CONCEPT OF LIFTING OR PIERCING OF CORPORATE VEIL

 

CONCEPT OF LIFTING OR PIERCING OF CORPORATE VEIL:

1. INTRODUCTION:

Company is defined by various legal experts according to their own understanding. However, section 2(20) of the Companies Act, 2013 defines the term company in the following words: Company means a company incorporated under this act or under any previous company law. Since, the definition is blurry and did not deliver the true meaning so, a simpler meaning would be.

‘It is a legal entity formed by an individual or a group of individuals to engage in and control a business, commercial or industrial’.

The concept of corporate veil distinguishes itself from the famous perception that creates a line between company and its members and portrays company as a separate legal entity. The idea of company being a separate legal entity independent from its members and shareholders which has it owns set of legal rights and obligations was propounded in the well-known case of Saloman v Saloman & Company Ltd.

The essence of separate corporate personality is one of the fundamentals of the company law and the basis of all commercial and business activities and it is said to cast a veil upon its human elements, 'the corporate veil. It is to be noted here that, the corporate veil is merely a metaphorical veil, which separates the company from its members, while preventing arising of any liability on either side. Nonetheless, there are situations where the law discards this veil worn out by a company. The act of performing the same is known as lifting the veil.

The theory that a company is completely separated from its members, is well illustrated by the Privy Council in Lee v. Lee’s Air Farming Ltd, wherein Mr. Lee formed a company of which he was the managing director. In that capacity he appointed himself as the pilot. Mr. Lee died in a flying accident while in course of employment of the company. Subsequently, Mr. Lee’s widow sued the company to recover compensation under the Worker’s Compensation Act. Her claim was agitated by the company on the ground that Mr. Lee was not a worker as the same person could not be both employer and employee. In this case the Privy Council held that there was a valid contract of service between Mr. Lee and company, and Mr. Lee was, therefore, a worker entitled to get compensation under the Workmen’s Compensation Act.

This feature of company was established by the Hon’ble Supreme Court of India in the case of Rustom Cavasjee Cooper v. Union of Indian, where it was held that “a company registered under the Companies Act is a legal person, separate and distinct from its individual members. Property of the company is not the property of the shareholders.

The chief advantage of incorporation from which all others follow is the separate entity of the company. In reality, however, the business of the legal person is always carried on by, and for the benefit of, some individuals. In the ultimate analysis, some human beings are the real beneficiaries of the corporate advantages, for a while, by fiction of law, a corporation is a distinct entity, yet in reality it is an association of persons who are in fact the beneficial owners of all the corporate property.

The effect of this Principle is that there is a fictional veil between the company and its members. That is, the company has a corporate personality which is distinct from its members. The human ingenuity however started using the veil of corporate personality blatantly as a cloak for fraud or improper conduct. Thus, it became necessary for the Courts to break through or lift the corporate veil and look at the persons behind the company who are the real beneficiaries of the corporate fiction.

This theory of corporate entity is indeed the basic principle on which the whole law of corporations is based. But, in a number of circumstances, the Court will pierce the corporate veil or will ignore the corporate veil to reach the person behind the veil or to reveal the true form and character of the concerned company. In those circumstances in which the Court feels that the corporate form is being misused it will rip through the corporate veil and expose its true character and nature disregarding the Salomon principal as laid down by the House of Lords.

2. COMPANY AS A SEPARATE LEGAL ENTITY:

The company as separate legal entity was first established in the case of Salmon Vs. Salmon Company Ltd. Salmon who was a sole trader sold his manufacturing business to the respondent’s company that's Salmon company Ltd which is a company, he incorporated by getting consideration for all and six shares in the company and got 10 pounds in form of debentures. His wife and his five children were the subscribers of memorandum, and each took one share. The business was collapsed subsequently, and he made a claim that debentures held is a secured debenture. It was argued by the liquidator that the company and salmon are one another the same that is business was carried on behalf of Salmon. The house of lords on appeal held that Salmon and company Ltd was not a sham and the debts of the company are not the debts of Salmon because they were two separate entities and once an artificial person has been established, they must be treated like an independent person.

In another leading case Macura Vs. Northern assurance company Ltd, it was decided by the house of lords that insurers will not be held liable under the contract for insurance on any property that was insured by the plaintiff, but which was owned by the company in which the plaintiff has all the paid shares. The house of lords held that only the company can have the separate legal owner of the property and not the plaintiff have any insurable interest. The plaintiff being a shareholder did not have any insurable interest in the property as he only the shareholder of the company. In another leading case of Lee Vs. Lee Air farming it was held by Privy council that Lee is separate entity form the company which was controlled by Lee who would be an employee of the company so the wife of Lee can claim compensation for his death under the workmen compensation act.

In the case of Horbert bridge Co Ltd Vs. FCT, the house of lords relied upon the judgement given in the leading case of Gas lighting improvement company Ltd Vs. IRC, it was held that between the investors who had participated as a shareholder and between the undertaking carried which is carried on the law will impose another person either real or artificial or the company itself and the business which is carried on by the company and the capital employed is the capital and not in either case the business or the capital shareholder.

In the most recent case of Industrial equity Vs. Blackburn the high court held that principle that operates to prevent the holding company being treated as wholly owned and subsidiary profits if its own. Therefore, it can be said that there is a highest authority for the separate entity concept. But consideration has to be given to limitations of separate entity principle which will completely deny the efficiency of the entity as a legal person which is separate from its founders and other members of the company. Judgement given by the judges in the case of Salmon Vs. Salmon company Ltd has indicated the recognition of certain exceptions to the principle of separate legal entity by the courts.

In a leading case of Littlewoods Mail order stores Ltd Vs. IRC, Lord Denning stated that incorporation of a company does not fully cast a veil over the personality of a company limited by shares which the courts cannot see. The courts can remove the mask and then they can look behind the mask or veil to see the person who has hidden behind the veil and held that a corporation will be looked upon as a legal entity as a general rule but when notion of legal entity is used to defeat the convenience of the public at large justify anything done wrong protect fraud and also defend crime the law or the court will regard the corporation as an association of person. The judicial discretions and also the legislative action allows the principle of separate entity of a company.

3. MEANING AND CONCEPT OF LIFTING OF CORPORATE VEIL:

Lifting of corporate veil means disregarding the corporate personality and looking behind this personality, the real persons who are in actual control of the company. In other words, 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. In this regards the court will break through the corporate veil. According to the definition of Black Law Dictionary, the piercing the corporate veil is the judicial act of imposing liability on otherwise immune corporate officers, Directors and shareholders for the corporation's wrongful acts. So, the doctrine of lifting of corporate veil means ignoring the corporate nature of the company.

When the principle is involved, it is permissible to show that the individual hiding behind the corporation is liable to discharge the obligations ignoring the concept of corporation as a legal entity. In Delhi Development Authority v. Skipper Construction Co. Private Ltd., the Supreme Court referred to the principle of lifting corporate veil. The concept of corporate entity was evolved to encourage and promote trade and commerce but not to commit illegalities or to defraud people. The corporate veil indisputably can be pierced when the corporate personality is found to be opposed to justice, convenience and interest of the revenue or workman or against public interest. In United States v. Milwaukee Refrigerator Co., the position was summed up as follows:

A corporation will be looked upon as a legal entity as a general rule 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 person.

4. HISTORY OF THE DOCTRINE OF THE CORPORATE VEIL:

The doctrine of corporate veil has been originated in 1897 with the Solomon case. Since then, it is being followed till the present date. But during the years 1897-1966, the way the doctrine of corporate veil is followed has taken different approaches. From 1897 to 1966, was called the period of early experimentation where the courts experimented with different approaches of the doctrine. The different approaches were tried keeping in view the decision of house of lord in salmon’s case.

From 1966 to 1989 was period where the rules of the House of Lords in Solomon’s case were changed, and the lifting of veil was encouraged. Lord Denning in Littlewoods Mail stores v IRC stated that the doctrine laid down in Salman's case has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see. But that is not true. The courts can, and often do, pull off the mask.

From 1989 to the present date, the doctrine of corporate veil lifting began to be disfavored by the courts. The classic case which started the trend of disapproving the doctrine is Woolfsan v. Strathclyde, Regional Council in which Lord Keith stated that the only situation where a corporate veil could be lifted was where there are special circumstances indicating that the company is a mere facade concealing the true facts. Thus, the English court started to take a very narrow view of the doctrine and the judgement of the court of appeal in Adams v Cape Industries Plc.

There were only three circumstances in which the corporate veil could be pierced. They were:

1) If the court is interpreting a statute or document and the statute itself is ambiguous, it would allow the court to treat a group as a single entity.

2) If special circumstance indicate that it is a mere facade concealing the true facts, the court may lift the veil. It is an application of the agency principle. Parent companies and subsidiaries are unlikely have express agency agreements and it is even difficult to prove an implied agency. Evidence is required that day to day control was being exercised by the parent company over its subsidiaries.

3) When the court ignore the company and concerns itself directly with the members or managers.

5. DEVOLOPMENT OF THE DOCTRINE OF LIFTING OF CORPORATE VEIL:

One of the most important characteristic features of a company is that the company is regarded as a separate legal entity which is distinct from its members shareholders promoters. The most relevant illustrative case in respect to the separate legal entity concept is the case which was decided by the House of Lords- in Salomon v. A Salomon & Co. Ltd. In this case Mr. Solomon had started a business of shoe and boots manufacture. Salomon & Co. Ltd. was incorporated by Solomon which has seven subscribers one subscriber being Himself, his wife, his daughter and his four sons. All the shareholders held the shares of UK pound one each the company have purchased the business of Salomon for an amount of 39000 pounds, the consideration for purchase was paid in terms of 10000 pounds debentures by securing the company’s assets 20000 pounds in fully paid 1 pound share each and the balance in form of cash. The company within one year ran into many difficulties and liquidation proceedings was commenced. The assets of the company were not even sufficient to discharge the debentures, and nothing was left to give to the insured creditors. The House of Lords had unanimously held that the company had been validly incorporated since the Act only required seven members holding at least one share each and that Salomon is separate from Salomon & Co. Ltd. Thus, the entity of the company is entirely different or separate from that of its shareholders; it bears its own name and has a common seal with its own name its assets are distinct and separate from those of its members; it has the right to sue and be sued exclusively for this purpose; liability of the members is limited to the capital invested by them.

Further in the case of Lee v. Lee’s Air Farming Ltd, it was held by house of lords that that there was a valid contract of service in between Lee and the Company, and Lee was a therefore a worker within the meaning of the Act. In the case of The King vs Portus the ex-parte Federated Clerks Union of Australia where Latham CJ while deciding the question whether or not employees of a company owned by the Federal Government were not employed by the Federal Government ruled that the company is a distinct person from its shareholders. The shareholders are not liable to the creditors for the debts of the company. The shareholders do not own the property of the company Federal Government were not employed by the Federal Government ruled that the company is a distinct person from its shareholders.

6. GROUNDS FOR APPLYING THE DOCTRINE OF CORPORATE VEIL:

The following grounds have become well established for piercing the corporate veil:

• a)    Determination of Character of company;
• b)    To prevent tax evasion;
• c)    To detect fraud or misconduct;
• d)    Determination of Government companies;
• e)    Avoidance of welfare legislation.
• f)     Statutory provisions.

a) DETERMINATION OF CHARACTER OF COMPANY:

Occasionally it becomes necessary to determine the character of a company to examine the realities that lie behind the company, the court therefore is required to lift the veil of corporate personality because the character of a company can’t be determined without lifting the corporate veil.

For example, to see whether it has an enemy character. There is a famous case on this point name Daimler Co. Ltd. V. Continental Tyre and Rubber Co. Ltd., where a company was incorporated in England name Daimler Co. Ltd for the purpose of selling in England, tyres and rubbers made in Germany by a German company which held the bulk of shares in the English company. The holders of the remaining shares, except one, and all the directors were Germans, residing in Germany. And during the conduct of business there was various transaction between Daimler Company and an English Company name Continental Tyre and Rubber Co Ltd, and then World War 1 broke out and now Daimler Company filed a suit against Continental Tyre and Rubber Company to recover the 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 can’t be a friend or an enemy. However, it may assume an enemy character or when persons in de facto control of its affairs are residents of the enemy territory.

Therefore, the suit filed by the company to recover debt was dismissed. It was rather held in the case Sivfracht vs. Van Undens Scheepvart, 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.

b) TO PREVENT TAX EVASION:

The Court has the power to disregard corporate entity if it is used for tax evasion or to circumvent tax obligations. A clear illustration is Dinshaw Maneckjee Petit, Re.

The assess was a wealthy man enjoying huge dividend and interest income. He formed four private companies and agreed with each to hold a block of investment as an agent for it. Income received was credited in the accounts of the company, but the company handed back the amount to him as a pretended loan. This way he divided his income into four parts in a bid to reduce his tax liability. But it was held that, the company was formed by the assesses purely and simply as a means of avoiding super tax and the company was nothing more than the assesses himself. It did no business but was created simply as a legal entity to ostensibly receive the dividends and interests and to hand them over to the assesses as pretended loans.

In Commissioner, Income Tax v. Associated Clothiers Ltd. the assesses, Associated Clothiers, formed a company holding all its shares. The assesses' company sold certain premises to the new company, and their income was assessed on the difference between the selling price and the cost of the property in the hands of the assesses. They contended that this could not be done as there was no commercial sale, but only a transfer from self to self. The Calcutta High Court rejected this contention and held that it was sale from one entity to another and not a trading with oneself.

c) TO PREVENT FRAUD OR MISCONDUCT:

It is obvious that no company can commit fraud on its own. There has to be a human agency involved to commit such acts. The court will refuse to uphold the separate existence of the company where the corporate entity has been used for fraud or improper conduct or to defeat or circumvent the law. 

Corporate veil can be lifted in cases of fraud, misrepresentation, diversion of funds. One clear illustration is Gilford Motor Co. v. Horne- This is an instance for prevention of façade or sham. In this case, an employee entered into an agreement that he shall not at any time while he shall hold the office of a managing director or afterwards, solicit their customers by setting up his own business. Shortly afterwards he set up a company of the same business and the business solicited customers of the previous company. The Court held that the formation of the new company was a mere cloak or sham to enable him to breach the agreement with the plaintiff.

In the case of Jones v. Lipman, a man contracted to sell his land and thereafter changed his mind in order to avoid an order of specific performance he transferred his property to a company. Russel judge specifically referred to the judgments in Gilford v. Horne and held that the company here was ‘a mask which holds before his face in an attempt to avoid recognition by the eye of equity’. Therefore, he awarded specific performance both against Mr. Lipman and the company.

In P.N.B. Finance v. Shital Prasad Jain, case a person borrowed money from a company and invested it in shares of three different companies in all of which he and his son were the only members, permitted the lending company to attach the assets of such companies as they were created only to hoodwink the lending company.

d) DETERMINATION OF GOVERNMENT COMPANIES:

A company may sometimes be regarded as an agent or trustee of its members or of another company and may, therefore, be deemed to have lost its individuality in Favour of its principal. In India this question has frequently arisen in connection with Government companies. A large number of private companies for commercial purposes have been registered under the Companies Act with the President and a few other officers as the shareholders. The obvious advantage of forming a government company is that it gives the activities of the State and little of the freedom which was enjoyed by private corporations and the Government escaped the rules and principles which hampered action which it was done by a government department instead of a government corporation. And in order to assure this freedom the Supreme Court has reiterated in a number of cases that a government company is not a department or an extension of the State. It is not an agent of the State.

But now it is settled position that the private company acquired by the Act of Parliament is regarded as an instrumentality of State under Article 12 of the Constitution of India. Hence, writ would be maintainable against such Government companies.

And on this point, there is a well-known case, Som Prakash Rekhi v. Union of India, in this case a company named Burmah Shell was acquired by the Central Government and all its assets vested in the Central Government. The employee who had certain rights as to provident fund etc., against the former company, claimed them against the Government by means of writ. His claim was resisted on the ground that the undertaking had been vested in a company registered under the Companies Act and the question of a writ against a private company could not arise. The Supreme Court observed that the law should not go by the fact whether the Company is registered under the Companies Act or otherwise, but by the nature of the functions that the unit was performing. In this case the statement of reasons mentioned that the acquisition of company in question was due to public interest, therefore, a new company was created to perform a function of public nature. The Court clarified that State’s performance of public duty through company, cannot be regarded to frustrate the right of an employee. The Supreme Court cited the remark of one of the most popular Presidents of USA Mr. Franklin D. Roosevelt: Concentration of economic power in all embracing corporations representing private enterprises become a kind of private Government which is a power unto itself – a regimentation of other people’s money and other people’s lives.

Moreover, in Ramana Dayaram Shetty v. The International Airport Authority of India (Airport Authority’s case), Bhagwati, J, preferred a broader test and the Court held that if a body is an agency or instrumentality of government, it may be an ‘authority’ within the meaning of Article 12 of the Constitution of India, whether it is a statutory corporation, a government company or even a registered society.

e) AVOIDANCE OF WELFARE LEGISLATION:

In cases where it is found that the sole purpose for the formation of a new company was to use it as a device to avoid liability under any welfare legislation, the court may lift the corporate veil to look at the real transaction and purpose behind it. The Supreme Court decision in Workmen of Associated Rubber Industry Ltd. v. The Associated Rubber Industry Ltd. is an illustration on the point.

The fact of the case was that a new company was created wholly owned by the principal company, with no assets of his own except those transferred to it by the principal company, with no business or income of its own except receiving dividends from shares transferred to it by the principal company and serving no purpose whatsoever except to reduce the gross profit of the principal company.

The Supreme Court found that the creation of the new company was intended as a device to reduce the amount of bonus payable to workmen of the principal company and therefore the separate existence of the two companies had to be ignored while computing the bonus. And the court observed that “It is the duty of the court, in every case where ingenuity is expected to avoid taxing and welfare legislations, to go behind the smokescreen and discover the true state of affairs.

f) STATUTORY PROVISIONS TO LIFT THE CORPORATE VEIL:

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.

i. NON-COMPLIANCE OF REQUIREMENTS OF INCORPORATIONS:

As per Section 464 of the Companies Act, 2013, the purpose of the provision is to withdraw the advantages of incorporation when the conditions of incorporation are not maintained.

ii. MIS-DESCRIPTION OF NAME OF COMPANY:

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 collects 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.

iii. MIS-STATEMENT 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.

iv. FRAUDULENT CONDUCT OF BUSINESS:

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, 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.

V. 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: -

•    An agreement of acquiring, disposing, subscribing or underwriting securities.
•   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.
•   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.

vi. FURNISHING FALSE STATEMENT:

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 is sent on the letterhead 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. 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.

vii. HOLDING AND SUBSIDIARY COMPANIES:

A Company becomes a holding company when it has the power to control the composition of the Board of Directors of another company or holds a majority of its shares.

Even a hundred per cent subsidiary company is a separate legal entity, therefore, the founder and controller of such company cannot be held liable for wrong done by such subsidiary company. The Delhi High Court in Free Wheel (India) Ltd. v. Dr. Veda Mitra has observed that a subsidiary company may lose its separate entity, only in two situations firstly, - if the legislature brushes aside the requirement and make provisions to present the group of companies jointly. Secondly, if the court is of the opinion that in fact the control and conduct of the business of the subsidiary company rests completely in the hands of nominees of the holding company, which may show that the subsidiary company is only a branch of the holding company.

7. CONCLUSION:

As a result of incorporation, an incorporated company wears a ‘corporate veil’ and thus acquires the ‘corporate personality’, behind which there are shareholders who have formed the company. Although in law the company has an independent personality, it is an artificial person and hence, behind the corporate curtain, there are natural persons, i.e., shareholders who have associated themselves into a company. So, if this corporate personality is uncovered or unveiled, the shareholders or the directors mostly are found to be behind the veil.

This doctrine merely seeks to strike a balance between the interest of the public and the concept of a separate personality. The doctrine is a powerful weapon in hands of judiciary to ensure justice by lifting the corporate veil and examining the persons behind the company, who are the actual beneficiaries of the corporate entity. So, the theory of lifting of corporate veil is necessary when unscrupulous people started using the corporate veil as a tool to conceal fraud or misconduct in company’s affairs.