Lifting of Corporate Veil: Concept, Judicial and Statutory Grounds Explained

Origin: Doctrine of Lifting of Corporate Veil

Effect of Company Being Treated as Separate Legal Entity

• The chief advantage of incorporation is, of course, the separate legal entity of the This position has been well established ever since the decision in the case of Salomon v. Salomon and Co. (1987).
• The Salomon casewell established the existence of the veil of corporate
• In reality, however, the business of the artificial person is always carried on by, and for the benefit of, some individual.
• It may, therefore, happen that the corporate personality of the company is used to commit frauds or improper or illegal acts.

Lifting of Corporate Veil

• Since an artificial person is not capable of doing anything illegal or fraudulent, the facade of corporate personality might have to be removed to identify the persons who are really guilty. This is known as ‘lifting the corporate veil’.
• The corporate veil is said to be lifted when the court ignores the company and concerns itself directly with the members or managers.
• It must be noted that lifting the corporate veil is an exception and not the It does not override the generality of the principle laid down in Salomon’s case.
• We can say that adherence to the Salomon principle will not be rigidly followed where this would cause an unjust result.

Grounds for Lifting Corporate Veil

A. Judicial Grounds for Lifting Corporate Veil

1. Prevention of Fraud or Improper Conduct

1. Where the medium of a company has been used for committing fraud or improper conduct, courts have lifted the veil and looked at the realities of the situation.
2. In Gilford Motor Company v. Horne [1933] , ‘Horne’ had been employed by the company under an agreement that he shall not solicit the customers of the company or compete with it for a certain period of time after leaving its After ceasing to be employed by the plaintiff, Horne formed a company which carried on a competing business and caused the whole of its shares to be allotted to his wife and an employee of the company, who were appointed to be its directors. It was held that since the defendant (Horne) in fact controlled the company, its formation was a mere ‘cloak or sham’ to enable him to break his agreement with the plaintiff. Accordingly, by lifting the corporate veil an injunction was issued against him and against the company he had formed restraining them from soliciting the plaintiff’s customers.

2. In Case of Economic Offences

In Santanu Roy v. Union of India[(1989), it was alleged that the company had violated Central Excises and Salt Act, 1944. The Court held that the corporate veil of the company can be lifted in this case so as to determine as to which of the directors or officers was concerned with the evasion of excise duty by reason of fraud or wilful mis-statement or suppression of facts.

3. Determination of the Enemy Character of a Company

1. Company being an artificial person cannot be an enemy or friend. However, during war, it may become necessary to lift the corporate veil and see the persons behind as to whether they are enemies or friends. It is because, though a company enjoys a distinct entity, its affairs are essentially run by individuals.
2. In Daimler Company V. Continental Tyre & Rubber Co. (Great Britain) Ltd. [1916], a company was incorporated in London for the purpose of selling tyres manufactured in Germany by a German company. Its majority shareholders and all the directors were Germans. On declaration of war between England and Germany in 1914, it was held that since both the decision-making bodies, the Board of directors and the general body of shareholders were controlled by Germans, the company was a German company and hence, an enemy company. Accordingly, the suit filed by the company to recover a trade debt in UK was dismissed on the ground that such payment would amount to trading with enemy.

4. Tax Evasion

1. If a company is used for tax evasion or to circumvent tax obligations, the courts have the power to disregard the corporate veil of the company.
2. In Sir Dinshaw Maneckjee Petit, Re(1927), the assessee was a millionaire earning huge income by way of dividend and interest. He formed four private companies and transferred his investments to each of these companies in exchange of their shares to avoid tax burden. The dividends and interest income received by the company was handed back to Sir Dinshaw as a pretended loan. It was held that the company was formed by the assessee purely and simply as a means of avoiding tax and company was nothing more than assessee himself. It did no business, but was created simply as a legal entity to ostensibly receive the dividends and interest and to hand them over to the assessee as pretended loans.

5. Formation of Subsidiaries to Act as an Agent or to Circumvent the Law

1. In Merchandise Transport Limited British Transport Commission[1982], a transport company wanted to obtain licences for its vehicles, but it could not do so if it made the application in its own name. It, therefore, formed a subsidiary company and the application for licences was made in the name of the subsidiary. The vehicles were to be transferred to the subsidiary. By lifting the corporate veil it was held that the parent and the subsidiary company were one commercial unit and the application for licences was rejected
2. In the State of U.P. v. Renusagar Power Co.[1991], the Supreme Court held that where the holding company holds 100% shares in a subsidiary company and the latter is created only for the purpose of the holding company, corporate veil can be lifted.

6. Where Company Is Used to Avoid Welfare Legislation

1. Where it was found that 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 to workmen, the Supreme Court upheld the piercing of the veil to look at the real transaction.
2. In Workmen v. Associated Rubber Industry Ltd.[(1985), a company created a subsidiary and transferred its investment holdings to it in a bid to reduce its liability to pay bonus to the workers. The subsidiary company had no assets of its own except those transferred to it by the principal company and no business or income of its own except receiving dividends from shares transferred to it by the principal company and serving no purpose whatsoever except to reduce the profits of the principal company. The Supreme Court brushed aside the separate existence of the subsidiary company for the purpose of calculating bonus payable to the workmen.

7. To Punish for Contempt of Court

In Jyoti Limited v Kanwaljit Kaur Bhasin there was a partnership firm of two partners. The firm agreed to sell two floors of a certain property but later cancelled the agreement unilaterally. The buyer filed a suit. The High Court restrained the firm from selling the property. The partners incorporated a company in which those two partners were members. One partner was Chairman and the other Managing Director of the company. The property was transferred to the company. The company sold off the two floors in spite of High Court’s restraint order. The corporate veil of the company was lifted to determine who has disobeyed the orders of the court.

8. Where a Company Is Created to Defraud Creditors

In PNB Finance Ltd. V. Shiv Prasad Jain Ltd. (1983), a person (defendant-respondent) borrowed money from a company for the purpose of purchasing immovable property. The loan was sanctioned on the condition that the borrower would deposit the title deeds of the property with the plaintiff-appellant company, as security. The borrower (defendant-respondent) did not pay anything towards the principal and interest and invested the borrowed money in shares of three different companies. He and his son were the only members in all these three companies. The fund, so diverted was utilized to purchase properties. The plaintiff company filed a suit. It contended that the defendant had committed fraud by not purchasing the property in his own name and diverted the borrowed money to three companies and these companies were sought to be made liable for repayment of the loan. The Court allowed the plaintiff company to attach the assets of the three companies as they were created only to hoodwink the plaintiff company.

Also Read: Doctrine Of Mens Rea Under BNS 2023 With Case Laws

B. Statutory Grounds of Lifting of Veil

The Companies Act, 2013itself provides for certain cases in which the directors or members of the company may be held personally liable. In such cases, while the separate entity of the company is maintained, the directors or members are held personally liable along with the company. These cases are as follows:

1. Misdescription of Name [Section 12]

As per section 12, a company shall have its name printed on hundies, promissory notes, bills of exchange and such other documents as may be prescribed. Thus, where an officer of a company signs on behalf of the company any contract, bill of exchange, hundi, promissory note, cheque or order for money, such person shall be personally liable to the holder if the name of the company is either not mentioned, or is not properly mentioned.

2. Mis-Statements in Prospectus [Section 35]

Section 35 states that in case of misrepresentation in a prospectus, the company and every director, promoter, expert and every other person, who authorized such issue of prospectus shall be liable to compensate the loss or damage to every person who subscribed for shares on the faith of untrue statement.

3. Failure to Return Application Money [Section 39]

In case of issue of shares by a company to the public, if minimum subscription, as stated in the prospectus has not been received within 30 days of the issue of prospectus or such other period as may be specified. The application money shall be repaid within a period of fifteen days from the closure of the issue and if any such money is not so repaid within such period, the directors of the company who are officers in default shall jointly and severally be liable.

4. Acceptance of Deposits with Intent to Defraud Depositors (Section 75)

In case the company fails to repay the deposit or a part thereof or any interest thereon, within the time limits as applicable, and where it is proved that such deposits were accepted with intent to defraud the depositors or for any fraudulent purpose, every officer who was responsible for acceptance of deposits shall be personally liable (without any limitation of liability) for all the losses or damage that may have been incurred by the depositors.

5. Failure to Distribute Dividends (Section 127)

Where a dividend has been declared by a company but has not been paid or the warrant in respect thereof has not been posted within thirty days from the date of declaration to any shareholder entitled to the payment of the dividend, every director of the company shall, if he is knowingly a party to the default, be punishable.

6. For Investigation of Ownership of Company (Section 216)

Under section 216, the Central Government may appoint one or more inspectors to investigate and report on the membership of any company for the purpose of determining the true persons who are financially interested in the company and who control its policy or materially influence it.

7. Fraudulent Conduct (Section 339)

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 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.

8. Liability for Ultra Vires Acts

Directors and other officers of a company will be personally liable for all those acts which they have done on behalf of a company if the same are ultra vires the company.

9. Liability Under Other Statutes

Besides the Act, directors and other officers of the company may be held personally liable under the provisions of other statute.

 

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