By: Shailendra Shukla
The 21st century has seen a meteoric rise in the commission of white-collar crimes, which can be attributed to the rapid pace of technological advancement. Now, money can be transferred to any part of the world in seconds. Additionally, there is increased interconnectivity across the globe, which gives miscreants access to a larger pool of victims. Countries around the world have taken note of the progressive increase in white-collar crimes, and this concern has been reflected in the legislative enactments and amendments in relevant statutes. For example, India saw the amendments to the Prevention of Corruption Act, 1988 in 2018, the amendments to the Prevention of Money Laundering Act, 2002 in 2019 and the enactment of the Fugitive Economic Offenders Act in 2018. Globally, the UK Bribery Act in 2010, Sweden’s SCC Amendment in 2015 and amendments to the Spanish Criminal Code in 2015 are of a similar nature. All of these statutes/amendments have strengthened scrutiny on corporate crime and incorporated stringent penalties for violations.
That being said, the question of corporate criminal liability is still relatively unexplored, due to the nascent recognition of its many facets and possibilities. While corporate behaviour is increasingly coming under the spotlight now to ensure legally compliant business behaviour, it is imperative to also explore certain grey areas where there is little legislative clarity that can be used as loopholes to escape liability. One such area, that although has been explored but not rigorously scrutinised is the corporate successor liability in India. In this article, I will start by discussing the concept of corporate successor liability and the precedents in India and abroad. Then, I will delineate the criticism of this concept and explore what could be a possible solution through the doctrine of substantial continuity.
In recent times, more and more statutes are exploring the imputation of vicarious liability on a corporation for the criminal acts of its agents and employees. This is to ensure that the separate legal entity does not become a vehicle for abuse. Owing to this debate, another pertinent question has arisen; should a corporation be held criminally liable for the acts of its predecessor in the event of a merger? The answer to this is not straightforward. After the merger, the predecessor no longer exists on paper, and as common law dictates, the death of a corporation is akin to the death of a person, wherein all criminal proceedings against the person generally abate on such an event. Although it is understood that a merger entails the transfer of all rights and liabilities agreed upon of the transferor to the successor, this principle is generally used for the settlement of civil liabilities, as the assets of the predecessor can be used for such settlements. At this stage, it must be mentioned that in case the predecessor corporation is already under investigation for any criminal offence in India, then it is likely that the merging entity will be privy to such information as the merger has to be sanctioned by the NCLT. However, the situation gets trickier when the merger takes place before any investigation has commenced into an offence.
The common law viewpoint of the dissolution of the legal company being akin to death creates problems. When it comes to criminal liability, the application of this principle would imply that the predecessor corporation would get away scot free after getting merged, since it will cease to exist. This of course is harmful to shareholders and investors who will not be able to get any legal relief after such an event. On the flip side, if liability is to be strictly applied, it would be transferred to the successor since that is the corporate identity which the predecessor wears. Consequently, the successor would be liable for the crimes of the predecessor, or that a person who did not commit the crime would be punished for the crimes of another, and it defeats a foundational principle of criminal punishment, which is deterrence. In the scenario that the investigation has not commenced till the merger, if liability is imposed on the successor, then it would be for a crime that could not have been known about even after due diligence.
The most pertinent case law regarding criminal liability of a successor in India is the case of Brooke Bond Lipton India Ltd. V. State of Assam, where the Gauhati High Court noted that transfer of rights and liabilities does not entail transfer of all rights and liabilities, but those that are capable of being legally transferred. The court acknowledged that criminal liability is incapable of being transferred under law or contract and consequently the automatic fastening of the criminal liability of the dead company on the petitioner company is “unheard of and impractical”. A number of American judgments (most notably Oklahoma Natural Gas Co. vs. State of Oklahoma and American Exch. Bank V. Mitchell, among others) arguing that a corporation cannot be revived to settle litigation and all matters are abated were used to propel arguments. The High Court went on to reject this line of argument. The Court observed that owing to the nature of the violation (of the Food Adulteration Act, a social welfare law) and when the criminality of the predecessor was evident but not brought before the Calcutta High Court with regards to the merger, a criminal proceeding does not abate ipso facto on merger or amalgamation of the company. The court then went on to citeSaraswati Industrial Syndicate Ltd. Vs. C.I.T. Haryana, Himachal Pradesh, Delhi-Ill, New Delhi where the Apex Court laid down that the true effect and character of the amalgamation largely depends on the terms of the scheme of merger, including the respective rights and liabilities. Because in the current case the corporation was a partnership firm, its dissolution does not require the consent of any authority, the firm’s non-prosecution and hence non-accountability may be exploited to cause chaos that is harmful to the public interest, and subsequently the firm can be dissolved to avoid culpability. In such a circumstance, it cannot be stated that the demise of a business should result in abatement, and the merger scheme’s terms must be read into in order to proceed with prosecution. A pending criminal prosecution, in any event, cannot be “thrown overboard” by merger. Thus, the Indian case law on this issue has largely navigated the infliction of liability on the premise of public interest. The subsequent questions regarding this issue are left, to be dictated by the terms of the scheme of the merger, which is ostensibly subject to the review and approval of authorities. Since this reasoning is not founded on statutory provisions or the interpretation thereof, the drawback here would be the uncertainty this would bring, as innocent companies and shareholders would be punished if the successor corporation is held liable for the crimes of the predecessor, in case the investigation has commenced after the dissolution.
If we compare this to the United States, several case laws (examples being Melrose Distillers, Inc. v. United States and United States v. Shields Rubber Corp) have seen the question of liability largely boiled down to the provisions in the statute governing the incorporation of companies in that particular state. There too, the concerns arose from the common law principle of equating the death of a company to that of a person, which is “harsh” and “inequitable” on creditors and shareholders. Consequently, it has been established that a dissolved company can be prosecuted at a later stage only if allowed by the laws of the state of its formation. Thus, the aforementioned cases have seen American courts leave it to the state statute to decide on whether or not a prosecution can be taken forth after the dissolution. However, there is a similar problem that faces the Indian regime, which is that statutes which do allow for prosecutions to continue against the successor can entrap bona fide investors that had nothing to do with the crime. This can be seen in the case of United States v. Alamo Bank of Texas. Before the merger, the Central National Bank (CNB) violated provisions of the Bank Secrecy Act 3-4 years prior to the merger and Alamo Bank was subsequently prosecuted for it. Alamo Bank claimed that it was being prosecuted for the crimes of other entities, and the prosecution was a violation of its due process rights under the US and Texas constitutions. The court of appeals rejected the argument, and relied on the banking statute to state that after the merger, Alamo “has become CNB” and is responsible for its actions and duties, and CNB cannot escape fines for its conduct by joining with Alamo and taking its corporate identity. This case exemplifies that criminal liability may stem from the previous corporation’s acts years before the merger and that the successor’s responsibility will not be affected by ignorance of pre-merger wrongdoing. In any case, the successor may face formal indictment for offences committed years before to the merger.
The approach towards successor criminal liability is divergent, as can be seen. India, which has not seen many cases with this issue, has left it upon the scheme of merger to navigate upon the transfer of criminal liabilities. The USA, through its experience of having seen a number of cases with this scenario has left this responsibility on the statute where the predecessor was incorporated. The commonality here is that both of these scenarios can give way to situations where innocent investors and shareholders will have to pay the brunt for the crimes of another entity. This of course contravenes fundamental notions of criminal justice. In the other possible scenario, corporations that actually do commit the crime will simply be able to escape liability by devising schemes that will benefit them, especially when the investigation and subsequent prosecution for the crime in question have not yet started. The approach to be adopted here has to be one where loopholes cannot be exploited by any stakeholder, to ensure equitable treatment of all players.
A Possible Solution
The doctrine of substantial continuity is worth looking into here. Essentially, the doctrine which emanated from labour law states that if a successor corporation retains the same business as its predecessor, with the same employees, doing the same jobs, for the same supervisors, under the same working conditions, and using the same production processes to produce the same products for the same customers, the successor corporation can be made liable for the acts of its predecessor corporation. When there is a similarity in stock, shareholders, directors, management, employees, physical location, and activities, the purchaser is viewed as a simple continuation of the seller, and liability can be transferred on that basis.
What is worth mentioning here is that through the application of this doctrine, those corporations that attempt to avoid liabilities that come with a merger by going through the route of an asset purchase (wherein instead of a full-fledged merger, only certain assets are purchased and the org. can avoid the liabilities that may come with the entirety of the merger) are also penalised. The application of this doctrine is fact-specific and allows the judiciary to peruse the circumstances regarding the asset purchase and explore the background which can give an insight as to what prompted the organisation to take this particular route over another. The application therefore requires the courts to examine the transaction, whether it was actually a de-facto merger in substance done by the way of asset purchase to avoid liability and a continuation of the predecessor’s business, or if it is a bona-fide purchase supported by business reasons. If the Court concludes it is the former, then culpability can be imposed on the successor. When the courts review a merger, they take into account several factors, including but not limited to determining if the successor is in the same line of business as the transferor in terms of production, process, supply etc. The factors often referred to in such a review were explained by a United States Court of Appeal in United States V. Carolina Transformer II, wherein the factors were retention of employees, supervisory personnel, manufacture of same product etc. The dissolution of the predecessor is seen, to compare circumstances and verify if the successor was formed only to continue the business of the predecessor. Common management, employees and key personnel are other factors that lead court to believe that the asset purchase is a de-facto merger. It must be noted that the examination of the pre and post identity of the entities involved in the asset merger is done with the objective of understanding the motives of the asset purchase or merger itself, and a key focus is to understand how liabilities of the predecessor, if any, are being understood and navigated by the successor corporation. Therefore, this doctrine allows the attribution of liability on the successor even if the criminal misconduct is discovered after the merger is complete and the predecessor is dissolved, owing to finding a strong motive to merge or purchase assets and continue business under another corporate identity. In conducting this inquiry, which can be much later to the merger, the court will be able to more holistically appreciate the arguments and defences taken by the corporations, whether it is the evidence adduced by innocent shareholders as to not being aware of criminal activities of the predecessor due to no pending investigations at the time, or explanations floated by bad faith actors using the merger to escape liability.
If we talk about India, the leading case law has stated that the scheme of the merger will play a deciding factor in establishing criminal liability of a successor post merger. However, it does not seem prudent to believe that the terms and conditions designed by the entities themselves, in relation to a scheme that intends to benefit the entities will take the ethically upright stance on accepting liability for crimes committed by the predecessor. This is especially unlikely if they are made aware of the crimes of one of the entities, which is yet to be investigated. In fact, such a scheme might allow them to employ the means of a merger to escape liability and continue similar business practices under a different name and structure. In these situations, it seems that it would be beneficial for the community at large to let the court be a neutral arbiter of truth regarding a merger or an asset purchase, and examine every such case on the basis of the facts tied to each of them.
Alternatively, the same approach would also work in the USA, where instead of letting potentially rigid application of state statutes dictate liability, the courts could let a fact-based finding, taking into account new management, investors and shareholders paint a clearer picture in deciding the liability to be accorded to the successor. Through this, bad faith actors that would purposely establish corporations in states where incorporation statutes do not explicitly allow for claims post the dissolution of a company would also be brought to justice, on the merits of the case instead of a straitjacket application of the law.
There have been a few cases where the principle of an establishment “substantially continuing” has been discussed in Indian courts, mostly relating to provident fund cases, although the doctrine itself has not been formally recognised. However, seeing that the use case of the doctrine which started out in labour law has spilled over to several other areas, it is arguably a useful tool for the evaluation of any case regarding attribution of liability of a successor on merits, in the absence of any statutory provisions regarding this issue in Indian laws.
With increased investment, complex transactions and globalization, white-collar crimes are increasing around the world, including India. With its eyes set on becoming a global superpower in the near future, it is imperative that the legal system in India can successfully navigate and punish bad faith actors intending to take advantage of any leaks and legal loopholes that currently exist. This must become a priority to ensure that bona-fide investors in India can rest assured knowing that the judiciary will faithfully tackle questions of law in the developing jurisprudence of corporate criminal law in India. Fixing the potential problems in the corporate successor liability regime is one of the many ways that India can rise to the challenge of the ever-changing face of corporate crimes, and bring the perpetrators to justice.
Author is a Fourth Year Student at Gujarat National Law University