This phenomenon of perceptual physiology, the Thatcher illusion, describes a discovery by Peter Thompson (1980), which he found with the aid of the portrait of the former premier minister Margaret Thatcher.
According to that, small distortions of a face are barely recognized when the face is turned upside down, even though the same distortions can not be overlooked when the faces are the right way up.
The reason for this phenomenon, according to the author, is our daily perception of our everyday world, where distortions immediately catch our eye. An upside down face is less common to us and thus less correctable by the experiences of our brain. Thus, the difference between the correct and the distorted face is perceived as far less extreme and disturbing when it's upside down.
Prosopagnosia is the term for the inability to recognize or differentiate people based on their face. Persons who suffer from this perceptual disorder are not affected by the Thatcher illusion.
Thompson P (1980) Margaret Thatcher: a new illusion. Perception 9:483–484 [PDF]