10 February, 2016
This is to update you on a recent ruling by the Supreme Court of India in the case of State of Rajasthan v. Gotan Limestone Khanij Udyog1. In this matter the Supreme Court dealt with a case involving validity of transfer of a mining lease.
The Supreme Court has held that where a corporate entity has been used to conceal a real transaction through two separate transactions and, thereby, achieving a result which was not legally permitted, the doctrine of lifting of corporate veil has to be applied to give effect to law which is sought to be circumvented.
Brief Facts
(a) M/s. Gotan Limestone Khanji Udhyog (“GLKU”), a partnership firm, held a mining lease for mining limestone from the State of Rajasthan. Under the relevant provisions of the Rajasthan Minor Minerals Concession Rules, 1986 (“Applicable Rules”), GLKU applied to the competent authority for a transfer of that mining lease in favour of a private limited company called Gotan Limestone Khanji Udhyog Pvt. Ltd. (“GLKUPL”), which they represented was a mere change in form of the mining lease holder. Essentially, they represented that GLKU itself would be converting into a private limited company and that the partners of the firm would continue as directors of the company. GKLU also represented that no illegal benefit, price or premium was being taken from the transferee. On the basis of these representations, the transfer of the mining lease in favour of GLKUPL was allowed.
(b) Soon after receiving the said permission, GLKUPL sold its entire shareholding to another company, which was a listed company, for a consideration of Rs. 160 crores.
(c) This was challenged by the competent authority that had previously given the permission for the transfer of the mining lease under the Applicable Rules, on the ground that the directors of GLKUPL who were partners of the firm were subsequently replaced by new directors and even the shareholders were now different. The competent authority alleged that this was an indirect transfer of the mining lease itself. It was also alleged that these facts, which were contrary to the submissions made by GLKU at the time of its transfer application, demonstrated that the transfer was secured by a conspiracy and in circumvention of the Applicable Rules. Accordingly, the competent authority cancelled the previous permission for the transfer of the said mining
lease.
(d) This matter was considered by the Rajasthan High Court, first through a single bench and then in appeal to a division bench, both of which held that the transaction was valid in law, effectively reinstating the original consent of the competent authority. A key extract from the division bench order is set out below:
“The entire corporate business is run through contracts, which may give statutory or non-statutory rights to the Company. A Company may apply and become the owner of the license, permit, concessions and lease under the statutory schemes of various statutes, under which the Company carries out its business. In all such cases, the license, concessions, permit and lease are the property of the Company and not of its shareholders. The shareholders may keep on changing and the control and management in the Company may also undergo changes on such transfer of shares, but the assets and properties of the Company including license, permit, concessions and lease continue to belong to the Company and that any acquisition or transfer of such assets will not relate back to the share-holding of the Company or the management of the Company, which may change on the change in the shareholding of the Company……”.
(e) Aggrieved by the orders of the Rajasthan High Court, the Government of Rajasthan appealed to the Supreme Court.
(f) The key question before the Supreme Court was whether the transfer of entire shareholding and change of all the directors of a newly formed company, to which lease rights were transferred based on a declaration that it was mere change of form of partnership business without any transfer for consideration being involved, could be taken as unauthorized transfer of lease which could be declared void.
IV. Summary of Supreme Court Observations
(a) The Supreme Court, through a detailed order, has set aside the order of the division bench of the Rajasthan High Court and made certain important observations, which are summarized below.
(b) While, when viewed separately, there may be nothing wrong with the individual sub-transactions, but if real nature of the entire transaction is seen, the illegality is patent. Thus, if these facts were disclosed to the competent authority, permission for transfer of mining rights for financial consideration would not have been allowed. Mining rights belong to the State and not to the lessee and the lessee has no right to profiteer by trading such rights. In fact, the lessee has also not claimed such a right. Lessee can either operate the mine or surrender or transfer only with the permission of the competent authority, as legally required. In the present case, the lessee has achieved indirectly what it could not have directly, by concealing the real nature of the transaction.
(c) The doctrine of lifting the veil can be invoked if public interest so requires or if there is violation of law, as alleged, by using the device of a corporate entity. In the present case, the corporate entity has been used to conceal the real transaction of transfer of mining lease to a third party for consideration without the required consent. This has been done by disguising the transaction as two separate transactions – the first of transforming a partnership into a company and the second of sale of entire shareholding to another company. The real transaction is sale of mining lease which is not legally permitted. Thus, the doctrine of lifting the veil has to be applied to give effect to law which is sought to be circumvented.
(d) The original lessee gave declaration while seeking transfer that no consideration was received, which though apparently correct was actually false as the subsequent transaction of sale of shares was an integral part of the first transaction of transfer of lease to private company (which soon thereafter became a subsidiary of another company). The said real transaction cannot be ignored to find out the substance.
(e) Even in absence of a policy and irrespective of exercise of power in the past, transfer of lease for private benefit without corresponding benefit to the public or the State exchequer is not permitted.
(f) The original lessee sought transfer merely by disclosing that the partnership firm was to be transformed into a private limited company with the same partners continuing as directors and there was no direct or indirect consideration involved. It was specifically declared that no pecuniary advantage was being taken in the process which is clearly false. The permission to transfer the lease in favour of a private limited company was granted on that basis. The original lessee did not disclose that the real purpose was not merely to change its partnership business into a private limited company, as claimed, but to privately transfer the lease by sale to a third party. On the facts of the case, it was clear that GLKUPL has been formed merely as a device to avoid the legal requirement for transfer of mining lease and to facilitate private benefit to the parties to the transaction, to the detriment of the public.
(g) The general principle that sale of shares by itself is not sale of assets but this principle is subject to the doctrine of piercing of corporate veil, wherever necessary to give effect to the policy of law. In the present case, this principle clearly applies as transfer of shares to cover up the real transaction which is sale of mining lease for consideration without the previous consent of competent authority, as statutorily required. The statutory requirement is sought to be overcome with the plea that it was a transaction merely of transfer of shareholding when on the face of it the transaction is clearly that of sale of the mining lease.
V. Conclusion
This is an important decision, which may have far reaching implications on corporate transactions, including from a tax perspective. While the law is well-settled that the a company and its shareholders are two distinct persons in the eye of law, the doctrine of lifting the veil can be invoked if public interest so requires or if there is violation of law, as alleged, by using the device of a corporate entity. The Supreme Court has emphasized that, even though each step in a transaction, when viewed independently, may appear legal, where the entire transaction as a whole is merely a device, the authorities would be justified in disregarding the legal form of the transaction and consequently, pierce the corporate veil.
1 Order of the Supreme Court dated January 20, 2016 in Civil Appeal No. 434 of 2016, reported in [2016] 66 taxmann.com 72 (SC).
For further information, please contact:
Zia Mody, Partner, AZB & Partners
zia.mody@azbpartners.com
