Lifting of corporate veil of company under company law

lifting the corporate veil

The word company is derived from the Latin word Com meaning with or together and panis meaning bread, and it originally referred to an association of persons who took their meals together. Today the business matters have become more complicated and word “Company” has assumed greater importance. Company is thus a voluntary association of people who come together to for carrying on some business and sharing profits therein. Members contribute capital and the profits are distributed among various stakeholders.Thus, a company denotes an association of likeminded persons formed for the purpose of carrying on some business or undertaking. It can be for profit or it can be for a charitable purpose. A company is a body and a legal person having status and personality distinct and separate from that of the members constituting it.

A Company is a not a ‘person’ in the layman’s language.   It is an organisation created by a group of individuals who come together for the purpose of business. It is thus the personification of group or series of individuals making it a legal person. By the provision of law, a corporation is clothed with a distinct personality. A company being an artificial person, does not have a mind of its own and thus cannot act on its own, it can only act through natural persons or the people who are members of it. The business is carried on by real person, and for the benefit of, some individuals, i.e. some human beings are the real beneficiaries of the corporate advantages[i].

However, sometimes the corporation may commit certain fraud or misrepresentation and in such a case, the façade of corporate personality might be removed to identify the persons who are really guilty. As it has been earlier elucidated that Courts usually follow the principle of separate entity as laid down in the Solomon’s Case however, it may be in the interest of the members or the general public to identify and punish the persons who misuse the medium corporate personality.

Thus where a fraudulent and dishonest use is made of the legal entity, the individuals concerned will not be allowed to take shelter behind the corporate personality. The Court will break through the corporate cloak and will look behind the corporate body as if there is no separate existence of the company from its members. Further, if found guilty of any misconduct, it can penalise the members for actions of the company including any pending debt. This is known lifting the corporate veil.

Doctrine’s Applicability in India

The doctrine is very much applicable in Indian Law. Though it can be traced to Common Law, since Indian Laws are heavily reliant on Common Law, this doctrine has also been adopted and applied in toto.

In Life Insurance Corporation of India v. Escorts Ltd[ii], the Supreme Court held that

“While it is firmly established ever since in Solomon v. Solomon that a company is an independent and legal personality distinct from the individuals who are its members, the corporate veil may be lifted, the corporate personality may be ignored and the individual members recognised for who they are in certain exceptional circumstance”

There are various instances where the courts of the country have pierced through the corporate veil. It can be done due to provisions in the various statutes or to prevent fraud and misrepresentation or evasion of taxing provisions[iii] or a beneficent statutes is sought to be escaped or where associated companies are inextricably connected as to be, in reality, part of on concern.

The concept of lifting the corporate veil is a very dynamic concept. The veil of corporate
personality, even though not lifted sometimes, is becoming more and more a transparent form of ensuring smooth business practices in modern jurisprudence.

Circumstances in which courts may lift the corporate veil

The conditions under which the courts may pierce through the corporate veil can be classified under the following two heads:

Under Statutory Provisions:

The Companies Act, 2013

The Act provides for certain cases in which the directors or members of the company may be held personally liable. Herein, the entity of the company is overlooked and the constituent members such as directors are held liable personally along with the company. These cases are as follows:

Misstatements in Prospectus(Section 34-35)

In case of misrepresentation in a prospectus, the company and every director, promoter, expert and every other person, who authorised such issue of prospectus shall be liable to compensate the loss or damage to every person who subscribed for shares on the faith of untrue statement. Besides, these persons may be punished with imprisonment for a term which shall not be less than six months but it may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud .

Failure to Return the Application Money (Section 39):

 In case of issue of shares by a company to the public, if minimum subscription, as stated in the prospectus has not been received within 30 days of the issue of prospectus or such other period[iv] the application money shall be repaid within a period of fifteen days from the closure of the issue and if any such money is not so repaid within such period, the directors of the company who are officers shall jointly and severally be liable to pay that money with fifteen percent per annum. In addition, the company and its officer who is in default shall be liable to penalty of one thousand rupees for each day during which such default continue or one lakh rupees, whichever is less.

Misdescription of Name (Section. 121):

As per section 12, a company shall have its name printed on hundis, promissory notes, bills of exchange and such other documents as may be prescribed. Thus, where an officer of a company signs on behalf of the company any contract, bill of exchange, hundi, promissory note or cheque or order for money, such person shall be personally liable to the holder if  the name of the company is cither not mentioned or is not properly mentioned.

For Example; where on a cheque, the name of a company was stated as “LR Agencies Limited” whereas the real name of the company, was “L&R Agencies Ltd”, the signatory directors were held personally liable[v].

Fraudulent Conduct (Section 339)

Where in the case of winding up of a company it appears that any business of the company has been carried on with intent to defraud the creditors or any other person, or for any fraudulent purpose, if the Tribunal thinks it proper so to do, be made personally liable without limitation to liability for all or any debts or other liabilities of the company. Liability under this section may be imposed only if it is proved that the business of the company has been carried on with view to defraud the creditors.[vi]

Ultra-Virus Acts:

Directors and other officers of a company will be personally liable for all those acts which they have done on behalf of a company if the same are ultra vires the company. 

Under Other Statues:

Besides the Act, directors and other officers of the company may be held personally liable under the provisions of other statutes. For example, under the Income-tax Act, 1962  where any private company is wound-up and if tax arrears of the company in respect of any income of any previous year cannot be recovered, every person who was director of  that company at any time during the relevant previous year shall be jointly and severally liable for payment of tax. Similarly, under Foreign Exchange Regulation Act, 1973, the directors and other officers may be proceeded individually or jointly for violation of the Act.

Under Judicial Interpretation:

Though initially court using the principle and the concept of separate entity and a district corporate personality refused to lift the corporate veil, however, with the growth of corporations and the increasing conflict between companies and its various stakeholders, court have adopted a pragmatic approach and lifted the corporate veil.

It is very difficult to enlist each and every decision of courts in which they have lifted the veil, however, the following paragraphs try to give an idea as what are the different circumstances under which the façade of corporate personality can be removed and persons behind the corporate entities may be identified and penalised.

Prevention of Fraud and Improper Conduct:

Where the medium of a company has been used for committing fraud or improper conduct, courts have lifted the veil and looked at the realities of the situation.

In Gilford Motor Company v Horne[vii], Horne had been employed by the company under an agreement that he shall not solicit the customers of the company or compete with it for certain period of time after leaving its employment. After ceasing to be employed by the plaintiff, Horne formed a company which carried on a competing business and caused the whole of its shares to be allotted to his wife and an employee of the company, who were appointed to be its directors. It was held that since the defendant, i.e Horne in fact controlled the company, its formation was a mere cloak or sham enable him to break his agreement with the plaintiff. Accordingly, an injunction was issued against him and against the company he had formed restraining them from soliciting the plaintiff’s customers

Similarly, in Jones v. Lipman[viii] seller of a piece of land sought to evade specific performance of a contract for the sale of the land by conveying the land to a company which he formed for the purpose. Initially the company was formed by third parties, and the vendor purchased the whole of its shares from them, had the shares registered in the name of himself and a nominee, and had he and the nominee appointed directors. It was held that specific performance of the contract cannot be resisted by the vendor by conveyance of the land to the company which was a mere ‘facade’ for avoidance of the contract of sale and specific performance of the contract was therefore ordered against the vendor and the company.

Formation of Subsidiary to act as Agents:

If Company A forms a subsidiary Company B for carrying out its functions there exists no difference between the two companies as both perform the same functions in such case, the court can pierce the corporate veil and penalise the entities.

In Merchandise Transport Limited v. British Transport Commission[ix], a transport company wanted to obtain licences for its vehicles, but it could not do so if it made the application in its own name. It, therefore, formed a subsidiary company and the application for licences was made in the name of the subsidiary. The vehicles were to be transferred to the subsidiary. Held, the parent and the subsidiary company were
one commercial unit and the application for licences was rejected

In State of U.P. v. Renusagar Power Co.[x]the Supreme Court held that where the holding company holds 100% shares in a subsidiary company and the latter is created only for the purpose of the holding company, corporate veil can be lifted. In JR Exports Ltd, v. BSES Rajdhani Power Ltd[xi] the appellant No. I company acquired entire share capital of appellant No. 2 company, which was a registered consumer of electricity connection granted at its factory premises and on finding that electricity was being consumed by appellant No. 1, Electricity Board passed impugned order demanding sub-letting charges from appellant No. 2. Court held that by applying principle of piercing of corporate veil, both companies appeared to be same entity and, therefore, there was no question of sub-letting. 

Protection of Revenue:

Many a time, a company is formulated in to get an ostensible benefit in the garb of loans and revenue. To tackle such problems, the court may pierce the corporate veil.

In Sir Dinshaw Maneckjee Petite[xii] the assesse was a millionaire earning huge income by way of dividend and interest. He formed four private companies and transferred his investments to each of the companies in exchange of their shares. The dividends and interest income was received by Sir Dinshaw as a pretended loan. It was held that the company was formed by the assesse purely and simply as a means of avoiding tax and company was nothing more than assesse himself. It did no business, but was created simply as a legal entity to ostensibly receive the dividends and interest and to hand them over to the assesses as pretended loans.

Similarly in CIT v. Sri Meenakshi Mills Ltd[xiii], where the veil had been used for evasion of taxes and duties, the court upheld the piercing of the veil to look at the real transaction.

Economic Offences

In case of economic offences a court is entitled to lift the veil of corporate entity and pay regard to the economic realities behind the legal facade.

In Santanu Ray v. Union of India[xiv], it was alleged that the company had violated section 11(a) of the Central Excises and Salt Act, 1944. The Court held that the veil of the corporate entity could be lifted by adjudicating authorities so as to determine as to which of the directors was concerned with the evasion of the excise duty by reason of fraud, concealment or wilful misstatement or suppression of facts or contravention of the provisions of the Act and the rules made there under.

Company Avoiding Welfare Legislations:

Welfare Legislations especially in country like India hold a profound role and importance since the working class are often subjected to exploitation at the hands of the corporations. Thus any attempt to evade and escape the responsibility entrusted by the statute is a gross violation of law and must be punished with the strictest of the hand of the court.

The Supreme Court in Workmen of Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd[xv] held that where the sole purpose for the formation of the new company was to use as a device to reduce the amount to be paid by way of bonus to workmen, the Court can rightfully pierce of the veil to look at the real transaction.

Company used for Illegal/Improper Purpose:

Courts have shown immense willingness to lift the veil where device of incorporation is used for some illegal or improper purpose. In PNB Finance Limited v. Shital Prasad Jain[xvi] pursuant to a request made by S’, the financial advisor of a financing public limited company, granted a loan of Rs. 50 lakhs to ‘S’ on his representation that he would utilise the said amount for the purchase of immovable property in Delhi and the directors of the plaintiff company sanctioned the loan, on the condition that the loan would be secured by deposit of the title deeds of the property.  S also executed a promissory note. However, he didn’t pay a penny on the loan or its interest. Instead, he diverted the amount of the loan to three public limited companies floated by him and his son.  He in fact in the garb of the companies used the loan amount for purchasing immovable properties at New Delhi. The question that arose was whether the defendants could be restrained from alienating the properties purchased. The court granted relief to the plaintiff by piercing the corporate veil and restraining the defendants from any alienation, transfer, disposal or encumbering of the properties in question

Company Acts a Mere Sham or a Cloak:

If any Corporate entity is a mere sham and a trick to escape the illegal acts done by the person behind the veil, the corporate personality and entity shall seem to be non-existent and the veil can be broken.

The Supreme Court in Delhi Development Authority v. Skipper Construction Company[xvii], held that the directors and members of the family had created several corporate bodies did not prevent the court from treating all of them as one entity belonging to and controlled by the director and his family if it was found that these corporate bodies were mere cloaks and that the devise of incorporation was really a ploy adopted for committing illegalities and or to defraud people.

Conclusion

A company is a legal person which has been given personification by law. It acts not according to its own whims and fancies being an artificial person but according to the men behind the curtains of the corporation. This curtain or veil when is overlooked to understand the true nature and real beneficiaries of company is called lifting of Corporate Veil. This doctrine has primarily emerged to strike a balance between the needs of corporate independence and public interest. Originally the court was quite stringent in applying this doctrine to preserve the model of corporate structure however with the growth of conflicts between companies and its stakeholders and in the interest of justice, courts have now adopted a liberal approach. However, a rule of caution must be adopted by the courts in applying this doctrine. Though the horizons are expanding, it can’t be applied in every situation. It depends upon situation to situation and therefore a standardised rules can’t be made by courts.

Frequently Asked Questions

What does Company mean?

A company is an association of people who come together for a common purpose or object. Under 2(20) of Companies Act, 2013 a company is a company which has been incorporated under this act or previous company law. In layman’s terms, a company is an artificial person created by law, having separate entity with perpetual succession and common seal.

What is Corporate Veil?

A company has a separate district legal entity from the persons who constitute it. Thus, a company in legal terms is a totally different person called as an artificial or legal person. Thus, it a concept which segregates the liability of company from its makers and protects them from being personally liable.

What do you understand by Doctrine of Piercing Corporate Veil?

A Company being an artificial person can’t act on its own. Thus, if and when it performs any such act which is against public morality or against its articles of association, the court will break the corporate cloak and look into corporate entity and will eliminate any difference between the corporate entity and its constituent members.

Under what circumstances can courts pierce corporate veil?

The Courts have in a plethora of cases pierce the corporate veil. It can be done primarily in two ways, one is by statutory provisions which have been elucidated in the Companies Act, Income Tax Act etc. and the second way is by judicial interpretation which is an evolving form of jurisprudence.

Edited by Shikhar Shrivastava

Approved & Published – Sakshi Raje 

Reference

[i]Gallaghar v. Germania Brewing Company [1893] 53 MIN

[ii][1986] 59 Comp. Cas. 548

[iii]BSN (UK) Ltd. v. Janardan Mohandas Rajan Pillai [1996] 86 Comp. Cas. 371(Bom).].

[iv]It may be specified by the SEBI, then as per Rule 11 of Companies (Prospectus and Allotment of Securities Rules, 2014,

[v]Hendon v. Adelman (1973) Ne-Delhi LR 637)

[vi]Re. Augustis Barnett&Sons Ltd. (1986 B CLC 170 Ch. D.

[vii][1933]T CH 935

[viii]1962] 1 All. ER 442

[ix]1982] 2 QB 173

[x]1991 70 comp case 27

[xi][(2007173 SCL 133 (Delhi),

[xii]Re AIR 1927 Bom. 37Khe

[xiii]AIR 1967 SC 819

[xiv][1989] 65 Comp Cas. 196 (Delhi),

[xv][1986] 59 Comp. Cas. 1341

[xvi][1983] 54

[xvii]1996 4 SCALE 202