State of Rajasthan And Ors. Vs. Gotan Limestone Khanji Udyog Pvt. Ltd. And Ors.

In this case the veil of corporate entity was used to give effect to an illegal transaction by dividing it into two separate transactions. It was held that the lessee privately and unauthorizedly cannot sell its rights for consideration and profits from rights belong to State as it is an illegal transfer.
Estimated Reading Time: 8 minutes

In the case of State of Rajasthan v. Gotan Limestone Khanji Udyog Pvt. Ltd.[1], the Supreme Court ruled on the established principle of lifting of corporate veil. The Court opined that the partnership firm holding lease hold rights has successfully transferred the said rights to a third party for consideration in the form of share price which is nothing but price for sale of mining lease which is not allowed and for which no permission has been granted and which is patently illegal.

Facts

Gotan Limestone Khanji Udyog (hereinafter referred to as GLKU) was a partnership firm which had a mining lease for mining limestone. In 2012, it wrote an application for transfer of this lease to a private company, which was supposed to be itself except after conversion of their partnership firm into a private limited company. It was clarified that the firm and directors of the company will be the same individuals and there are no monetary or other illegal benefits involved in this transaction. The transfer was allowed on 25th April 2012. Later on, the new private limited company, GLKUPL, instead of operating the mining lease by itself, sold the entire shareholdings of the company to another company for 160 Crores.

On 21st April 2014, a show cause notice was issued to the respondent no.1 proposing a cancel of the transfer order because the directors of the private company were changed and allegedly, a roundabout method was used for sale of the mining lease without the permission of competent authorities. The respondent no.1 was now listed a subsidiary of Ultra Tech Cement limited company with the Bombay stock exchange. The Respondent no. 1. tried to contest the allegations made in show cause notice on the premise that, there is no bar to change of directors or shareholders of a company. Therefore, this transfer of shareholders or directors is not equivalent to transfer of mining lease.

This stand was unsatisfactory which led to declaration of the order dated 25th April 2012 as void, by the competent authorities by way of an order dated 21st April 2014. It was claimed that the actions of the Respondent no. 1. were in violation of Rule 15[2] of The Rajasthan Minor Mineral Concession Rules, 1986 (Hereinafter referred to as the Rules). The respondents filed a writ petition No. 9669 of 2014 in the high court against the order dated 21st April 2014 and other consequential orders.

J. K. Cement limited (JKCL) was a third party in all this transaction who had previously requested  for partial transfer of mining lease and was rejected on 5th September,2012. Later on, this company moved an application to the high court for being added a party to oppose the writ petition filed by the respondents. The single judge bench ruled in favour of the respondents and stated that Rule 15 (1)(b) of the rules were not violated. Aggrieved parties appealed to a division bench which affirmed with the findings of the learned single judge and failed to find any wrongful or malicious transactions made by the lessee. Thus, the aggrieved parties moved to Supreme Court. 

Issues

  • Whether an illegal transfer of mining lease was involved?
  • Whether transformation of partnership into company and transfer of lease rights to such company has to be seen with the next transaction of transfer of the entire shareholding to a third company for a price?
  • Whether on this basis the State is justified in cancelling the lease which the High Court has quashed?

Arguments

Arguments of the Appellants

  • It was declared by the GLKU that no third party was involved, nor any direct or indirect consideration were involved in the transfer. However, the transfer of shareholdings took place immediately after the formation of the GLKUPL. It is clear that the formation of the private limited company was just a facade to get required approval from the competent authorities. It was done to hide the real nature of the transaction which was transfer of lease.
  • The court must see the substance of the matter and not just the mere form of it.
  • The respondents intended to mislead the competent authorities. The real transaction was the impermissible sale of the lease which was the only asset of the newly formed private company.
  • The public power of permitting transfer of lease must not use to benefit private operators. It would be a violation of law. The doctrine of lifting of corporate veil must be invoked.
  • The constitutional principles and the regulatory regime in relation to the mining leases of minerals which vest in the State cannot be defeated by the abstract doctrine of corporate personality being separate from the entire body of shareholders without having regard to the real nature of transaction and the well-known exceptions to this abstract doctrine[3]

Arguments of the respondent

  • The Transfer of shareholdings between two private companies do not need permission. It was only a transfer of shareholdings and not that of lease.
  • The Transfer of shareholdings were independent of the transfer of lease and the consideration was paid for the sale of shareholdings. It was correct.
  • Even in case of transfer of lease there is nothing inherently illegal. There are considerations and procedural formalities which need to be fulfilled.

Judgement

The Supreme Court quashed the transaction by lifting the corporate veil of GLKUPL. The Court noted that in the present case there are two transactions. In first transaction of transfer of lease from the firm to the company, with the permission of the competent authority, only disclosure made while seeking permission for transfer is of transforming partnership business into a private limited company with same partners as directors without there being any financial consideration for the transfer and without there being any third party. In the second transaction, the entire shareholding is transferred for share price and control of mining lease is acquired by the holding company without any apparent price for lease.

The Court reiterated the doctrine of public trust in relation to the largesse and held that the lessee privately and unauthorizedly cannot sell its rights for consideration and profits from rights belong to State as it is an illegal transfer.

Analysis

The lifting of corporate veil is a necessity in this case, the appeal is allowed and the order of high court stands quashed.  The doctrine of lifting of corporate veil can be invoked even in cases of public interest, as stated in State of U.P. v. Renusagar Power Company[4]. In this case the facade of corporate entity has been used to hide the real nature of the transaction. The court must see the substance of the transaction to figure out the real nature of it. The real transaction is sale of mining lease which is not legally permitted. Thus, the doctrine of lifting the veil had to be applied to give effect to law which is sought to be circumvented.

In Aron Salomon v. Salomon & Company Limited[5], the House of Lords had observed, “the company is at law a different person altogether from the subscriber…; and though it may be that after incorporation the business is precisely the same as it was before and the same persons are managers and the same hands received the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by that Act”.

Since then, however, the Courts have come to recognize several exceptions to the said rule. While it is not necessary to refer to all of them, the one relevant to us is “when the corporate personality is being blatantly used as a cloak for fraud or improper conduct”. (Gower: Modern Company Law-4th Edn. (1979) at P. 137). Pennington (Company Law-5th Edn. 1985 at P. 53) also states that  “where the protection of public interests is of paramount importance or where the company has been formed to evade obligations imposed by the law”, the court will disregard the corporate veil. A Professor of Law, S. Ottolenghi in his article “From Peeping Behind the Corporate Veil, to Ignoring it Completely” says the concept of ‘piercing the veil’ in the United States is much more developed than in the UK.

The motto, which was laid down by Sanborn, J. and cited since then as the law, is that ‘when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons. The same can be seen in various European jurisdictions.

The mining rights rest with the state. It is the state who has to regulate transfer of such rights in the public interests. Such transaction take place in consistence with the public trust doctrine and no private body can transfer such rights without the consent of competent authorities in writing. The mining lease can be operated strictly within the statutory framework. The original lessee declared that there was no consideration taken for the sale of mining lease, which was apparently correct but factually false. The receipt of 160 crores as “investment” in shares was nothing but a sale price of the lease.Consent of competent authority is not a formality and transfer without consent is void. No lessee can trade mining rights by adopting a device of forming a private limited company and transfer of entire shareholding only with a view to sell the mining rights for private profit.

Conclusion

The Supreme Court is justified in quashing the order of the high court. In this case, the respondents had used an indirect method to sell the mining lease to another private body without following the correct procedure by the law. First of all, there was no as such reason was presented for the transformation of the partnership firm into a private company. In fact, a false promise of no changes in the directors of the firm that is, the holders of lease agreement were made. It was done to mislead the statutory bodies. The intention of the firm was to sale the lease as there was no other asset of the company and this “sale of shareholdings” took place immediately after the formation of the new company.

It demonstrates that the purpose of formation of the new company was to enter into a sale agreement with the third party. This fact was, if not hidden, at least kept secret from the competent authorities. It is a legal obligation of the supreme court to find out the truth of the matter piercing as many veils of lies as required. In this case the veil of corporate entity was used to give effect to an illegal transaction by dividing it into two separate transactions. However, the final object of both the transactions was the transfer of mining rights from original lessee to a third party without the consent of the competent authorities. Therefore, lifting the corporate veil was a necessity in this case.


[1] 1973 AIR SC 106

[2] 15 Transfer of Mining Lease:- (1) The lessee shall not without the previous consent in writing of the competent authority:- (b) Enter into or make any arrangement, contract or understanding whereby the lessee will or may be directly or indirectly financed to a substantial extent by, or under which the lessee’s operations or undertakings will or may be substantially controlled by any person or body of persons other than lessee.

[3] Victorian Granites (P) Ltd. v. P. Rama Rao and Ors. (1996) 10 SCC 665.

[4] (1988) 4 SCC 59

[5] (1897) AC 22

Hey there!

come here often?

Login To Come In