Lifting of Corporate Veil

Introduction

The concept of ‘Corporations’ dates back to the 16th century when institutions were established for the public good and not for generating profits. These corporations were in the form of non- profit organizations, hospitals and educational institutions working for the welfare of the people at large. For the sake of colonial expansion, European corporations made ‘revenue’ the primary focus for the formation of corporations leading to the establishment of monopolies such as east India Company, Royal African Company, Dutch West India Company and so on. 

In 1844, the Joint Stock Companies Act was passed in Britain, paving the way for incorporation of companies by registration. A similar act was passed in India in the year 1857. The main advantage of incorporation was that it created a separate legal entity from its members. Because the liability of the members was limited, their personal assets were safeguarded from being liquidated to pay off the company’s debts. The theory of separate legal entity for a corporation is, in fact, the fundamental assumption upon which the whole law of companies is established.

Meaning of Corporate Veil

The Companies act, 2013 defines the term ‘company’ as a company incorporated under this act or under any previous company law. In the landmark case of Salomon v/s Salomon Co. Ltd., where the respondent company went bankrupt and Salomon, who was the sole proprietor of the company prior to the company’s incorporation filed a claim as a secured creditor based on the debentures it owned. The House of Lords held that the company is a separate legal person and has a different identity from its members and shareholders and therefore the debts owned by the company shall not be considered as the personal debts of the petitioner. Lord Macnaghten observed “The company is at law a different person altogether from the subscribers to the memorandum, and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them.”

This judgment gave birth to the concept of ‘Corporate Veil’. It implies that there is a fictitious veil between a company and its members. The veil is considered to be fictitious as in reality a corporation is nothing but a group of people managing and handling its operations. This principle was formulated only to safeguard the interests of the proprietor and shareholders.

However, there exists certain exceptions to this principle. For example: If a company has been incorporated in order to dupe other people and is not a company in real sense then in that case this principle will not be applicable. In Littlewoods Mail Orde Stores Ltd. v/s IRC, Lord Denning observed that the incorporation does not cast a veil between the company and its members which is not visible by the courts. In order to reach a just and fair decision, the courts can anytime pull off the veil and have a look at the affairs of the company. Any company, being an artificial person, cannot commit a crime on its own in the absence of mens rea, and therefore, the members of a company are the one’s behind those illegal activities. Many times, these people seek protection under the guise of this concept and therefore, in order to punish such wrongdoers, the corporate veil is lifted by the courts and this lifting of veil is known as “Piercing of Corporate Veil”.

Piercing of Corporate Veil

‘Piercing of corporate veil’ is one of the most commonly used doctrines in the corporate law world. It means lifting of the corporate veil to look past the corporate persona and into the hearts and minds of those in charge of the organization. In the case of Littlewoods Mail Order Stores Ltd. v/s Inland Revenue Commrs., it was observed that, “The doctrine laid down in Salomon v. Salomon and Salomon Co. Ltd., has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited liability company through which the Courts cannot see. But, that is not true. The Courts can and often do draw aside the veil. They can and often do, pull off the mask. They look to see what really lies behind.” The discretion to pierce the corporate veil lies solely with the courts and therefore, whenever the court is of the opinion that it is necessary to look at the company through its members, it can lift the corporate veil. There are certain instances where the corporate veil can be lifted. These are mentioned below:

1. Fraud or Improper Conduct:

Many a times, companies are incorporated with a fraudulent intention in order defraud some third parties. In such instances, the court has the power to pierce the corporate veil and punish the people behind those illegal activities. It is pertinent to note that such activity must be carried out with the intention to defraud other people. In the case of Adams v/s Cape Industries Plc., it was observed that it is important to determine the motive of such fraud but it is also important to determine the character or nature of the legal right that has been infringed.

2. Group Companies:

Group companies consists of a parent company along with a number of subsidiary companies. When there are a group of companies, there profits and loss, accounts, balance sheets, etc. are treated as one and therefore, all the subsidiaries must be considered as one single economic entity. However, in the case of Adams v/s cape Industries Plc., it was held that every company in the group must be treated as a separate company especially when it comes to the debts of the company. In the Indian case of State of U.P. and Ors. v/s Renusagar Power Co. and Ors. the court observed that the parent company and the subsidiaries have separate legal entities. However, when the corporate veil is lifted, the subsidiary companies appear to be closely linked, as if there are, in fact, part of the same concern.

3. Trust:

The courts have the liberty to pierce the corporate veil of trusts in order to look into the terms under which the shares are held by the trustees.

4. Agency:

The principal or the parent company is bound by the acts of the agents carried out within the scope of authority given to them. If such power or authority is given to the agent through an express agreement then the court can pierce the corporate veil and can hold the principal liable for the acts carried out by the agent. However, in the absence of an agreement, the court will have a difficult time establishing a relationship between the principal and the agent and determining who is at fault.

5. Tax Evasion:

In the event of a tax disparity, such as tax evasion or tax avoidance, the courts can pierce the corporate veil and overlook the company’s legal entity as a separate legal entity.

6. Determination of Enemy Character:

When a country is at war with another country then the citizens of these countries would also become enemies of each other. In the case of Daimler Co. Ltd. v/s Continental Tyre & Rubber Co (Great Britain) Ltd., the court lifted the corporate veil to determine the shareholding of the companies at the time of World War I.

7. Public Interest:

The corporate veil can also be lifted if the court is of the opinion that it is necessary for the public good. For instance: The corporate veil can be raised to punish the actual perpetrators if a large sum of public money is involved and the company is alleged to be involved in fraudulent activities.

Conditions in which Corporate Veil can be lifted

The corporate veil can be lifted under two conditions:

• By Statute
• By Judicial Interpretations

Statutory Provisions

The Companies Act, 2013 provides for various provisions under which the corporate veil can be lifted by the court.

• Section 5 of the act, defines an ‘official who is in default’ as a person who is involved in a transgression or conduct that is considered to be incorrect in practice and who is held at risk in relation to violations.
• Section 45 states that if the members of an organization are found to be less than seven for a public organization and two for private organization, and the company continues to operate for more than half a year even when the count is low, then all the members of the company who are aware of this will be held liable.
• Furthermore, section 147 makes a person liable if he/ she signs any Bill of trade, Hundi, promissory note, etc. in which the name of the organization is not mentioned as per the rules.
• Under section 239, the inspector is vested with the power to inspect into the affairs of all the subsidiary companies of the parent company.
• Section 339 of the act makes every such director, member or officer of the company who were a party of any fraudulent activity or were aware of any fraudulent activity carried out in the company liable. The tribunal has the power to punish such person with imprisonment for up to two years or with a maximum fine of fifty thousand rupees or both on a complaint made by an Official liquidator, Company liquidator or any creditor of the company.
• The Central Government may appoint an inspector to investigate in regard with the membership of an organization under section 216 of the act to determine the actual individuals who are involved in the financial matters of the company. To do so, the Central Government can pierce the corporate veil.

Judicial Interpretations

The judiciary has the power to lift or pierce corporate veil whenever the need arises. The corporate veil can be lifted by the courts under certain circumstances, but they are not exhaustive. The courts can choose to lift the corporate veil at their discretion after considering the facts and circumstances of each case. In the case of Las Palmas Assocs. v/s Las Palmas Ctr. Assocs,the court held that, “If there is one overriding principle in all piercing cases, it is that each one must be decided upon its own facts.” The courts have refrained from lifting or piercing the corporate veil on numerous occasions. The hypothesis, on the other hand, cannot be pushed to abnormal extremes. There must be circumstances that require the court to link a corporation to its employees or officers to lift the corporate veil.

In the case of Subhra Mukherjee v/s Bharat Coking Coal Ltd., even before the company was nationalized, the real estate of the private coal company was being sold to the wives of the executives. For this very reason, many files were tampered with and documents misappropriated. The Hon’ble court was in the favor of piercing the corporate veil in order to discover the parties involved in such a deal and to determine whether the deal was carried out in good faith or as a ‘façade’ for another company.

In another case of Singer India v/s Chander Mohan Chadha, the Hon’ble court observed that the concept of a company having a ‘separate legal entity’ is advanced to promote the trade, commerce and industry and not to carry out illegal or fraudulent activities and therefore, if the court is of the opinion that the business is being established for illicit purposes, it can pierce the corporate veil and uncover who was actually behind the veil, utilizing the company as a means to carry out fraudulent activities.

In the landmark case of Universal Pollution Control (P.) Ltd. v/s Regional Provident Fund Commissioner, the court observed that the company and its sister concern are two different companies as per the Companies Act and there is no provision under the Provident Fund act that the liability of one organization can be imposed on the other related organization by piercing the corporate veil.

In another landmark judgment of Life Insurance Corporation of India v/s Escorts Ltd., the Hon’ble court observed that the corporate veil shall be lifted in cases where the subsidiary or associated companies are directly related and are the part of the parent company. However, no specific list of classes of cases were provided under which veil can be lifted as “that must necessarily depend on the relevant statutory or other provisions, the object sought to be achieved, the impugned conduct, the involvement of the element of public interest and the effect on the parties who may be affected.”

Therefore, the decision rests with the courts to lift the corporate veil of a company after examining all the facts, circumstances and other important elements of the case.

Conclusion

Piercing of the Corporate veil is one of the most important doctrines in the Company law. There are two ways by which the corporate veil can be lifted. One of them is by using statutory provisions which are enumerated under the Companies act, 2013. Another way by which corporate veil can be lifted is when the court is of the opinion that it is necessary to do so.

In the case of Chiranjitial Chaudhary v/s Association of India, the apex court was of the opinion that the fundamental right of life and liberty enshrined under article 21 of the Indian Constitution is also available to the corporate bodies. They are considered as a separate entity possessing several rights such as purchasing and selling properties, carrying out its operations and so on. A company, being an artificial person can also commit crime and as they have been given a status of a person they can also be held liable for the same. However, by lifting or piercing the corporate veil, the courts are infringing on the fundamental rights of the corporation, since we tend to perceive the company as a group of individuals rather than a separate entity.