The doctrine of Lifting of Corporate Veil

After defining company, the article discusses the history of the conept of lifting of corporate veil by analysing the famous case of Salomon. Later on the concept was also applied by the Indian judiciary and the relevant judgments passed by courts in India are also discussed. The doctrine of piercing of corporate veil is not subjected to any strict rule; it is generally dependent on the facts and circumstances of each matter. However, the courts have laid down certain grounds on which corporate veil can be lifted such as fraud, enemy character etc.
Estimated Reading Time: 8 minutes

Introduction

With the growing economy and trends in the corporate sector, the sector has faced repetitive instances of corporate frauds, insider trading and other acts prohibited under the law per se and which also affects the working of corporate world. The concept of “lifting of corporate veil” plays a crucial role in identifying the culprit behind the illegal acts carried upon by the corporates. Before delving into the concept of lifting of corporate veil it is quint essential to peruse the term “company” and its essential features. Company is defined under Section 2(20) of the Companies Act, 2013 (hereinafter referred as ‘the Act’), which articulates the term company as any company incorporated under this Act or any other previous company law. Though the definition has come into force with the enforcement of the act, still it cannot be considered exhaustive. Lord Justice Lindley in his endeavour to define the term company envisaged that “company is an association of many persons who contribute money or money’s worth to a common stock and employ it in some trade or business, and who share profit and share arising there from.”[1] Further in simpler words, a company can be articulated as an association of persons who hold a separate legal entity independent from its members. It pertains legal existence and is considered as an artificial person or as a juristic person in the eyes of law.

It can be deduced through the judgments and literature available in this regard that company is a separate legal entity although it is managed by its board of directors. It is to be noted that for the very first time this principle was observed and established in the matter of Solomon v. Solomon (hereinafter referred as ‘Solomon”) which further cemented the twin policy of limited liability and separate entity in English law.[2]Following this, the same has been held by the Hon’ble Supreme Court of India in the celebrated judgment of Rustom Cavasjee Cooper v. Union of India[3], wherein the court observed that a company is a separate legal entity distinct from its individual members and even the property of a company is also not the property of its members or shareholders. When the person operating the business of company uses the identity of company to undertake unlawful acts then the main issue arises.

Doctrine of Separate Legal Entity

Section 9 of the Act stipulates in this regard that a company enjoys an independent existence. It is capable of carrying out functions as a corporate individual and the Act also bestows certain rights and duties to be carried on by the corporate. The corporate legal existence of a company enables it to act as a legal person. It articulates that it is distinct from identity of shareholders, directors, promoters etc. The concept of separate legal entity in simpler terms means that a member’s liability is limited as concerned to a liability incurred through the actions of company. This is also known as limited liability concept or doctrine of limited liability. Further under normal circumstances a shareholder’s liability is limited to its unpaid shares and cannot be held liable for the actions of company. This concept was firmly held in Solomon’s case. But certain times the members of the company misuse this separate legal entity of the company to commit frauds and earn illegal profits for themselves and make the company liable for it. In the famous case of Solomon, who was a businessman who also committed fraud and later claimed that company should be made liable as all the acts are undertaken in company’s name. Considering the facts and circumstances of the case, the House of Lords opined and held that though company is a separate legal entity and hence the no other person can be made liable for such acts. The House of Lords also observed that the company is neither a trustee nor a subscriber of its members.

This judgment has been widely criticised as a company is incapable of entering into transactions by its own. The court also held that it is the mind of directors and other persons involved in the controlling the affairs of the company, which runs a company and makes transactions on behalf of the company. Hence, the person responsible for conducting such illegal acts under the garb of company’s identity shall be made liable. Despite this decision it was later on observed by Lord Halsbury that in certain situations it is essential to not apply this principle and instead pierce the corporate veil. However, it is now been increasingly restricted in its application to an increased extent by the legislation to prevent the abuse of limited liability protection and to ensure that liability for tax is not avoided.[4] But there are certain situations which are exceptional to this doctrine of separate legal entity of corporate. Such exceptions are as follows:

After the judgment pronounced in Solomon’s case it wasn’t longer when it was admitted in the matter of Littlewoods Mail Order Stores Ltd. v. IRC[5] by Lod Denning that

“cast a veil over the personality of a limited company through which the courts cannot see. The courts can, and often do, pull off the mask. They look to see what really lies behind.”

Akin to this, in the matter of United States v. Milwaukee Refrigeration Transit Company[6]it was held that:

“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.”

Further, it can be said that judicial discretion and also legislative action allows the separate entity principle to be disregarded where some injustice is intended, or would result, to a party (either internal or external to the company) with whom the company is dealing.[7]

Concept of Lifting of Corporate Veil

The fact, that the liability is  of the company and not of the members, create a veil between the members and third party but sometimes to make the real culprit liable this corporate veil is pierced. This is popularly known as lifting or piercing of corporate veil. Piercing of corporate veil exists as a check on the doctrine of the separate legal entity. Generally, the veil is used by the members who conduct illegal acts and later on take shelter of the veil. Then in such situation the corporate veil is lifted or pierced. The grounds on which corporate veil is lifted are as follows:

Fraud

The famous Solomon principle is often rejected by the courts when the court is of the opinion that there exists some kind of fraud transactions by the directors of the company or even when some kind of fraud is seemed to be perpetrated. The two famous cases of fraud are Gilford Motor Company Ltd v. Horne[8]and Jones v. Lipman.[9] In both the cases the Court firmly opined that the companies or for that matter sham companies cannot be used as a cloak by the members for their wrongdoings. The Courts have been of the opinion that while perusing the existence of fraud in a transaction it is quintessential to understand and to examine the motive of the person alleged to commit fraud.

Group Enterprises

During the time of transactions by a group of enterprises, in order to reach the economic realities of the particular group, the Court may sometimes pierce the corporate veil. Professor Gower in this regard has opined that the determination of lifting of corporate veil is highly dependent on the nature of shareholding and control in the corporate.

Trustee

Whenever there is a sufficient reason to believe for the Court that the trustee of a trust are undertaking actions to incur profits for themselves then in such a situation the Courts may pierce the corporate veil and find the true nature of the malafide transactions, if any of the shareholders or trustees.

Enemy Character

During the times of war, the Court generally pierces the corporate veil with the intent to determine the shareholding as was done in Daimler’s case.[10]

Deficiency of Shareholder’s Equity

The corporate veil is also lifted in circumstances where there is a deficiency in shareholder’s equity and the company is made liable for the same. The deficiency must be determined taking the purpose and activity size in account.

Intermingling of Assets and Funds of Shareholders and Entities[11]

The shareholders, with the purpose to mislead the third parties, mingle the assets and funds of the shareholders and entities. Lifting of corporate veil shall apply where the company fails to distinguish between the funds and assets of the shareholder and the company.

Statutory Provisions relating to lifting of corporate veil

Section 2 (60) of the Act  broadly articulates that the person liable for such acts shall be referred as “officer who is in default.” The Actalso has made certain clear provisions that the person involved in activities like fraud shall be made liable. Some of the relevant provisions are below mentioned:

It is ascertained by the Act that when there is a contract in the name of company then it shall be legally binding and if any act of fraud or illegal acts are conducted then such person shall be made liable. Section 26(9), 35 and 36 of the Act clearly articulates that the person publishing any misstatement or untrue statement which can mislead public shall be made liable for the same. Further, Section 339 of the Act also punishes the person committing fraudulent acts undertaken on behalf of the company. Further coming to judicial pronouncements, judiciary is empowered to lift the corporate veil if the conduct of a company is in conflict with public interest. In Jyoti Limited vs Kanwaljit Kaur Bhasin And Anr.[12], the Hon’ble Delhi High Court held that corporate veil can be lifted if the representative of the company commit contempt of court.[13]

Conclusion

The doctrine of the piercing of corporate veil is not subjected to any strict rule; it is generally dependent on the facts and circumstances of each matter. All the matters shall be adjudged by keeping in mind the gravity of the issues involved in the matter. It shall also be acknowledged by the judiciary that the concept of lifting of corporate veil is a powerful weapon in the hands of judiciary to make people liable for fraudulent and illegal acts. It acts as a watchdog on the concept of separate legal entity. But it shall be borne in mind that the application of this principle is to be done in exceptional situations only. Before applying this principle the Court shall highly scrutinize the situations and issues involved in the matter in hand.


[1]Principle of lifting of corporate veil, legal services India, http://www.legalservicesindia.com/article/2335/Principle-of-Lifting-the-Corporate-Veil.html last accessed on 20th June 2019 at 2:22 PM.

[2]Solomon v. Solomon1897 AC [22]

[3]RustomCavasjee Cooper v. Union of India 1970 AIR 564.

[4] A company is a separate legal entity as distinct from its members, https://www.lawteacher.net/free-law-essays/business-law/separate-legal-entity-as-distinct-from-its-members-business-law-essay.php last accessed on 22nd June 2019 at 9:53 PM.

[5]Littlewoods Mail Order Stores Ltd. v. IRC [1969] 1 W.L.R. 1241, 1254

[6]United States v. Milwaukee Refrigeration Transit Company  142 F.247 (1906)

[7]Harshit Saxena, Lifting of Corporate veil,http://dspace.jgu.edu.in:8080/jspui/bitstream/10739/45/1/Harshit%20Saxena%20-%20Lifting%20the%20Corporate%20Veil.pdf

[8]Gilford Motor Company Ltd v. Horne  [1933] Ch. 935 (CA)

[9]Jones v. Lipman.[9][1933] Ch. 935 (CA)

[10]Daimler’s case.[10] [1916] 2 A.C. 307 (HL)

[11]Sezi Demirçark, Lifting the Corporate Veil: An Exceptional Concept of The Shareholders’ Limited Liability Principle, http://www.mondaq.com/turkey/x/575632/Shareholders/Lifting+The+Corporate+Veil+An+Exceptional+Concept+Of+The+Shareholders+Limited+Liability+Principle last accessed on 23rd June, 2019 at 1:54 PM.

[12]Jyoti Limited vs Kanwaljit Kaur Bhasin And Anr., 1987 62 CompCas 626 Delhi

[13]Kratika Saxena, Concept of Lifting of Corporate Veil, LegoDesk, https://legodesk.com/blog/lifting-of-corporate-veil/  last accessed on 23rd June, 2019at 1:29 PM.

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