Principle of Lifting the Corporate Veil
There is often talk about how a company is a ‘person’ in eyes of law. A company is treated as if it’s a human of it’s own kind. It is given mandate to provide various kinds of information such as minutes of meetings, number of directors, list of objects for what the company is formed and others. However, it is a person in eyes of law only. It is not a real person but a juristic person, and is under obligation to go through a different type of scrutiny. This artificiality of the company is in fact an addition to the personality of the company. The company’s personality is said to be different to that of their directors, promoters and other members. Relation between personality of company and personality of members is the added protection which the former gives to the latter. The company’s personality acts as a curtain to hide the faces of it’s members, which is usually taken advantage of to commit illegal acts. Thus, this paper looks to define, explore and establish the various aspects of the doctrine of lifting the corporate veil. The doctrine is a tool in hands of the Judiciary, that where this corporate personality maybe ignored in order to find the real culprit and hold him liable instead of holding the company liable.
What is a ‘company’?
Before learning about the principle of lifting the corporate veil, it is expedient for us to understand what acompany is, as the principle applies only to the corporate world. The term ‘company’ is actually a derivative of Latin term ‘companis’. If we break this term, we get ‘com’ which means to ‘together’ and ‘panis’ which means ‘bread’. Hence, the term companis means a number of persons who eat together. But this was the ancient approach, where people used to form groups, only for purpose of filling their bellies. Modern day recognizes ‘company’ as group of persons, working together for purpose of carrying out a commercial or industrial activity.
‘Company’ in India, is defined under Section 2 (20) of The Companies Act, 2013 (hereinafter referred as “The Act”), which defines it as, a “company incorporated under this Act or under any previous company law.” But this definition is not exhaustive. Lord Justice Lindley defines company as “an association of many persons who contribute money or money’s worth to a common stock and employ it in some trade or business, and who share the profit and loss (as the case may be) arising there from.” It may not be incorrect to state that, company is thus, an association or group of persons, being in cooperation, for purpose of achieving common goals approved by law, while these goals being with motive of personal gains and not public gains. It has to be understood, company is a mere creature of law. It is not a real person unlike human beings, it is rather an artificial person or juristic person. It’s existence is lawful when approved.
Company, though is run by it’s Board of Directors or even just one director, has a personality of it’s own. It has a separate legal identity, independent of it’s owners or directors. This feature of company was established by the Hon’ble Supreme Court of India in case of Rustom Cavasjee Cooper vs. Union of India, where it washeld that “a company registered under the Companies Act is a legal person, separate and distinct from its individual members. Property of the company isnot the property of the shareholders. "This feature of an incorporated company was first found in case Salomon v Salomon & Company Ltd., adopted throughout the globe in different forms.
What is the principle of lifting the corporate veil?
Company enjoys a separate position from that of position of it’s owners. It is artificial but yet a person in eyes of law. Problems arise when this position of the company is misused. It is not incorrect to say that, though the company is an unreal person, but still it cannot act on it’s own. There has to be some human agency involved so that company is able to perform it’s functions. When this human agency is working, in the name of the company, for achieving goals approved by law, the social order is not disturbed. But when this medium of operations begins to be tainted, conflicts arise. This authority rather becomes firing of bullets from someone else’s gun.
When directors, or whosoever be in charge of the company, start committing frauds, or illegal activities, or even activities outside purview of the objective/articles of the company, principle of lifting the corporate veil is initiated. It is disregarding the corporate personality of a company, in order to look behind the scenes, to determine who the real culprit of the committed offence is. Thus, wherever this personality of the company is employed for thepurpose of committing illegality or for defrauding others, Courts have authority to ignore the corporate character and look at the reality behind the corporate veil in order to ensure justice is served. This approach of judiciary in cracking open the corporate shell is somewhat cautious and circumspect.
In the case United States v. Milwaukee Refrigerator Transit Company, it was stated “A corporation will be looked upon as a legal entity, as a general rule, and until sufficient reason to the contrary appears; but, when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons.” Supreme Court of India had adopted the similar thinking in the case Tata Engineering And Locomotive Co. Ltd. vs. State of Bihar & Ors where the corporations petitioning had joined together and claimed protection under Article 286 of Constitution of India for non-imposition of taxon the sale or purchase of goods, the Apex Court held that “If their contention is accepted, it would really mean that what the corporations or companies cannot achieve directly, they can achieve indirectly by relying upon the doctrine of lifting the veil.”
When can be the veil lifted?
The doctrine, though one of the most used doctrines by Courts, is still, however, not running upon a hard-and-fast rule. The basis for invoking such operations does not follow a laid down policy. Howsoever, over the period of time, Courts and Legislatures throughout the globe have attempted to narrow down scope and applicability of the doctrine under following two heads:-
1) Statutory Provisions
The Companies Act, 2013 has been integrated with various provisions which tend to point out the person who’s liable for any such improper/illegal activity. These persons are more often referred as “officer who is in default” under Section 2(60) of the Act, which includes people such as directors or key-managerial positions. Fewinstances of such frameworks are as following:-
A. Misstatement in Prospectus:-
Under Section 26 (9), Section 34 and Section 35 of the Act, it is made punishable to furnish untrue or false statements in prospectus of the company. Through issuing prospectus, companies offer securities for sale. Prospectus issued under Section 26 contains key notes of the company such as details of shares and debentures, names of directors, main objects and present business of the company.If any person attempts to furnish false or untrue statements in prospectus, he is subject to penalty or imprisonment or both prescribed under the aforesaid sections, depending upon the case. Each of these sections create a distinct aspect, that which type of incorrect information furnishing would make such person liable for what amount or serving term.
B. Failure to return application money:-
Under Section 39 (3) of the Act, against allotment of securities, if the stated minimum amount has not been subscribed and the sum payable on application is not received within a period of thirty days from the date of issue of the prospectus, then such officers in default are to be fined with an amount of one thousand rupees for each day during which such default continues or one lakh rupees, whichever is less.
C. Mis description of Company’s name:-
The name of the company is most important. Usage of approved name entitles the company to enter into contracts and make them legally binding. This name should be prior approved under Section 4 and printed under Section 12 of the Act. Thus, if any representative of the company collect bills or sign on behalf of the company, and enter in incorrect particulars of the company, then such persons are to be held personally liable.
Similar things happened in the case Hendon vs. Adelman where signatory directors were held personally liable for stating company’s name on a signed cheque as “L R Agencies Ltd” while the original name was “L & R Agencies Ltd.”
D. For investigation of ownership of company:-
Under Section 216 of the Act, the Central Government is authorized to appoint inspectors to investigate and report on matters relating to the company, and its membership for the purpose of determining the true persons who are financially interested in the success or failure of the company; or who are able to control or to materially influence the policies of the company.
E. Fraudulent conduct:-
Under Section 339 of the Act, wherever in case of winding up of the company, it is found that company’s name was being used for carrying out a fraudulent activity, the Court is empowered to hold any such person be liable for such unlawful activities, be it director, manager, or any other officer of the company. In the case Delhi Development Authority vs. Skipper Construction Company (P)  it was stated that “where, therefore, 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 so as to enable it to pass appropriate orders to do justice between the parties concerned.
F. Inducing persons to invest money in company:-
Under Section 36 of the Act, any person who makes false, deceptive, misleading or untrue statements or promises to any other person or conceals relevant data from other person with a view to induce him to enter into either of following:-
i. An agreement of acquiring, disposing, subscribing or underwriting securities.
ii. An agreement to secure profits to any of the parties from the yield of securities or by reference to fluctuations in the value of securities.
iii. An agreement to obtain credit facilities from any bank or financial institution.
In such circumstances, the corporate personality can be ignored with a view to identify the real culprit and make him personally liable under Section 447 of the Act accordingly.
G. Furnishing false statements:-
Under Section 448 of the Act, if in any return, report, certificate, financial statement, prospectus, statement or other document required, any person makes false or untrue statements, or conceals any relevant or material fact, then he is liable under Section 447 of the Act.
If any document is sent from company to any place else, content of the documents are sent on the letter-head of the company, Now when this letter is received by any other person, he is supposed to be under assumption that he has received the letter from the company. This “any other person” here is persons appointed under the Act, such as Registrar of Companies (ROC). If he is furnished any false or untrue statement, that is also an offence. Thus, in order to determine the real guilty person, who allowed such documents being released in the name of the company is to be found by way of lifting the corporate veil.
H. Repeated defaults:-
Under Section 449 of the Act, if a company or an officer of a company commits an offence punishable either with fine or with imprisonment and this offence is being committed again within period of 3 years, such company and officer are to pay twice the penalty of that offence in addition to any imprisonment provided for that offence.
2) Judicial Pronouncements:-
Though the Legislature has attempted to insert numerous provisions in the Act to make sure guilty person is pointed out as veil is pierced, there are instances where Judiciary has played it’s part better and kept a check that no guilty person, due to a mere technicality, walks free. Following are few such scenarios where Court may without any doubt lift the corporate veil:-
A. Tax Evasion:-
It’s duty of every earning person to pay respective taxes. Company is no different than a person in eyes of law. If anyone attempts to unlawfully avoid this duty, he is said to be committing an offence. When strict rules are laid down for human being, why leave company? One clear illustration was is DinshawManeckjee Petit re where the founding person of 4 new private companies, Sir Dinshaw, was enjoying huge dividend and interest income, and in order to evade his tax, he thus found 4 sham companies. His income was credited in accounts of these companies and these amounts were repaid to Sir Dinshaw but in form of a pretended loan. These loans entitled him to have certain tax benefits. It was rather held that purpose of founding these new companies was simple as means of avoiding super-tax.
B. Prevention of fraud/ improper conduct:-
It is obvious that no company can commit fraud on it’s own. There has to be a human agency involved to commit such acts. Thus, one may make efforts to prevent upcoming frauds. Similar thing was observed in the case Gilford Motor Co Ltd vs. Horne where, Horne was appointed as Managing Director of the company, provided he accepts the condition that he will not attempt to entice or solicit customers of the company while he is holding the post or even afterwards. However, shortly thereafter, he opened a company, in his wife’s name, which carried out a competing business to that of the first company, with himself being in management. When the matter was brought into the Court, it was held that the newfound company was mere cloak or sham, for purpose of enabling Sir Dinshaw to commit breach of his covenant against solicitation.
C. Determination of enemy character:-
The purpose behind formation of company is self-profit. A company will not attempt to do good towards society consciously. However, it may opt to cause damage instead. Similar things were observed in the case Dailmer Co Ltd vs. Continental Tyres & Rubber Co Ltd.The facts were such that a Germany based company was incorporated in England to sell tyres manufactures in Germany. The German company had however held the bulk of shares in this English company. As World War I broke out, the English company commenced an action to recover trade debt. The question was brought before House of Lords which decided the case against the claimant, stating that, company is not a real person but a legal entity, it cannot be a friend or an enemy. However, it may assume an enemy character when persons in de facto control of it’s affairs are residents of the enemy territory. Thus, the claim was dismissed.
It was rather held in the case Sivfracht vs. Van UdensScheepvart that, if in such scenarios where a company is suspected to be of enemy character or is proved to be of enemy character, then such granted monetary funds would be used as machinery to destroy the concerned State itself. That would be monstrous and against public policy of that concerned State.
D. Liability for ultra-vires acts:-
Every company is bound to perform in compliance of it’s memorandum of association, articles of association, and the Companies Act, 2013. Any action done outside purview of either is said to be “ultra-vires” or improper or beyond the legitimate scope. Such operations of the company can be subjected to penalty.
The doctrine of ultra-vires acts against companies was evolved in the case Ashbury Railway Carriage & Iron Company Ltd v. Hector Riche where a company entered into a contract for financing construction of railway lines, and this operation was not mentioned in the memorandum. The House of Lords held this action as ultra-vires and contract, null and void.
E. Public Interest/Public Policy
Where the conduct of the company is in conflict with public interest or public policies, Courts are empowered to lift the veil and personally hold such persons liable who are guilty of the act. To protect public policy is a just ground for lifting the corporate personality.
One such scenario is Jyoti Limited vs. Kanwaljit Kaur Bhasin & Anr., where it was held that corporate veil maybe ignored if representatives of the company commit contempt of the Court so punishment can be inflicted upon.
F. Agency companies:-
Where it is expedient to identify the principal and agent concerning an improper action performed by the agent, the corporate veil maybe neglected. Such as in the case of Bharat Steel Tubes Ltd vs IFCI where it was held that it doesn’t matter and it isn’t necessary that Government should be holding more than 51% of the paid-up capital to be the principal. In fact, in the case New Tiruper Area Development Corporation Ltd vs. State of Tamil Nadu where Government was holding mere 17.4% of the investment funds, it was found that Area Development Corporation was actually a public authority through the Government. It was created under a public-private participation to build, operate and transfer water supply and sewage treatment systems.
G. Negligent activities:-
Every company law distinguishes between holding and subsidiary companies. Holding companies under Indian company laware the companies which have right in composition of Board of Directors, or which have more than 50% of the total share capital of the subsidiary company. For example, Tata Sons is the holding company while Tata Motors, TCS, Tata Steel are it’s subsidiary companies.
In cases where subsidiary companies have been found with tainted operations, Courts have power to make holding companies liable for actions of their subsidiary companies as well for breach of duty or negligence on their part. Such as in the case of Chandler vs Cape Plc where an employee brought an action against holding company ‘Cape Plc’ for not taking proper health and safety measures, even though employee was employed in it’s subsidiary company.
Employee was appointed in the year 1959 in the subsidiary company while he had discovered the fact that he is suffering from asbestosis in year 2007. When he was aware of his condition it was that the subsidiary company was no longer in existence, thus, he brought action against the holding company, which was still in existence. This matter was held to be maintainable. Rather, holding company was held guilty and made liable as it owed duty of care towards employees. It was for the first time where a holding company, despite the fact that it’s a legal entity separate from that of its subsidiary, is however liable for actions of it’s subsidiary.
H. Sham Companies:-
The Courts are also empowered to lift the corporate veil if they are of the opinion that such companies are sham or hoax. Such companies are mere cloaks and their personalities can be ignored in order to identify the real culprit. This principle can be seen in the prior discussed case of Gilford Motor Co Ltd vs. Horne where it was held that the newfound company was mere cloak or sham, for purpose of enabling Sir Dinshaw to commit breach of his covenant against solicitation.
I. Companies intentionally avoiding legal obligations:-
Wherever it is found that an incorporated company is deliberately trying to avoid legal obligations, or wherever it is found that this incorporation of a company is being used to avoid force of law, the Courts have authority to disregard this legal personality of the company and proceed as if no company existed. The liabilities can be straight away imposed on persons concerned.
Though there aren’t strict and stern disciplines that whether or not the corporate personality can be neglected, the doctrine is however, a very powerful weapon in hands of Judiciary to find the needle in haystack. The company having this corporate personality acts as haystack where directors, promoters, or other such persons are able to act in the name of the company and hide themselves in the haystack like a needle. However, over the period of time, Judiciary around the globe has evolved many methodologies and approaches to make sure no one takes advantage of this shield for carrying out their immoral and tainted practices. Respective penalties and punishments have been prescribed by Legislatures of different countries for committing different types of illegal acts in the name of the company. Indeed it is correct to say that, though at an immature stage, the doctrine acts as a watchdog over companies, which barks at and bites whosoever attempts to illegally trespass the owner’s house.
Company Law, BBA–III, Dr. Ashok Sharma, published by V.K. (India) Enterprises. ISBN 978-93-80006-46-8
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