Article

In the matter before the Division Bench of the Hon’ble Delhi High Court [Eveready Industries India Ltd. v. KKR India Financial Services Limited FAO(OS) (COMM) 2/2021 and CM APPL. 173/2021 & 2166/2021 decided on 07.02.2022], the Hon’ble Court once again elaborated on the applicability of Group Companies Doctrine to arbitration agreements when dealing with applications under section 9 of the Arbitration and Conciliation Act, 1996.

The issues arise out of the default in repayment of a loan granted in favour of two Indian companies. There were two personal guarantors and an obligor for the said loan.  Since there was an arbitration agreement, the Lender (Respondent No. 1) which is a non-banking financial Company, moved an application under section 9 of the Arbitration and Conciliation Act, 1996 seeking an order to restrain the borrowers, guarantors and the obligor from dealing with their assets along with seeking similar order for restraining the appellants, which were stated as “Reference Entities” in the loan documents. In order to justify the same, the Respondent No. 1 invoked the Group Companies Doctrine stating that credit facility under the loan agreement was advanced to borrowers after due verification of the credit worthiness of the group companies including the appellants. The Ld. Single Judge granted the injunction against the appellants wherein they were restrained from selling, transferring, alienating, disposing, assigning, dealing or encumbering or creating third party rights on the assets and from carrying out any change in their capital structure, or any corporate or debt restructuring, during pendency of the arbitral proceedings. The order was challenged before the Division Bench of the Hon’ble High Court.

After hearing the parties at length, the Hon’ble Court first discussed the origin and scope of the Group Companies Doctrine. The doctrine was propounded in the case of Dow Chemicals v. Isover Saint Gobain ICC Case No. 4131, YCA 1984. The Hon’ble Supreme Court applied the doctrine for the first time in Chloro Controls India v Sereven Trent Water Purification (2013) 1 SCC 641. The Supreme Court, while acknowledging the nature of modern business transactions which are carried out through multiple agreements creating intrinsically related transactions between the parties within a corporate group, clarified that a third party or a non-signatory can be subjected to an arbitration agreement without its consent but only in exceptional cases and propounded two legal theories on the basis of which an arbitration agreement may also bind a non-signatory – one on the good faith principle when there is a clear intention of parties to bind a non-signatory and second on legal principle of principal and the agent. In such circumstances, the arbitration agreement entered into by one of the entity in the group can bind the non-signatories and affiliates or the parent company.

The Court held that in addition to examine the aspect whether composite reference of third parties would serve the ends of justice, the Court shall also look at the issue from the “touchstone of direct relationship to the party signatory to the arbitration agreement, direct commonality of the subject matter and the agreement between the parties being a composite transaction. The transaction should be of a composite nature where performance of mother agreement may not be feasible without aid, execution and performance of the supplementary or ancillary agreements, for achieving the common object and collectively having bearing on the dispute.” The Court further added that “The principle of ‘composite performance’ would have to be gathered from the conjoint reading of the principal and supplementary agreements on the one hand and the explicit intention of the parties and the attendant circumstances on the other.”  

The doctrine was applied in Cheran Properties Ltd. V. Kasturi& Sons Ltd. (2018) 16 SCC 413to enforce an award against a non-signatory. In Mahanagar Telephone Nigam Ltd V. Canara Bank, (2019) SCC Online SC 995, the Court went on to  established the test of “single economic entity” or “single economic reality”. The court explained through illustrations as to when a non-signatory is held to be bound. For instance, a non-signatory is bound when the entity is engaged in the negotiation or performance of the commercial contract. It is also construed to be bound when it made statements indicating its intention to be bound by the contract. The Court also elaborated that an entity in a group is bound when the nature of transaction is composite. A composite transaction refers to “where the performance of the agreement may not be feasible without the aid, execution, and performance of the supplementary or the ancillary agreement, for achieving the common object, and collectively having a bearing on the dispute.” The Court also explained that the Doctrine is also applicable where there is a tight group structure with strong organizational and financial links, “so as to constitute a single economic unit, or a single economic reality”. The Court illustrated that this will apply in particular when the funds of one company are used to financially support or re-structure other members of the group.

Applying the principles to the facts and circumstances of the case, the Court found that the facility was extended to the borrower companies for repayments of existing loans of one of the appellants. The appellant was therefore beneficiary of the loan. The appellant however had contended that it had no obligation to either repay, or secure the facility. As per the loan documents any entity controlled by the two guarantors was included in the promoter group. One of the guarantors was the Vice Chairman and Managing Director of the appellant. His father was the Chairman. The other guarantor and cousin of the first guarantor was the director of the appellant. The Court stated that while a managing director as per the Companies Act is entrusted with substantial powers of the management of the affairs of the company, a promoter has control over the affairs of the company. In the same manner, the guarantors held similar positions in the other two appellants also. Moreover, the borrower companies and guarantors and their families were part of the promoter group. They had control over the reference entities which included the appellants.

The Court then went on to further observe that the promoter group held a substantial portion of Eveready Industries Ltd. The two borrower companies and Eveready Industries Ltd. were promoters of one of the appellants. The Court after extensively reviewing the shareholding pattern of the group entities observed that as per the loan documents all security providers, along with guarantors, were also obligors and  the borrowers, guarantors and promoter group were restrained from selling, transferring or disposing off, the shareholding in borrowers. A similar bar on selling, transferring, or disposing off shares of any reference entities held by the promoter group without prior consent of the lenders was also provided for. In the loan documents there were several terms and conditions to be observed with respect to the reference entities which showed that the group entities including the appellants consciously sought to provide comfort and binding assurance to the lender so as to secure their loans, by binding the reference entities in every way. To state few of such terms and conditions, it was provided in the loan documents that promoter group, borrowers and obligors or any of their directors were obliged to ensure that they did not appear in the RBI’s list of defaulters and ECGS caution list; reference entities were to be protected from any material adverse effect ; operations of the reference entities had to be in compliance with applicable laws; there was obligation on borrowers to maintain the corporate character of the reference entities and to maintain transparency in the matter of maintenance of the accounts of the reference entities; Event of Default clause set out in loan agreement provided defaults that were with respect to reference entities etc.

The Court therefore concluded that the intention of the parties was clearly to bind the appellants i.e. the reference entities. It was further stated by the Court that the email exchanges clearly showed that the appellants had not just knowledge of the loan agreement, they acknowledged their obligations under the loan agreement. Further, it confirmed that the appellants were intended by all parties, including the appellants, to be bound by the terms of loan document.

The Court, therefore concluded that the ‘tight group structure’ is writ large from the overlapping shareholding pattern in the group, guarantors holding important positions in the appellant companies and a perceivable involvement of the appellant towards giving promise of performance under the loan documents. The Court further stated in strong terms that had there been no security of assets and shareholding of the reference entities/appellants, the Respondent No. 1 would not have extended the loan to the borrower companies. The Court held that respondents as lenders heavily relied on the assets, shareholding and the valuation of the reference entities/appellants and rejected “the contention placed by the Appellants that their assets could be only reached after lifting the corporate veil.” The Court further clarified that “The reason why the assets of the Appellants are liable to be preserved is, because it was the underlying financial strength of the Appellants, on the basis of which the loan was extended by the Lenders/ Respondents. The borrowers have no assets of their own, so it becomes imperative to protect these assets for the aid of the Arbitral tribunal.” The Court finally dismissed the appeal imposing the cost of Rs. 2 lakhs each.