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Introduction of the case
A company in simple terms, is an association of persons, who come together for profit making. The law regulating companies in India is the Companies Act (CA), 1956 amended in 2013. When a company is registered (date of incorporation), it becomes a body corporate by the name mentioned in the Articles of Association (AOA).[1] This means that a company is an artificial person created by the law. This is called ‘separate legal personality’ of a company. A company is different from its members, who are liable only to the extent of their shares in the company. The separate legal personality of a company comes with many advantages for the shareholders; their liability is limited only to the extent of their shares in the company. However, this principle has to applied cautiously and should differ from case to case. There are instances where the members or shareholders have misused the separate legal entity status of a company for fraud and dishonest purposes. When individuals start misusing and taking shelter behind this corporate veil, the Court can break through the veil and look behind the Company or the corporate body. Further, it can punish or penalise on the same grounds. This process is known as ‘lifting the corporate veil’. The article discusses the case of Gilford Motor case in detail explaining the concept of corporate veil.
Facts In The Case
In the case of Gilford Motor Company Ltd V Horne[2], Gilford Motor Co Ltd had its registered office in Holloway Road, London. Mr Horne was a former director of the plaintiff company, appointed for a term of six years. Before the completion of the term, he was fired. Contract of his employment contained a non – competent clause (9), which prohibited him from soliciting its customers. However, after he was fired, he set up a company named J.M. Horne & Co. Ltd which undercut Gilford Motor Co’s prices. He also solicited the customers whom he knew while working with Gilford. He also sent out circulars to various persons in which it was stated that the defendant was ready and, in a position, to supply spare parts for Gilford vehicles. Since the contract was with Holmes, Gilford could not sue him as per separate legal personality of a company. However, he contended that the company was used as an ‘instrument of fraud’ to conceal Mr Holmes’s actions.
Issue In The Case
The main issue in the case was
- Whether the company was used as a cloak by the defendant to commit breach of the contract?
Judgment
The High court held that the defendant did not break his contract. 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”, since it was clear that the main purpose of incorporation of a company was to perpetrate fraud. As against the defendant’s pleading, the court said that “the covenant was not wider than was reasonably necessary for the protection of the plaintiff company’s trade and was therefore enforceable by injunction.”
The defendant’s company is obviously carried on wholly by the defendant Horne. It was used as the channel through which the defendant Horne was carrying on his business. It held that the new company is nothing but a sham or cloak, for merely enabling the defendant to commit a breach of the contract. Subsequently, Lord Handworth granted an injunction to the defendant’s business.
Analysis
This case sets the best precedent of ‘lifting the corporate veil’. The court in the case took into consideration, the purpose for which the company was incorporated. It was clear that the company was a sham to cover the acts of the directors who were the defendant and his family members. They masked the ‘separate legal personality’ of a company for violation of the contract and to produce unfair competition.
In Prest v Petrodel[3], Lord Sumption argued that Gilford case was decided based on evasion principle. This principle enables the court to depart from the fundamental principle of separate legal personality of a company, when it is used by a person who is liable, to evade his obligation. The Court can pierce the veil in certain circumstances for depriving the company or its members taking advantage of this characteristic.
The major grounds in the Companies Act, 2013 under which Corporate veil can be lifted can be broadly categorized into two: Statutory provision and Judicial interpretation.
The Companies Act explicitly provides for different circumstances where the directors or members shall be personally liable.
- When there is misleading or untrue statement in a prospectus, every person authorising such issue shall have criminal liability.[4]
- Similarly, Section 35 of the Act imposes civil liability on the company and every other person who is a director or has authorised to such prospectus which is misleading.
- If allotment of securities has been made without the minimum subscription, the company and the officers in default shall be liable. The penalty is 1000 rupees for each day of default or one lakh rupees, whichever is less.[5]
- S 339 says that when a company is found to be carried on with the intent to defraud its creditors at the time of winding up, the Company Law Tribunal can hold the parties personally liable.
Indian case laws
Life Insurance Corporation of India v. Escorts Ltd[6] was one of the first Indian case laws under this principle. A scheme under FERA, 1973, allowed non-resident companies owned by NRIs where their investment is minimum 60%, to invest in the Indian company. Thirteen companies, which were owned by Caparo Group Limited, invested in an Indian company, Escorts Limited. The shares of the company were held by a trust, whose members were Mr Swaraj Paul and his family. This investment was challenged on the ground that it circumvented the prescribed ceiling of 1%. The Supreme Court in the case considered to lift the corporate veil as to identify the ownership in the investment.
It is after the Bhopal Gas leak tragedy, the concept of lifting the corporate veil has escalated. The chemical plant from which Methyl Isocyanate leaked was Union Carbide India Limited (UCIL), which is a subsidiary of Union Carbide Corporation (UCC). UCC argued that corporate veil could not be lifted to hold it liable. It said that UCIL was a subsidiary company, and UCC should not be held liable for the acts of its subsidiary. High court of Madhya Pradesh held that UCC is liable and the Act itself contemplates to lift the corporate veil in cases of fraud etc.
The Supreme Court in State of U.P. v. Renusagar Power Co.[7] held the same view. 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. In JR Exports Ltd, v. BSES Rajdhani Power Ltd,[8] the appellant No. I company acquired entire share capital of appellant No. 2 company, which was a registered consumer of electricity connection granted at its factory premises and on finding that electricity was being consumed by appellant No. 1, Electricity Board passed impugned order demanding sub-letting charges from appellant No. 2. By applying principle of piercing of corporate veil, both companies appeared to be same entity and, therefore, there was no question of sub-letting.
CIT v. Sri Meenakshi Mills Ltd[9] the corporate veil had been used for evasion of taxes and duties; the court upheld the piercing of the veil to look at the real transaction. Even for economic offences, the court has lifted the corporate mask. In Santanu Ray v. Union of India,[10] the company had been alleged to have violated section 11(a) of the Central Excises and Salt Act, 1944. The Court held that the veil of the corporate entity could be lifted by adjudicating authorities so as to determine as to which of the directors was concerned with the evasion of the excise duty by reason of fraud, concealment or wilful misstatement or suppression of facts or contravention of the provisions of the Act and the rules made there under.
Conclusion
The court has to be cautious while dealing with the cases; the facts in different cases have to be properly analysed. There should be a necessary balance between the interest of the public and the corporate personality. There cannot be a single rule for the doctrine of corporate veil. Since no right is absolute, lifting of corporate veil to disregard limited liability of members should be emphasised and for this, the courts must stick to a set of statutory standards.
References:
[1] Section 9, The Companies Act, 2013 (NO. 18 OF 2013).
[2] 1933 Ch 935 (CA)
[3] [2013] UKSC.
[4] Section 34, The Companies Act, 2013 (NO. 18 OF 2013).
[5] Section 39(5), The Companies Act, 2013 (NO. 18 OF 2013).
[6] (1986) 1 SCC 264.
[7] 1991 70 comp case 27.
[9] AIR 1967 SC 819.
