LIFTING OR PIERCING THE CORPORATE VEIL
From the juristic point of view, a company is a legal person distinct from its
members [Salomon v. Salomon & Co. Ltd., (1897) A.C. 22]. This principle may be
referred to as ‘the veil of incorporation’. The Courts in general consider themselves
bound by this principle. The effect of this principle is that there is a fictional veil
(and not a wall) between the company and its members. The company has a
corporate personality which is distinct from its members. The corporate veil
protects the members from the liability of the company. The human ingenuity,
however, started using this 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 or crack the shell of corporate personality and
look at the persons behind the company who are the real beneficiaries of corporate
fiction.
Exceptions: The various cases in which corporate veil have been
lifted are as follows:
1. Protection of revenue.
The Courts may ignore the corporate entity of a company where it is used for
tax evasion [Juggilal v. Commr. of Income-tax, A.l.R. (1969) S.C. 982]. Tax
planning may be legitimate provided it is within the framework of law. Colorable
devices cannot be considered a legitimate part of tax planning. Sir Dinshaw
Maneckjee Petit, Re, A.l.R. (1927) Bom. 371.
D, an assessee, who was receiving huge dividend and interest income,
transferred his investments to four private companies formed for the purpose of
reducing his tax liability. These companies transferred the income to D as a
pretended loan. Held, the companies were formed by D purely and simply as a
means of avoiding tax obligation and the companies were nothing more than the
assessee himself. They did no business but were created simply as legal entities to
ostensibly receive the dividends and interest and to hand them over to D as
pretended loans.
2. Prevention of fraud or improper conduct.
The legal personality of a company may also be disregarded in the interest of
justice where the machinery of incorporation has been used for some fraudulent
purpose like defrauding creditors or defeating or circumventing any law. Jones v.
Lipman, (1962) All E.R. 442,
L agreed to sell a certain land to J. He subsequently changed his mind and to
avoid the specific performance of the contract, he sold it to a company which was
formed specifically for the purpose. The company had L and a clerk of his
solicitors as the only members. J brought an action for the specific performance
against L and the company. The Court looked to the reality of the situation,
ignored the transfer, and ordered that the company should convey the land to J.
3. Determination of character of a company whether it is enemy.
A company may assume an enemy character when persons in de facto control
of its affairs are residents in an enemy country. In such a case, the Court may
examine the character of persons in real control of the company, and declare the
company to be an enemy company. Daimler Co. Ltd. v. Continental Tyre &
Rubber Co. Ltd., (1916) 2 A.C. 307.
A company was incorporated in England for the purpose of selling in England
tyres 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, resident in Germany. During the First World War, the
English company commenced an action for recovery of a trade debt. Held, the
company was an enemy company and the payment of debt to it would amount to
trading with the enemy, and therefore the company was not allowed to proceed
with the action.
4. Where the company is a sham.
The Courts also lift the veil where a company is a mere cloak or sham (hoax).
The following case illustrates the point: Gilford Motor Co. Ltd. v. Horne, (1933)
Ch. 935 C.A.
Horne, a former employee of a company, was subject to a covenant not to
solicit its customers. He formed a company to carry on a business which, if he had
done so personally, would have been a breach of the covenant. An injunction was
granted both against him and the company to restrain them from carrying on the
business. The company was described in this judgment as ‘a device, a stratagem’,
and as “a mere cloak or sham for the purpose of enabling the defendant to commit
a breach of his covenant against solicitation.”
5. Company avoiding legal obligations.
Where the use of an incorporated company is being made to avoid legal
obligations, the Court may disregard the legal personality of the company and
proceed on the assumption as if no company existed.
6. Company acting as agent or trustee of the shareholders.
Where a company is acting as agent for its shareholders, the shareholders will
be liable for the acts of the company. It is a question of fact in each case whether
the company is acting as agent for its shareholders. There may be an express
agreement to this effect or an agreement may be implied from the circumstances of
each case.
7. Avoidance of welfare legislation.
Avoidance of welfare legislation is as common as avoidance of taxation and the
approach of the Courts in considering problems arising out of such avoidance is
generally the same as avoidance of taxation. It is the duty of the Courts in every
case where ingenuity is expended to avoid welfare legislation to get behind the
smokescreen and discover the true state of affairs.
8. Protecting public policy.
The Courts invariably lift the corporate veil to protect the public policy and prevent
transactions contrary to public policy or public interest. Thus, where there is a
conflict with public policy, the Courts ignore the form and take into account the
substance [Connors v. Connors Ltd., (1940) 4 All E.R. 174].
Statutory Exceptions
1. Misstatement in Prospectus (Secs. 34 & 35).
In case there is any misstatement in prospectus, the company and every
director, expert, promoter and any other person who was involved in the issue of
prospectus shall be liable to compensate for loss or damage to every person who
subscribed to shares on believing the untrue statement published in the prospectus.
2. Failure to refund application money (Sec. 39).
No allotment of any shares of a company offered to the public for subscription
shall be made unless the amount stated in the prospectus as the minimum amount
has been subscribed and the sums payable have been paid to and received by the
company. If the amount of minimum subscription is not received within 30 days
from the date of issue of prospectus or such other period as may be specified by
SEBI, the amount shall be returned within such time as may be prescribed. In case
of default, the company and its officer who is in default shall be liable to a penalty,
for each default, of `1,000 for every day of default or `1,00,000 whichever is less.
3. Holding and subsidiary companies [Sec. 129 (3)].
In the eyes of the law, the holding company and its subsidiaries are separate
legal entities.Each of the company has a separate corporate veil. Just because a
company is a holding company it does not mean that the holding company and the
subsidiary companies within it, all constitute one company except to the extent that
the statute indicates the nature of holding company and the subsidiary company,
the corporate veil remains [CDS Financial Services (Mauritius) Ltd. v. BPL
Communications Ltd. (2004)].
However, a subsidiary company may lose its separate identity, first, to present a
better picture of the group as a whole as per Section 129 (3) and, second, when the
Court opines that profits of subsidiary company as well as its control is completely
with the nominees of the holding company.
4. Fraud or Diversion of Funds (Sec. 339).
Concept of lifting the corporate veil can be invoked by the courts in case of
frauds and diversion of funds. Sometimes in the course of winding up of a
company, it may appear that some business of the company has been carried on
a) with intent to defraud creditors or any other person; or
b) for any fraudulent purpose. In such a case, the Tribunal may declare that any
persons who were knowingly parties to the carrying on of the business in
this way are personally liable.
In case of Atul Gupta (HUF) v. Trident Projects Ltd. (2010), it was held that in
case where the corporate veil is lifted, the law goes behind the corporate
personality of individual members or ignores the separate personality of each
company in favour of an entity incorporated by a group of associated companies
for an economic purpose. Fraud, therefore, is a necessary element for lifting the
corporate veil.
5. Investigation of ownership of the company (Sec. 216).
The Central Government on its own or on orders of the Tribunal may appoint
one or more inspectors to investigate on matters relating to its membership for the
purpose of determining the true person –
a) who are or have been financially interested in the success or failure, whether
real or apparent, of the company, or
b) who are or have been able to control or to materially influence the policy of
the company, or
c) who have or had beneficial interest in shares of a company or who are or
have been beneficial owners or significant beneficial owners of a company.
6. Ultra vires acts.
Concept of lifting corporate veil can be invoked when the directors and other
officers of the company are involved in acts which are ultra vires the company. In
this case, every director and officer involved will be personally liable for the acts
done on behalf of the company.
