Allahabad HC Directs ED To Probe Promoters Of Cloud 9 Projects, Says Reality Behind Corporate Veil Needs To Be Examined Due To Illegalities

The Allahabad High Court has held that the concept of a separate legal identity of a company was to encourage trade and commerce and not as front for the directors to commit illegalities and defraud people.

While directing the Enforcement Directorate under the Prevention of Money Laundering Act, 2002 to proceed against all the directors/promoters or designated promoter/officers who are in default and against the companies/other entities in which money from M/s Cloud 9 Projects Private Limited was siphoned or parked, the Court held

“….the concept of separate corporate entity was evolved to encourage and promote trade and commence, but not to commit illegalities or to defraud people. Therefore, where the corporate character is employed for the purpose of committing illegality or for defrauding others, the Court would ignore the corporate character and will look at the reality behind the corporate veil.”

The bench comprising of Justice Mahesh Chandra Tripathi and Justice Prashant Kumar observed that the New Okhla Industrial Development Authority ("NOIDA") kept its eyes closed against the illegalities committed by the Cloud 9 Projects and did not invoke the lease cancellation clause as per the lease agreement.

“Apparently there was an abject failure of Noida Authority and a complete abdication of their duties to protect the rights of hapless home buyers.”

Factual Background

M/s Cloud 9 Projects Private Limited is a special-purpose company incorporated for developing a Group Housing Project in Sector 100, NOIDA. The lease executed between Cloud 9 and Noida contained a lease cancellation clause that stipulated lease cancellation in case of breach of terms of lease and/or non-payment of allotment amount.

M/s Civic Properties Limited was a 50% shareholder of Cloud 9 and also the head of the consortium that led Cloud 9. Civic Properties was headed by the brother and wife of Mr. Ashish Gupta. Ashish Gupta together with his brother held 80% shares of Cloud 9.

It was alleged that out of 8 towers, 5 towers were completed, occupancy certificate was issued, and 366 flats were handed over to the flat buyers. One tower was sealed by NOIDA for non-payment of dues and in the last two towers, 148 out of 168 flats were handed over to the flat buyers without issuance of occupancy certificate.

It was stated that NOIDA refused to grant the occupancy certificate due to the pending dues of Rs. 62 crores owed by Cloud 9, and issued several recovery notices against the company. However, due to non-payment, NOIDA issued recovery notices against the company and its directors.

Ashish Gupta, the director of Cloud 9, approached the High Court asserting that he had resigned from the company and recovery could not be made from him. Counsel appearing on behalf of Mr. Ashish Gupta argued that ex-directors cannot be held liable for the acts of the company. It was submitted that if the unsold flats were sold by NOIDA, the amount fetched would be greater than the dues of NOIDA.

Further, it was argued that since there was no diversion of funds and tax evasion, the corporate veil could not be lifted for holding the directors liable for the acts of the company who is a separate juristic person.

The Court by an interim order directed the release of Gupta from civil prison on the conditions that his properties would be attached and he would not dispose of his shares which he had in the company M/s Cloud Nine Project Pvt. Ltd. or any company that is a member of the consortium.

Since the flat-buyers could not be impleaded in the writ petition of the director, they filed a separate writ petition seeking mandamus regarding the Completion Certificate and other amenities that were to be provided by the developer.

It was argued that the entire scheme of resignation from the company was a sham and a façade to deceive NOIDA, evade payment of dues to NOIDA, and evade labilities towards flat buyers.

Counsel for NOIDA submitted that show-cause notices were issued in 2011, 2014, and 2017 upon default in payment of installments of the allotment amount. Since the dues were not cleared, NOIDA issued recovery citations against the directors of Cloud 9. It was submitted that the 'Occupancy Certificate' will only be issued after payment of dues of NOIDA.

It was further argued that before their resignation, Mr. Ashish Gupta and his brother had siphoned of huge amounts from Cloud 9 into other companies. It was argued that both these persons still held 70% shares of Cloud 9 and could not be said to be ex-directors or not having control of the affairs of Cloud 9.

High Court Verdict

The Court observed that the directors/promoters of Cloud 9 had the intention of defrauding and cheating NOIDA as well as the home-buyers. The Court observed that Mr. Ashish Gupta and his family held 70% of the shares in Cloud 9 directly or through their companies. It stated that they were actively involved in the project, collecting funds and diverting the same to other companies.

The Court held that by resigning, the directors were only trying to shield themselves as being different juristic personalities. It

“We cannot keep our eye shut and be a mere mute spectator of the fraud, which the builders have played on the home buyers and Noida Authority. We are forced to lift the corporate veil to see how the promoters though after resigning as directors continued to be in full control over the company. They had made their petty employees/stooges as the director of the company. Even while they were directors a lot of money has been siphoned away to their other companies.”

The Court held that the veil of the separate corporate entity and separate legal personality is not inviolable nor impenetrable. The Court held that the veil/shield can be lifted in public interest where transactions have taken place with the intent to evade tax or to devoid statutory authorities of their lawful dues.

The Court observed that certain exceptions have been carved out by the Court in situations where the corporate veil can be pierced to hold the directors or officers of the company liable for its actions.

Amongst other judgments, the Court relied on State of Karnataka vs. J. Jayalalita and others, where the Supreme Court had held

“It was finally held that the concept of corporate entity was evolved to encourage and promote trade and commerce and not to commit illegalities or to defraud people and thus when the corporate character is employed for the purpose of committing illegality or for defrauding others, the Court ought to ignore the corporate character and scan the reality behind the corporate veil so as to enable it to pass appropriate orders to do justice between the parties.”

Accordingly, the Court observed that the transactions in question fell within the ambit of the Prevention of Money Laundering Act and the case must be referred to Enforcement Directorate. The Court directed NOIDA to issue an Occupancy Certificate and to conclude sale deeds in favor of flat owners. The Court directed that whatever amount would be left after recovery from ED proceedings, the NOIDA can recover the same by selling the unsold inventory of flats.

Appearances: Ashish Kumar Singh, counsel for director, Varad Nath, counsel for Apartment Owners Association, Anurag Khanna, Senior Advocate assisted by Raghav Dev Garg, Vinayak Mithal, Prateek Sinha, counsel for respondents, Amit Saxena, larned Senior Advocate assisted by Shivam Yadav and Kaushalendra Nath Singh, counsel for Noida Authority and S.C. Upadhyay, standing counsel for the State respondents.

Case Title: Ashish Gupta vs. State Of U.P. And 5 Others 2024 LiveLaw (AB) 129 [WRIT - C No. - 25554 of 2019]

Case citation: 2024 LiveLaw (AB) 129

Click Here To Read/Download Order