Mon, May 20, 2024

Limited Liability as a Hoax: The Failure of NRB to Uphold Core Principle in Debt Recovery

Srijan Pant
Srijan Pant May 6, 2024, 11:20 am
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Since the early 1990s, from the case of Saloman vs. Saloman to the 21st century, separate legal personalities have stood to be the fundamental pillars of Corporate Law across the world. It is an established legal principle that a company is a legal person having a separate legal personality. The key elements of the separate legal personality have been incorporated under the Companies Act 2063, (2006) of Nepal under which the company exercises exclusive rights and obligations under its own name which are separate from the rights and obligations of shareholders and directors. After the incorporation of the company at the Office of Company Registrar (OCR), the company attains a separate legal status from its founding shareholders. This means that the company possesses the power and capacity to independently enter and execute contracts, obtain debt and conduct business transactions. The independent legal status of the company ensures that the shareholders of the company are only exposed to the liability and obligations in the company to the maximum value of shares subscribed or undertaken to be subscribed. This also includes limitation of liability against any exposure to unproportionate financial liability as stated in Section 8 of the Companies Act 2006 which is pivotal for encouraging investment and fostering economic growth. 

There have been various landmark decisions from the Supreme Court including Piyush Pandey vs. Tax Office, wherein the Supreme Court has upheld the principle of limited liability against the claims of making any person responsible for financial liability of the company. In the case of Unity Life Insurance vs. Office of the Prime Minister, wherein the Supreme Court stated that all shareholders of company including shareholders who are not involved in the regular course of business in the company, cannot be made responsible for wrongful conduct committed by a few shareholders or directors. 

Although the principle of limited liability stands as a foundational pillar in Corporate Law, Nepal Rastra Bank (NRB) has utterly ignored the legal principle while incorporating provision to blacklist defaulting parties who fail to repay loans obtained from banks and financial institutions (BFIs). Directive No. 12/080, Clause 10.3, Sub-Clause (f) of the NRB Unified Directive Issued to Class A, B and C BFIs in 2080 (2023/24) specifies that directors and shareholders who own 15% or more of the shares in a company that has defaulted on repaying any credit facility or loan obtained from BFIs will be blacklisted at the Credit Information Bureau (CIB). The provision is a continuation of the previous Unified Directives which also mentions the same provision to blacklist shareholders. It is important to note that non-defaulting shareholders or directors who have already repaid the loan in which they have provided personal guarantee and collateral security will not be exempted from getting blacklisted at CIB due to this provision in NRB Unified Directives.

Recently, the CIB has started to freeze all bank accounts of blacklisted individuals as per the Unified Directives. In this context, many shareholders and directors who are blacklisted due to their investment in such defaulting companies have been completely deprived of access to any banking services from BFIs. The provision of Unified Directive does not fit the test of legal scrutiny as it overrules a clear provision under Section 8 of Companies Act which states that the shareholders of the company are only subject to liability limited to maximum value of shares which is undertaken to be subscribed. There is no provision in the governing laws of NRB and BFIs including BAFIA Act, NRB Act or even in the NRB Unified Directives which provides exception to the provision of limited liability under the Companies Act. The NRB Unified Directives fail to elucidate the rationale for the inclusion of a company’s shareholders in the blacklist, as such inclusion does not inherently grant the BFIs the authority to recover the defaulted loans from shareholders. 

There is one exception to the principle of limited liability under Corporate Law. Any party can recover bad debts or impose liability from shareholders of a company beyond the scope of limited liability by piercing the corporate veil of the company in case the default has occurred due to the wrongful act or omission of duty from shareholders. It is very clear that this exception only applies in offences of fraud and criminal activities. This principle of corporate veil necessitates the proof of fraudulent act or discharge of criminal conduct for discharging the liability of a company into its shareholders. However, the determination of such circumstance must be determined by a competent judicial authority rather than a commercial entity with inherent interests in the outcome. If the central bank justifies the act of granting authority to BFIs to pursue loan recovery from a company’s shareholders by employing the principle of piercing the corporate veil under all circumstances of default in loan repayment, then it would blatantly signify an arbitrary application of power of NRB, ostensibly legitimised by the regulatory body’s authority.  

The current framework to place the shareholders of defaulting companies in the blacklist is neither supported by the exemption to overrule principle of limited liability under the governing laws of BFIs and NRB nor does the default in loan repayment meet the degree of severity required to pierce the corporate veil of the company. 

Thus, in the existing violation of principle of limited liability, which is foundational to Corporate Law, NRB should remove the existing provision to blacklist non-defaulting shareholders of a defaulting company. Rather, the central bank should direct BFIs to strengthen its security as BFIs possess robust self-recovery rights, enabling them to seize collateral pledged by the borrower or recover bad debt from personal guarantor in case of default.  These existing mechanisms provide sufficient security for banks to secure appropriate collateral and guarantees during loan approvals, ensuring a measure of protection against defaults. Consequently, the focus should shift towards ensuring that BFIs sufficiently maintain collateral and guarantees against any recovery risk during disbursement of loans rather than employ a blunt instrument of blacklist disproportionately to shareholders of defaulting company. 

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