Lifting of corporate veil

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Lifting of the Corporate Veil Essay

Info: 2953 words (12 pages) Law Essay
Published: 31st Aug 2021

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Jurisdiction / Tag(s): UK Law

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ABSTRACT
From the juristic point of view, a company is a legal person distinct from its members [Salomon
v. Salomon and 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 between the company and its members. That is, the
company has a corporate personality which is distinct from its members. 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.
The rationale behind this is probably that the law will not allow the corporate form to be misused
or abused. 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. Broadly there are two
types of provisions for the lifting of the Corporate Veil- Judicial Provisions and Statutory
Provisions. Judicial Provisions include Fraud, Character of Company, Protection of revenue,
Single Economic Entity etc. while Statutory Provisions include Reduction in membership,
Misdescription of name, Fraudulent conduct of business, Failure to refund application money,
etc. This article at first introduces to the readers the concept of “Veil of incorporation”, then it
explains the meaning of the term-‘Lifting Of The Corporate Veil’, it then points out the Judicial
as well as the Statutory provisions for Lifting of The Corporate Veil with the help of various
case-laws.

Introduction-
Incorporation of a company by registration was introduced in 1844 and the doctrine of limited
liability of a company followed in 1855. Subsequently in 1897 in Salomon v. Salomon &
Company, the House of Lords effected these enactments and cemented into English law the twin
concepts of corporate entity and limited liability. In that case the apex Court laid down the
principle that a company is a distinct legal person entirely different from the members of that
company. This principle is referred to as the ‘veil of incorporation’.

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 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.” And what the Salomon case decides is that ‘in questions of property and
capacity, of acts done and rights acquired or, liabilities assumed thereby…the personalities of the
natural persons who are the companies corporators is to be ignored”.
This theory of corporate entity is indeed the basic principle on which the whole law of
corporations is based. Instances are not few in which the Courts have successfully resisted the
temptation to break through the corporate veil.

But the theory cannot be pushed to unnatural limits. “There are situations where the Court will
lift the veil of incorporation in order to examine the ‘realities’ which lay behind. Sometimes this
is expressly authorized by statute…and sometimes the Court will lift its own volition”.

Meaning Of Lifting Or Piercing Of The Corporate Veil-

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.

Lifting of the corporate veil means disregarding the corporate personality and looking behind the
real person who are in the 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
shell and apply the principle of what is known as “lifting or piercing through the corporate veil.”
And 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. 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 persons.”

In Littlewoods Mail Order Stores Ltd V. Inland Revenue Commrs, Denning observed as follows:

“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”.

Judicial Provisions Or Grounds For Lifting The Veil-

FRAUD OR IMPROPER CONDUCT- The Courts have been more that prepared to pierce the
corporate veil when it fells that fraud is or could be perpetrated behind the veil. The Courts will
not allow the Salomon principal to be used as an engine of fraud. The two classic cases of the
fraud exception are Gilford Motor Company Ltd v. Horne and Jones v. Lipman. In the first case,
Mr. Horne was an ex-employee of The Gilford motor company and his employment contract
provided that he could not solicit the customers of the company. In order to defeat this, he
incorporated a limited company in his wife’s name and solicited the customers of the company.
The company brought an action against him. The Court of appeal was of the view that “the
company was formed as a device, a stratagem, in order to mask the effective carrying on of
business of Mr. Horne” in this case it was clear that the main purpose of incorporating the new
company was to perpetrate fraud. Thus the Court of appeal regarded it as a mere sham to cloak
his wrongdoings.

In the second 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 (Mr. Lipman) 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.

FOR BENEFIT OF REVENUE-“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 assesse 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 assessee purely and simply as a means of
avoiding super tax and the company was nothing more than the assessee 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 assessee as pretended loans”.

ENEMY CHARACTER-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. In Daimler Co.Ltd V. Continental Tyre And Rubber Co.Ltd, 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, residing in Germany. During
the First World War, the English company commenced action for recovery of a trade debt. Held,
the company was an alien 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.

WHERE THE COMPANY IS A SHAM- The Courts also lift the veil where a company is a mere
cloak or sham (hoax).

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.
SINGLE ECONOMIC ENTITY- Sometimes in the case of group of enterprises the Salomon
principal may not be adhered to and the Court may lift the veil in order to look at the economic
realities of the group itself. In the case of D.H.N.food products Ltd. V. Tower Hamlets, it has
been said that the Courts may disregard Salomon’s case whenever it is just and equitable to do
so. In the above-mentioned case the Court of appeal thought that the present case was one which
was suitable for lifting the corporate veil. Here the three subsidiary companies were treated as a
part of the same economic entity or group and were entitled to compensation.

Lord Denning has remarked that ‘we know that in many respects a group of companies are
treated together for the purpose of accounts, balance sheet, and profit and loss accounts. Gower
too in his book says, “There is evidence of a general tendency to ignore the separate legal
group”. However, whether the Court will pierce the corporate veil depends on the facts of the
case. The nature of shareholding and control would be indicators whether the Court would pierce
the corporate veil. The Indian Courts have held that a ‘single economic unit’ argument could
work in certain circumstances. These circumstances would depend on the factual control
exercised. This view is strengthened by the Supreme Court decision (cited in Novartis v. Adarsh
Pharma) in New Horizons v. Union of India. State of UP v. Renusagar was decided in 1988.
Back in the year 1988 also, in Renusagar case, the Court proceeded, on the basis of prior English
law which had accepted the ‘single economic unit’ argument. Thus, Renusagar case seems to
support the conclusion that a ‘single economic entity’ argument would succeed in India for
lifting the corporate veil.

AGENCY OR TRUST- Where a company is acting as agent for its shareholder, 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 an agent for its shareholders. There may be an Express agreement to this
effect or an agreement may be implied from the circumstances of each particular case. In the
case of F.G.Films ltd, An American company financed the production of a film in India in the
name of a British company. The president of the American company held 90 per cent of the
capital of the British company. The Board of trade of Great Britain refused to register the film as
a British film. Held, the decision was valid in view of the fact that British company acted merely
as he nominee of the American Company.

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.

PUBLIC INTEREST- The Courts may lift the veil to protect public policy and prevent
transactions contrary to public policy. The Courts will rely on this ground when lifting the veil is
the most ‘just’ result, but there are no specific grounds for lifting the veil. Thus, where there is a
conflict with public policy, the Courts ignore the form and take into account the substance.

Statutory Provisions For Lifting The Veil-

REDUCTION OF NUMBER OF MEMBERS- Under Section 45 of The Indian Companies Act,
1956, if a company carries on business for more than six months after the number of its members
has been reduced to seven in case of a public company and two in case of a private company,
every person who knows this fact and is a member during the time that the company so carries
on business after the six months, becomes liable jointly and severally with the company for the
payment of debts contracted after six months. It is only that member who remains after six
months who can be sued.

FRAUDULENT TRADING- Under Section 542 of The Indian Companies Act, 1956, if any
business of a company is carried on with the intent to defraud creditors of the company or
creditors of any other person or for any fraudulent purpose, who was knowingly a party to the
carrying on of the business in that manner is liable to imprisonment or fine or both. This applies
whether or not the company has been or is in the course of being wound up. This was upheld in
Delhi Development Authority v. Skipper Constructions Co. Ltd. (1997).

MISDESCRIPTION OF THE COMPANY- Section 147 (4) of The Indian Companies Act, 1956,
provides that if any officer of the company or other person acting on its behalf signs or
authorizes to be signed on behalf of the company any bill of exchange, promissory note,
endorsement, cheque or order for money or goods in which the companies name is not
mentioned in legible letters, he is liable to fine and he is personally liable to the holder of the
instrument unless the company has already paid the amount.

PREMATURE TRADING- Another example of personal liability is mentioned in Section 117

(8) of The English Companies Act. Under this section a public limited company newly
incorporated as such must not “do business or exercise any borrowing power” until it has
obtained from the registrar of companies a certificate that has complied with the provisions of
the act relating to the raising of the prescribed share capital or until it has re-registered as a
private company. If it enters into any transaction contrary to this provision not only are the
company and it’s officers in default , liable to pay fines but if the company fails to comply with
its obligations in that connection within 21 days of being called upon to do so, the directors of
the company are jointly and severally liable to indemnify the other party in respect of any loss or
damage suffered by reason of the company’s failure.

FAILURE TO REFUND APPLICATION MONEY-According to Section 69(5) of The Indian

Companies Act, 1956, the directors of a company are jointly and severally liable to repay the
application money with interest if the company fails to refund the money within 130 days of the
date of issue of prospectus.

HOLDING AND SUBSIDIARY COMPANIES- In the eyes of law, the holding company and its
subsidiaries are separate legal entities.

But in the following two cases the subsidiary may lose its separate entity-

Where at the end of its financial year, the company has subsidiaries, it must lay before its
members in general meeting not only its own accounts, but also attach therewith annual accounts
of each of its subsidiaries along with copy of the board’s and auditor’s report and a statement of
the holding company’s interest in the subsidiary.

The Court may, on the facts of a case, treat a subsidiary as merely a branch or department of one
large undertaking owned by the holding company.

Conclusion-
Thus it is abundantly clear that incorporation does not cut off personal liability at all times and in
all circumstances. “Honest enterprise, by means of companies is allowed; but the public are
protected against kitting and humbuggery”. The sanctity of a separate entity is upheld only in so
far as the entity is consonant with the underlying policies which give it life.

Thus those who enjoy the benefits of the machinery of incorporation have to assure a capital
structure adequate to the size of the enterprise. They must not withdraw the corporate assets or
mingle their own individual accounts with those of the corporation. The Courts have at times
seized upon these facts as evidence to justify the imposition of liability upon the shareholders.

The act of piercing the corporate veil until now remains one of the most controversial subjects in
corporate law. There are categories such as fraud, agency, sham or facade, unfairness and group
enterprises, which are believed to be the most peculiar basis under which the Law Courts would
pierce the corporate veil. But these categories are just guidelines and by no means far from being
exhaustive.

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