act.

Having made the above conclusions, the DHC held that in the absence of an arbitration agreement between the petitioner and IGNOU, the arbitral award passed against the petitioner is without jurisdiction and thus not binding on the petitioner. It further held that the fact that an individual or a few individuals hold controlling interest in a company and are in-charge of running its business does not ipso jure render them personally bound by all agreements entered into by the company.

Conclusion:

The DHC has reconfirmed the legal position that an arbitrator is not entitled to lift the corporate veil. Further, the DHC has made vital observations with regard to the scope of the courts to interfere with the arbitral awards.