Piercing of Corporate Veil to Protect Homebuyers

Insolvency Proceedings are commenced upon bankruptcy of a debtor. In simple terms, bankruptcy is inability of a corporate debtor to pay back its creditors. Insolvency and Bankruptcy Code, 2016 (“IBC”) governs insolvency proceedings in India. A corporate insolvency resolution process (“CIRP”) is a recovery mechanism for the creditors of the corporate debtor and the CIRP can be initiated under Section 7 & Section 9 of the IBC.

By way of application, the IBC allows financial creditors to initiate the CIRP under Section 7 of the IBC and the operational creditors can initiate the CIRP under Section 9 of the IBC. In case of a real estate project, the CIRP cannot be initiated individually. As per second proviso of sub-section (1) of Section 7 of the IBC, an application for initiating the CIRP is required to be filed jointly by not less than one hundred of allottees under the same real estate project or not less than 10% of the total number of allottees under the same real estate project, whichever is less.

Recently, the National Company Law Tribunal (“NCLT”), in the case of Yadubir Singh Sajwan & Ors vs Som Resorts¹admitted CIRP proceedings against a real estate developer by lifting the corporate veil and held that the marketing agency (that was accepting payments for the project) and Som Resorts were under common management. While doing so, the NCLT has rejected the established doctrine of “distinct legal entity”. 

In 2012, Som Resorts Private Limited (“Som Resorts/Corporate Debtor”) launched a commercial cum residential project under the name ‘Casa Italia’ (“Project”). Subsequent to launch of the Project, Yadubir Singh Sajwan and twenty five other home buyers (collectively referred to as the “Petitioners”) booked certain units in the Project and entered into builder-buyer agreements (“BBAs”). The Petitioners deposited the money with the marketing agency of Som Resorts, Cosmic Structures Limited (“CSL”) The BBAs required Som Resorts to deliver the possession of the units to the Petitioners within thirty six months from the date of commencement of the construction of the Project. However, Som Resorts failed to deliver the possession of the units and failed to refund the money deposited by the Petitioners with CSL. The Petitioners filed a criminal complaint with the Delhi Police inter-alia against the Corporate Debtor, its promoters and directors. Additionally, a winding up petition was filed before the Delhi High Court (“DHC”) against CSL. The DHC appointed an official liquidator of CSL, who sealed the Project, considering it to be the property of Cosmic Infrastructure Private Limited.

Thereafter, a memorandum of settlement dated September 14, 2018 was executed amongst CSL, Som Resorts and the association of the allottees/ home buyers of the Project (“MOS”), whereby Som Resorts agreed to construct the Project within a period of eighteen months from the date of its de-sealing by the DHC. Additionally, it was agreed that in the event the Corporate Debtor failed to deliver the possession of the units within the stipulated time period, it would refund the entire amount received by CSL from the allottees of the Project, along with an interest at the rate of eighteen percent per annum.

The project was de-sealed by the DHC, however, the Corporate Debtor failed to deliver the possession of the units within the time period stipulated under the MOS. The Corporate Debtor also failed to make payments of the outstanding amounts due and payable by the Corporate Debtor as per the MOS to the allottees/home buyers of the Project. The Petitioners therefore, filed a petition inter-alia under Section 7 of the IBC to initiate the CIRP against the Corporate Debtor.

It was the Corporate Debtor’s submission that the agreement for appointment of CSL as the marketing agency of the Project (“Agreement”) provided the marketing rights to CSL only for a twelve months’ tenure. In addition, the Agreement provided that CSL shall be entitled to ten percent of the sale consideration as its commission and did not permit CSL to enter into any agreement with the allottees/home buyers of the Project.

It was also submitted by the Corporate Debtor that the Petitioners claimed to have paid huge amounts for the project units to CSL, however, the Corporate Debtor received only a marginal portion of such amounts from CSL towards the sale consideration. Further, the Corporate Debtor submitted that the Petitioners based their claim entirely on the MOS and it was an admitted position that the MOS was executed because the Petitioners had made the payments to CSL, which was actually not entitled to collect the same. Accordingly, it was claimed that no debt was payable by the Corporate Debtor to the Petitioners. However, it was held by the NCLT that the Agreement was executed for internal affairs of the Corporate Debtor and the Petitioners were not privy to such affairs. Further, it was also held by the NCLT that the Corporate Debtor had failed to produce any proof wherein the Corporate Debtor had disavowed its association with CSL. Therefore, as per the doctrine of indoor management, the Petitioners cannot be punished even if CSL was not entitled to receive payments for the units allotted in the Project.

It was further held by the NCLT that while the ‘doctrine of lifting the corporate veil’ is an exception to the separate corporate personality of a company, it is a well known and applied principle where protection of public interest is of paramount importance and/or the corporate entity fails to fulfil its legal obligations. Piercing of corporate veil is vital to ensure that the principle of distinct corporate personality is not misused. In this case, the promoter of the Corporate Debtor was also appointed as a director on the board of CSL. The NCLT lifted the corporate veil of the Corporate Debtor and held that the Corporate Debtor and CSL were being managed either directly or indirectly by the same person. The Corporate Debtor had merely used another corporate entity, i.e., CSL to enter into BBAs and collect the money from the Petitioners with an ulterior motive to conceal the real transaction. Resultantly, the NCLT admitted the petition filed by the Petitioners and ordered commencement of the CIRP against Som Resorts.

¹ Company Petition No. (IB)-67(ND)/2022