Lifting of Corporate Veil

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A company is an artificial person is clothed with a corporate veil. It cannot act on its own, it can act only through natural persons i.e. through the Directors. The corporate veil separates the company from its shareholders. This concept of corporate veil is applied in Solomon v. Solomon case, Lee v. Lee’s Air Farming Ltd. But the theory cannot be pushed to unnatural limits. Circumstances must occur which compel the Court to identify a company with its members. There are certain circumstances when the lifting of corporate veil becomes necessary.

The separate personality of the company and its statutory privileges should be used for legitimate purposes only. Where the legal entity of the company is being used for fraudulent and dishonest purpose, the individuals concerned will not be allowed to take the shelter behind the corporate personality. The court in such cases shall break through the corporate shell and apply the principle of what is known as “piercing or lifting of corporate veil”. Thus lifting of corporate veil refers to the possibility of looking behind the company’s framework (or behind the company’s separate personality) to make the members liable, as an exception to the rule that they are normally shielded by the corporate shell.

In Gallagher v. Germania Brewing Co. 53 Minn 214 case, the Court commented: “for while, by the 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 Tunstall v. Steigmann, (1962) 2 QB 593 case, a landlady’s bid to regain tenanted premises for self business could not succeed as the business was in the name of her company.

In State of Karnataka v. Selvi J. Jayalalitha, (2017) 201 Comp. Cas 230 (SC) case, the Court held that the company is a separate entity from members subject to the exception when the corporate entity is a mere cloak or sham used to misdirect shareholders and authorities.

In Life Insurance Corporation of India v. Escorts Ltd., [1986] 59 Comp. Cas. 548 case, the Court said: “It is neither necessary nor desirable to enumerate the classes of cases where lifting the veil is permissible, since 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, the effect on parties who may be affected, etc.”.

When Corporate Veil Can Be Lifted?

Lifting of Corporate Veil

There are certain instances in which justice cannot be made until the corporate veil is lifted. The main instances where the doctrine of lifting the corporate veil is applied are as follows:

Determination of Real Character of a Company/ Trading With the Enemy:

A company is an artificial person. It has no nationality. As it is not natural it cannot be loyal or disloyal similarly, it cannot be a friend or an enemy. Even in times of war, it should not be classified as “Enemy”. But it becomes necessary to find the nationality and interest of the people having control over the company. Thus at the time of war, it may become necessary to lift the corporate veil of a company to determine whether the company has an enemy character. In such a case the courts may in their discretion examine the character of persons who are in real control of the corporate affairs of the company.

In Daimler Co. Ltd. v. Continental Tyre & Rubber Co., (1916)2 AC 307case, a company was incorporated in England for the purpose of selling tyres manufactured in Germany by a German company, all the shares except one were held by the German subjects residing in Germany. The remaining one share was held by a British subject who was the Secretary of the company. Thus the real control of the English company was in German hands. During World War I, the company commenced an action to recover trade debts. The Court observed that since the real control of the “English Company” was in German hands, it would be considered to be of enemy nationality, and the company would not be allowed to file a suit in England to recover a trade debt, as England was at war with Germany.

In Subhra Mukherjee v. Bharat Cooking Coal Ltd., (2000) 3 SCC 312 case, On the nationalization of the coal mines of a company, it was found that it has sold an item of its immovable property to the wife of one of the directors. The Court has observed that the Court will be justified in piercing the veil of incorporation in order to ascertain the true nature of the transaction as to who the real parties to the sale were and whether it was between husbands and wives behind the facade of separate entity of the company.

For the Benefit of Revenue:

The Court has the power to disregard corporate entity if it is used for tax evasion or to circumvent tax obligations.

In Re. Dinshaw Maneckjee Petit, AIR 1927 Bom 371 case, the assessee 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 which was never repaid. This way he divided his income into four parts in a bid to reduce his tax liability. The Court observed that “the companies were formed by the assessee purely and simply as a means of avoiding 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”. The Court made him liable to be taxed on the aggregate income.

In Bacha F. Guzdar v. Commissioner of Income Tax Bombay, 1955 AIR SC 740 case, under the tax laws in force at that time, agricultural income was exempted from the tax but dividend income was not. The plaintiff got dividends on her shareholding in a tea company. Her plea was that as the dividend is given by the company from agricultural income, it should be made tax free. The Court held that for the company it is agricultural income but for the shareholder, it is dividend income. Hence for shareholders, the dividend income is taxable.

In Commissioner of Income Tax v. Associated Clothiers Ltd., AIR 1963 Cal 629 case, The assesses, Associated Clothiers, formed a company holding all its shares. They sold separate premises to the new company. The difference between the selling price and the cost of the property in the hands of assesses was assessed as their income. Assesses contended that it was not a commercial sale but only transfer from self to self. The Court held that it is a sale from one entity to another and not trading with oneself.

In Vodafone International Holdings BV v. Union of India (2012) 6 SCC 613 case, the Court observed that the principle of lifting the corporate veil is applied where the facts reveal that the companies (holding and subsidiary) are indulging in dubious methods for tax evasion.

In Apthrope v. Peter Schoenhofen Brewing Co. Ltd., (1899) 4 TC41 case, aliens were not allowed to hold land in New York. An English company acquired the business and assets of a New York Company. But the American company was kept on foot to hold the land. The business was financed and run by the English company. The Court held that the American company had become the agent of the English company and therefore, the whole of its profits was liable to be taxed as the income of the English company.

In Radhey Mohan Sharma v. CIT, 2014 SCC Online Guj 1329 case, the Court held that the directors of a public company cannot be made liable for tax dues of the company. Principles go0verning piercing of the corporate veil was not applicable to the facts of the case.

Under Statutory Provisions:

Under the Companies Act, the individual person committing a wrong or an illegal act to be held liable in respect of offenses as ‘officer who is in default’. This section gives a list of officers who shall be liable to punishment or penalty under the expression ‘officer who is in default’ which includes a managing director or a whole-time director.

Misstatements in Prospectus:

Under Section 26 (9), Section 34 and Section 35 of the Act, it is made punishable to furnish untrue or false statements in the prospectus of the company.

Failure to Return Application Money:

Under Section 39 (3) of the Act, against allotment of securities, if the stated minimum amount has not been subscribed and the sum payable on the application is not received within a period of thirty days from the date of issue of the prospectus, then such officers are liable for punishment.

Reduction of Membership Below Statutory Minimum:

This section lays down that if the members of a company is reduced below seven in the case of a public company and below two in the case of a private company and the company continues to carry on the business for more than six months, while the number is so reduced, every person who knows this fact and is a member of the company is severally liable for the debts of the company contracted during that time. It is only that member who remains after six months who can be sued.

In Nisbet v. Shepherd (1994) 1 BCLC 300 case, the member himself purchases the shares of the only other member of the company. The Court held that a member of a company became liable severally and jointly with the company for the debt incurred during the period when he was the sole member of the company.

In Madan Lal v. Himatlal & Co. (1997) 1 Comp LJ 399 case, the respondent filed suit against a private limited company and its directors for recovery of dues. The directors resisted the suit on the ground that at no point of time the company did carry on business with members below the legal minimum and therefore, the directors could not be made severally liable for the debt in question. It was held that it was for the respondent being dominus litus, to choose persons of his choice to be sued.

Misdescription of Name of the Company:

Under the Act, an officer of a company who signs any bill of exchange, hundi, promissory note, cheque wherein the name of the company is not mentioned in the prescribed manner, such officer can be held personally liable to the holder of the bill of exchange, hundi etc. unless it is duly paid by the company.

In Hendon v. Adelman, 1973 New LJ 637 case, the directors of the company were made liable for stating the company’s name as “L R Agencies Ltd.” on a cheque when the actual name of the company was “L & R Agencies Ltd.”

In Dermatine Co. Ltd. v. Ashworth, (1905) 21 TLR 510 case, when a rubber stamp of a company put on a bill of exchange did not contain the word “Ltd.”, because the rubber stamp was longer than the space available on the bill. The Court held that this was not intentional misdescription of the company’s name and directors would not be personally liable.

Under Section 216 of the Act, the Central Government is authorized to appoint inspectors to investigate and report on matters relating to the company, and its membership for the purpose of determining the true persons who are financially interested in the success or failure of the company; or who are able to control or to materially influence the policies of the company..

Inducing Persons to Invest Money in the Company:

Under Section 36 of the Act, any person who makes false, deceptive, misleading or untrue statements or promises to any other person or conceals relevant data from other people with a view to induce him to enter into either of following:-

  1. An agreement of acquiring, disposing, subscribing or underwriting securities.
  2. An agreement to secure profits to any of the parties from the yield of securities or by reference to fluctuations in the value of securities.
  3. An agreement to obtain credit facilities from any bank or financial institution.

In such circumstances, the corporate personality can be ignored with a view to identify the real culprit and make him personally liable under Section 447 of the Act accordingly.

Furnishing False Statements:

Under Section 448 of the Act, if in any return, report, certificate, financial statement, prospectus, statement or other document required, any person makes false or untrue statements, or conceals any relevant or material fact, then he is liable under Section 447 of the Act.

Repeated Defaults:-

Under Section 449 of the Act, if a company or an officer of a company commits an offence punishable either with fine or with imprisonment and this offence is being committed again within a period of 3 years, such company and officer are liable for punishment.

Fraud or Improper Conduct:

Section 339 imposes liability for fraudulent conduct of the company’s business. According to this Section “If in the course of the winding-up of a company, it appears that any business of the company has been carried on with intent to defraud creditors of the company or any other persons or for any fraudulent purpose, the Tribunal, on the application of the Official Liquidator, or the Company Liquidator or any creditor or contributory of the company, may, if it thinks it proper so to do, declare that any person, who is or has been a director, manager, or officer of the company or any persons who were knowingly parties to the carrying on of the business in the manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Tribunal may direct”. This principle was used in re.  William C. Leitch Bros Ltd., (1932) 2 CH 71 (ChD).

In Gilford Motor Company Ltd v. Horne 1933 Ch 935 (CA) 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 during employment or at any time thereafter. In order to defeat this, he incorporated a limited company in his wife’s name and solicited the customers of the company. His wife and another employee were the main shareholders and the directors of the company. Although it was in their name, Horne was the main controller of the business  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 the business of Mr. Horne” in this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud.  Refusing to accept that Horne and the company formed by him were two distinct entities, the Court held that “this company was a mere cloak or sham for the purpose of enabling the defendant to commit a breach of his covenant against solicitation”.

In Jones v. Lipman case, 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. The Court 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.

Holding and Subsidiary Companies:

Under Section 129 of the Companies Act, 2013 a company is required to prepare a consolidated financial statement of the company and all its subsidiaries, and such a statement is to be placed before its members at the annual general meeting of the company.

In Bajrang Prasad Jalan v. Mahabir Prasad Jalan  [2000] 6 Comp LJ 377 case, the Court held that for the purpose of considering a complaint of oppression held that the corporate veil can be lifted in the cases of not merely of a holding company, but also its subsidiary when both are family companies.

Liability for ultra-vires acts:

Every company is bound to perform in compliance with its Memorandum of Association, Articles of Association, and the Companies Act, 2013. Any action done outside purview of either is said to be “ultra-vires”. Such operations of the company can be subjected to a penalty.

In Ashbury Railway Carriage & Iron Company Ltd v. Hector Riche, (1875) 44 L.J.Exch 185 case, where a company entered into a contract for financing construction of railway lines, and this operation was not mentioned in their Memorandum of Association and Articles of Association. The House of Lords held this action as ultra-vires and the contract, null and void.

Public Interest/Public Policy:

Where the conduct of the company is in conflict with public interest or public policies, Courts are empowered to lift the veil and personally hold such persons liable who are guilty of the act. To protect public policy is a just ground for lifting the corporate personality.

Agency or Trust:

Where a company is acting as an 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 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 Re, FG (Films) Ltd., [1953] 1 All ER 615 (Ch D) case, the court refused to compel the board of film censors to register a film as an English film, which was in fact produced by a powerful American film company in the name of a company registered in England in order to avoid certain technical difficulties. The English company was created with a nominal capital of 100 pounds only, consisting of 100 shares of which 90 were held by the American president of the company. The Court held that the real producer was the American company and that it would be a sham to hold that the American company and American president were merely agents of the English company for producing the film.

Criminal Act:

When a crime is committed by a company, it is not only the company that is made liable to pay the prescribed fine, but all the officers in default are also similarly punishable. As a company cannot be sent to prison but the officers in default can be punished.

In Aneeta Hada v. Godfather Travels &Tours Pvt. Ltd. AIR 2012 SC 2795 case, the Court held that a company is not immune from criminal liability on the plea that it is not a human being and cannot, therefore possess any criminal intent. In such cases, the criminal intent of the officers of the company gets imputed to the company.

Conclusion:

It should be noted that the principle of Salomon v. A. Salomon & Co. Ltd. is still the rule and the instances of piercing the veil are the exceptions to this rule. The legislature and the courts have in many cases now allowed the corporate veil to be lifted. 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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