File photo of the Bombay High Court as seen from the Oval Maidan in Mumbai, India (Source: Michael Siegel/ Flickr)

Has The Bombay High Court Given NSEL’s Investors A Short-Cut For Recovering Their Claims?

In allowing the merger of scam-hit NSEL with its parent Financial Technologies, the Bombay High Court may have given the investors of NSEL an easier route to recover their alleged losses.

The National Spot Exchange Ltd., promoted by Financial Technologies India Ltd. (now called 63 Moons Ltd.) was ordered to stop trading in 2013 after a probe found that it allowed trading against stock that didn’t exist in warehouses. NSEL had failed to settle Rs 5,600 crore worth of investor dues and is under investigation by multiple agencies such as the Economic Offences Wing, Enforcement Directorate and the Serious Fraud Investigation Office.

FTIL-NSEL Merger: Public Interest Argument

In 2016, the government had directed NSEL’s merger with Financial Technologies using its powers under Section 396 of the Companies Act. The section allows the government to direct compulsory amalgamation of two or more companies in public interest. Financial Technologies had appealed against the direction on the grounds that the government order ignored the principle of corporate identity.

The Bombay High Court rejected the argument and held that “where public interest is a relevant consideration, the same must override other considerations like freedom of management or the right of stockholders to carry on the business of the company as they desire”.

If Section 396 had to be invoked, the sole governing consideration was to be public interest and the government had said that it is necessary for encouraging healthy operation of exchanges, but it’s not clear how this purpose is being served, Tushad Cooper, an advocate practicing at the Bombay High Court, told BloombergQuint. Cooper had argued for FTIL in the initial days of this litigation.

By merger of NSEL into FTIL — which have been held to be not a fit and proper person, Jignesh Shah who has been found to be not a fit and proper person— how will the amalgamation of NSEL with FTIL subserve the purpose of public interest which is to encourage the growth of forward contracts and confidence in stock exchanges. I fail to see how that element is at all subserved.
Tushad Cooper, Advocate, Bombay High Court

Senior advocate Vikram Nankani disagreed with this view. He pointed out that this is not just the case of an ordinary company but of an exchange which involves public interest.

Here the company involved was an exchange. So, this was the case where you dealt with a unique species of companies. An exchange is where the public interacts, uses the platform of the exchange for conducting transactions. That was the big picture which the government had in mind, which one may call a draconian step, in exercising its power under Section 396(3). That is where the public element comes in.  
Vikram Nankani, Senior Advocate, Bombay High Court

FTIL’s Arguments

But FTIL, its creditors and NSEL had contested this saying the government order amounted to lifting the corporate veil and that NSEL’s liabilties cannot be attached to FTIL. Further, the assumption that NSEL is liable to make good alleged investor losses is itself misplaced and so the purpose of the merger will not be achieved. And finally, they argued, the merger ignores the interest of FTIL’s creditors as the company’s capacity to service its loans will be severely affected.

Nankani said that this can’t be viewed as a case of lifting the corporate veil where a holding company is being held accountable for the acts of its subsidiary.

The provision in question contemplates amalgamation of two corporate companies or entities. It is not the case of lifting the corporate veil. If you are talking about lifting the corporate veil, then you are piercing the identity to take action against individuals who are behind the corporate veil and you are trying to reach out to those whom you see are guilty of an offence and have, by their culpable action, taken a wrongful step. I don’t think it is a case of lifting the corporate veil.
Vikram Nankani, Senior Advocate, Bombay High Court

Cooper had a contrary view and emphasised that the corporate veil is being lifted in a roundabout manner, which is an improper action. He cited the example of a public sector undertaking like Air India which has suffered heavy losses with the government being its shareholder.

If this argument (of lifting the corporate veil) were to be stretched, then every time there is default in a subsidiary which is under the control of a shareholder, a creditor will be entitled to say — invoke Section 396, make the principal company liable. On the same principle, let the government be liable (for losses) because it is the government who runs Air India. Where can this argument be stretched?
Tushad Cooper, Advocate, Bombay High Court

If it’s improper to suggest this for Air India, it would be equally improper to say this in the case of NSEL and FTIL, he said.

Bombay High Courts Verdict

But the high court wasn’t moved by similar arguments made by FTIL and NSEL.

It concluded that the government’s decision is in public interest as it aims to restore confidence in commodity exchanges and send a clear signal to investors that if defaults of such magnitude take place at exchanges, holding companies may have to take responsibility, or at least, not take shelter behind their wholly owned subsidiaries.

The high court also said this is not a case where the government has lifted the corporate veil and sought to apportion any liability upon either NSEL or FTIL. And even if so, the facts and circumstances of the case may have justified the lifting of the corporate veil.

Cooper pointed out that through this order, the investors of NSEL have received a free pass to recover their alleged losses.

They do not have to now go into the question of whether — assuming that there was a fraud or negligence by NSEL— they don’t have to establish any reason to trace it back to FTIL because now, with this merger being given effect to, they would simply look to the assets of FTIL to seek recourse for the losses which they may have suffered.
Tushad Cooper, Advocate, Bombay High Court

Nankani countered this view and said that the Bombay High Court was not concerned with individual claims of people but was only examining the government order, and as and when individual claims are made against the new amalgamated entity, it will be open to that entity to contest that case, deny or dispute the liability and due process of law will be followed.

It’s not that just by amalgamation, the liability against NSEL will get transferred on to the new amalgamated entity. As far as investors who have lost money are concerned, their direct cause of action is against the other party with whom the transaction had been consummated. As far as NSEL is concerned, it is a platform. Whether NSEL is liable because of other factors such as conspiracy, connivance, collusion or negligence, that is a matter which needs to be tried and tested in the court of law.
Vikram Nankani, Senior Advocate, Bombay High Court

The high court has granted a 12-week stay on the merger and FTIL has said that it will approach the Supreme Court against this order.