The Doctrine of Lifting the Corporate Veil: Its Legal and Judicial recognition in India

Abstract

The word ‘Company’ can be described as a collaboration of people who come together to pursue the same goal or to carry out similar business activities. A company is an artificial juristic person having characteristics such as separate legal entity, limited liability of members, perpetual succession, etc. The rules governing companies in India are prescribed under the Companies Act, 2013. With the growing trend in the economy, technology, and globalization, there is a tremendous increase in cases of corporate frauds and insider trading worldwide. To overcome  such frauds there is a concept of ‘Piercing of corporate Veil’. The concept came to uncover real offenders who hide behind the corporate shield. This doctrine acts as a statutory privilege given to the companies. Persons responsible shall not be allowed to take shelter behind the company instead they will be held liable personally for their fraudulent acts. The given article focuses on the concept of lifting the corporate veil and the relevant case laws.

KEYWORDS: Corporate veil, Company, Separate legal entity, Perpetual succession

Introduction

The concept of piercing the corporate veil for the first time was introduced in the case of Salomon in 1897. This doctrine plays a vital role in cases of corporate fraud because it is very important to punish the real offender. In Salomon’s case, the characteristic of a company as a separate legal entity was described and it was held that the company is separate from its members and subscribers. Subscribers of a company cannot be held liable just because they subscribed to the Memorandum of Association or having majority shareholding. A person can be a creditor and owner at the same time in a company. The benefits of incorporation can be enjoyed only for the collective benefit of the company and its members.

Some common examples where the veil may be pierced by the courts:

• Inaccurate corporate records
• Poor corporate governance
• Manipulation of assets and liabilities
• Concealment of facts and disclosures
• Inappropriate accounting policies

Corporate Personality

Corporate personality means the company is having a separate legal entity, distinct from its members and creators. A corporation is an artificial juristic person having rights and liabilities such as:

• Right to possess the property in its own name.
• Right to sue and be sued in its own name.
• Like a natural person, the company is also liable to pay taxes and other statutory duties.
• Right to contract in its own name.
• Liability to repay loans and creditors.

In Salomon v. Salomon and Co. Ltd.[1]

Facts: Salmon was a leather merchant and a boot manufacturer. He formed a limited company consisting of himself, his four sons, his wife, and his daughter as the shareholders of the company with total capital of 7 Pounds. Later on Salmon sold his solvent business to the limited company which was formed by him for the sum of 38782 pounds; out of this the Debentures of 10000 pounds were secured by floating charge on the Company’s Assets. Later, the company ran into difficulties & Debenture holders appoints a receiver and the company went into liquidation.

Issue: Whether a shareholder or a controller of a company could be held personally liable for the debts?

Judgment: The House of Lords decided that being a Separate Legal identity, both the Shareholders and Company are different persons, they are not the same in the eyes of law. So, Mr. Salmon will not be held personally liable for all the debts of the company.

Limited Liability

Another important Characteristic of a Company or Corporation is Limited Liability. This feature attracts investors to invest in a company. Under this Principle, the liability of a member is limited up to the extent of unpaid shares held by him. For example, if Mr. A holds 100 shares of Rs. 10 each at par and has already paid Rs. 5 on each, now his liability extends to remaining Rs.500 only i.e., unpaid value of the shares held by him.

Meaning of the Doctrine of Lifting the Corporate Veil

The statutory privilege of corporate personality given to the companies must be used for legitimate purposes only. When the said privilege is used to hide wrongful or fraudulent conduct, the court shall remove the veil or pierce the veil of the corporation. This concept is called piercing of the corporate veil. Salomon’s case is a classic example of this doctrine. Further in Lee v. Lee Air Farming Ltd., it was held that Lee was owner, director, and worker in the company at the same time and the contract of service between Lee and the company was valid. A person can be a master and a servant at the same time in the company.

However, the shareholders are not allowed to take advantage of this doctrine for their personal benefits. This was held in Premlata Bhatia v. Union of India (2004).[2]

The Karnataka high court, in the case of tax evasion, used this doctrine to look into the real nature of the case and the transactions involved therein. [Richter Holding v. The Assistant Director of Income Tax][3]

The two circumstances under which the corporate veil of the company may be lifted are:

• Statutory Provisions
• Judicial Interpretation

Statutory Provisions: The Companies Act, 2013  

Reduction in Membership [Section- 3A]: If at any time, the minimum requirement of members in a company as prescribed in section 3(1) is reduced below its statutory requirement, the remaining members need to fulfil the criteria of minimum requirement within six months. Otherwise, the remaining members shall be severely liable for all the debts taken after the expiry of six months from the date of reduction.

Misrepresentation in the prospectus: Under sections 34 and 35 of the Act, there is civil and criminal liability for false representation in the prospectus.  Every director, promoter, and every other person who is in charge of the issue of prospectus shall be held liable for such misrepresentation.

Misdescription of name [Section-147]: If an officer of a company signs any document such as bill of exchange, promissory note, hundi, cheque, etc., on behalf of the company and the name of the company is not mentioned in such document in a manner prescribed, then the person signing shall be held personally liable to the holder of such instrument.[4]

Failure to return Application money [Section-39]: If the minimum subscription as stated in the prospectus has not been subscribed within the prescribed time, the company must refund the entire application money to the applicants. If the company fails to do so, the directors shall be jointly or severely held liable to return interest and the application money.

Fraudulent conduct [Section-339]:   If at the time of winding-up of a company, it come into view that any business of the company has been carried on with intent to defraud creditors of the company, the person, who is or has been a director, manager, or officer of the company or any other person shall be personally responsible, without any limitation of liability, for all the debts of the company as the Tribunal may direct.[5]

Ultra-vires Acts: In case, if any action is done beyond the powers (MOA) of the company, the directors or officers intended to do so will be held personally liable for their acts.

Judicial Interpretations

Corporate façade only an agency instrumentality [Jones v. Lipman (1962)]: In the given case, Lipman transferred his property in the name of the company to avoid fulfillment of the contract. Therefore, he was held liable for the non-fulfillment of the specific performance of the contact. Lipman and the company shall be treated the same by creating an exception to the principle of corporate personality.

Public Policy [Re R.G. Films Ltd. (1953)]: In this case, the Board of Trade refused to register a film in India in the name of a British company. The film was actually produced by an American company in the name of a British company and this was in conflict with the public policy.

Tax Evasion [Re. Sir Dinshaw Maneckjee Petit (1927)]:  In the given case, the assessee divides his income into four parts to reduce his tax liability. He formed four companies as a means of avoiding super tax and did no business at all. Therefore, the court disregarded the corporate entity and held the assessee liable for tax evasion.

Conclusion

Whenever it is proved that the sole purpose for which the company is formed is fraudulent, misrepresentation, or any other purpose like tax evasion, the court will ignore the character of corporate personality and make officers concerned liable for their actions. The corporate veil could be lifted in cases allegedly opposed to justice and against public policy. Corporate personality is a boon for the company and lifting of corporate veil is like a shield that protects the identity of a company and helps in punishing the real offenders.

[1] Salomon v. Salomon & Co. Ltd., [1897] AC 22

[2] Company Law (2018-2019), ICSI Module

[3] Writ Petition No. 7716/2011 decided on 24.03.2011

[4]Simran Singh Chandel, https://lawbhoomi.com/lifting-of-corporate-veil-of-the-companies-in-india/ accessed: Jan 06, 2021

[5]The Companies Act, 2013, Bare Act https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf accessed: July10, 2021