In a legal context, the shareholders of the company and the members are considered as an altogether different legal entity. Like every other person, the shareholders or members may also have contracts with the company. Further, other parties that own every stake of the business do not take responsibility for its behaviour. Corporate assets as well as the corporation liabilities are the property of the company and this makes it that the company have a veil that separates it from its shareholders. Nevertheless, this division is not absolute. On very limited circumstances, the nature of the veil may be pierced to determine the true intention of the shareholders or the directors.
What is meant by Lifting of Corporate Veil?
Lifting the corporate veil also known as piercing the corporate veil, is a legal doctrine that enables the court to ignore the legal separate entity aspect of a corporation. This enables courts to provide legal responsibility in individual cases to shareholders or directors and make them take responsibility for the corporations’ debts and responsibilities. Although, the doctrine of separate legal personality puts the shareholders beyond the direct reach of the law in most occasions there are occasions where such structure is exploited.
The case of Salomon v. Salomon & Co. Ltd.
The landmark case showcased this principle by demonstrating a company's separate legal entity. Salomon sold his business to the newly formed company, shares of which were allotted to Salomon and certain family members. Into company debenture transactions, a creditor tried to state that Salomon and his company were one as it went bankrupt. But then, the court declared that Salomon and the company were separate, enabling Salomon to uphold his rights as debenture holder.
This principle highlights that a corporate veil exists between a company and its members with which the courts usually do not interfere. However, courts may pierce this veil when corporate structure is misused for fraudulent or immoral reasons.
The circumstances under which the courts may lift the corporate veil may be discussed under the following two heads:
- Common Law Exceptions or (Judicial interpretations
- Statutory Provisions Exceptions
Common Law Exceptions or (Judicial interpretations):
Determination of Enemy Character of a Company
- The Tribunal/Court lifts the corporate veil to determine the enemy character of a company and examine the real promoters of the company.
- If the company’s management is hostile aliens or residents acting under the instruction of hostile aliens, then the Tribunal has the power to pierce the corporate veil and take a look at the ‘real’ company.
- Case: Daimler Co. Ltd. v Continental Tyre and Rubber Co. Ltd., the Defendants In World War I business, Daimler Co., which was controlled by Germans, was an enemy company thus their operations in England were prohibited.
Where company is a sham
- The court will lift the veil where the company is a mere cloak or sham i.e. where the device of incorporation is used for some illegal or improper purpose.
- Case: Gilford Motor Co. Ltd. v. Horne
Horne violated a restraint of trade by creating a firm to lure customers that he used to deal with while at his former employer’s firm. The court discovered that the company was only a sham and thus granted an injunction.
Prevention of Fraud and Improper Conduct
- If any company goes on in a fraudulent and improper manner, then the Tribunal has the right to disregard the several corporate entity personality and may take the company and its members as one body.
- Case: Jones VS. Lipman
Lipman had contracted to sell his land to Jones, but later changed his mind. To evade the contract, he formed a company and sold his land to it. The court held the seller of land and the company were one and the same entity, and made him sell his land to Jones with whom he had made the commitment in the first place.
- Where the company is acting as the agent of the shareholders
- Where a company is acting as an agent of its shareholders or of another company, it will be liable for its acts.
- Case: Re F.G. Films Ltd.
A British company was found to be a nominee for an American company, with its corporate veil pierced to reveal its true nature.
Protection of revenue
- The court can also pierce the corporate veil if it is established that the formation of the company was with intent to allow member to avoid paying taxes.
- Case: Sir Dinshaw Mancekjee Petit
D was a wealthy man getting huge dividend and interest income. In order to avoid super tax, he formed four private companies and transferred his investments in part to each of the four companies in exchange of their shares.
Thus, he divided his income in four parts to avoid tax liability. The court held that as the companies did no business, the four companies were formed purely and simply as a means of avoiding tax.
Avoidance of welfare legislation
- Avoidance of welfare legislation is as common as the avoidance of taxation. Where the sole purpose for the formation of the new company was to use it as a device to reduce the amount to be paid by way of bonus, the Supreme Court upheld the piercing of the veil to look at the real transaction.
- Case: Workmen of Associated Rubber Industry VS. Associated Rubber Co.
A subsidiary was formed to split the profits of the company so that the incidence of bonus in the hands of the parent company will be reduced. The Supreme Court disregarded the existence of a separate company for the purpose of working out bonus for its employees.
Protecting Public Policy
- The Courts invariably lift the corporate veil or a disregard the corporate personality of a company to protect the public policy and prevent transactions contrary to public policy.
- Case: Daimler Co. Ltd. v. Continental Tyre and Rubber Co. Ltd.
As noted earlier, the corporate veil was lifted to ensure compliance with public policy during wartime.
Statutory Provisions/Exceptions
Reduction of Number of Members below the Statutory Limits
- According to the Companies Act, where at any time the number of members is reduced under the prescribed statutory minimum for a company (that is, below seven in case of a public company and below two in the case of a private company), the company continues to carry on business for more than six months after the reduction of the number of members, then every member who knows this fact becomes personally liable for all the contracts incurred by the company during that period.
- With the lifting of the corporate veil, its members also become liable for the company debts despite of showing limited liability.
Liability for Fraudulent Conduct of Business (Section 339)
- If in the course of winding up of a company it turns out that anything of the undertaking of the company has been carried with the intent to defraud the creditors or for any fraudulent purpose the Court may declare that any persons who have participated in such fraudulent carrying on of the business shall be personally liable for all the debts or other obligations of the company.
Liability for Ultra Vires Acts
- Ultra vires means beyond one’s power or authority. The directors of a company are personally liable for the ultra vires acts even if they are committed for and on behalf of the company.
Investigation of Ownership of Company (Section 216)
- The Central Government may appoint one or more inspectors to examine and report on any matter relating to the membership of the company and any other matter relevant to establishing the persons behind the company who has interest in the fortunes of the company, or control or affecting the policy of the company.
Mis-Description of Company's Name (Section 12)
- Where the name of the company and the address of its registered office has not been properly and clearly written or a wrong name has been filled up on any document or an agreement or a contract has been entered into in a wrong name, The persons actually guilty of such an offense shall be personally responsible for the consequences of such an offense notwithstanding the fact that such contract was in the name of the company.
- For instance, if a functionary of a company signs for a promissory note of the company using the wrong Company’s name on the promissory note, he will be held personally liable for the promissory note.
Mis-statements in Prospectus (Section 34 & 35)
- According to the Companies Act, any prospectus containing any untrue statement shall be due to pay compensation to every subscriber of the prospectus for any loss resulting from the subscription of the shares on the basis of a prospectus containing any untrue statement.
Failure to Refund Application money (Section 39)
- A current liability of a company is that in case of non-allotment of their share, the applicants of shares are to be refunded the amount they tendered to the company.
- Any such money which is not repaid within 15 days from the date of closure of issue. Where such money is not refunded to applicants who have not been allotted any shares the directors of the company shall be personally liable with 15% interest jointly with the company.
Conclusion
There is always an overlying principle which states that the veil is intended to preserve the legal entity of a company from its members. Nevertheless, the veil in this case can be pierced by the courts in circumstances where fraud, misrepresentation or statutory infringement has occurred with a view of ensuring that justice is done. It has been emphasized that the doctrine protects creditors, employees, or public policy from misuse of the corporate structure.
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