Piercing the Corporate Veil

This article discusses in detail about the separate legal entity of a company, provisions relating to piercing or lifting of the corporate veil and some case laws which will help to better understand the concept.
Estimated Reading Time: 7 minutes

ABSTRACT

Companies are formed by people and are run by them. Does this mean that the people running the company and the company it is the same thing? No, the law provides two distinct personalities to the company and the people involved in it. The company enjoys a separate legal entity, but this does not mean that those who are behind the formation or functioning of the company cannot be held liable for the illegal acts committed by them under the name of the company. This, understanding the intention of the people who are involved in a company, is known as the piercing of the corporate veil.

Introduction

A company enjoys a distinct and separate legal entity. It has its own seal, bank accounts in its name, its own assets and it can sue and be sued. Under the Companies Act, 2013, Company means “a company incorporated under the Act or under any previous company law”.[1]The registration of a company is important to give it legal and lawful status.

Veil of incorporation

To understand the doctrine of piercing the corporate veil, it is essential to understand the veil of incorporation first. The common law judgement of Salomon vs Salomon & Co. Ltd.[2] explains the principle of the separate legal entity of a company. Brief facts of the case are:

Mr Solomon formed the company with his wife, his four sons and daughter. The business is engaged in the manufacture and sale of shoes. After the formation of a business, he sold his business to the family members. Salomon becomes the managing director of the company. Later the company ran into difficulty comes at the verge of winding up the company. At the time of liquidation, the liabilities of the company are more than the assets of the company. The unsecured claimed on the whole of the assets of the company on the ground that the company is mere the agent of the Salomon and Salomon being the principal is liable for all the debts of creditors. The House of Lords held that the company has separate legal entity than its members and the existence of a company is independent and distinct from its members. The court recognized the separate legal personality of the company and ultimately Salomon was escaped from making the payment.”[3]

This landmark case made it clear that the law treats a company as a different entity than that of its members, but there is an exception. While the corporate veil protects the persons involved in a company by treating them a separate entity, the concept of piercing the corporate veil or lifting the corporate veil removes the guise to find those who are misusing the veil to commit illegal acts through the name of the company.

Piercing the Corporate Veil

Black’s Law Dictionary defines Piercing the Corporate Veil as “the judicial act of imposing liability on otherwise immune corporate officers, directors, and shareholders for the corporation’s wrongful acts.”[4]

In the case of State of Uttar Pradesh and Ors. vs Renusagar Power Co. and Ors, 1988[5], the Supreme Court talked about the horizons of the doctrine of the lifting of the corporate veil where Sabyasachi Mukharji, J. observed that. In this case, the court observed that with time and expansion of jurisprudence, lifting of corporate veil is also to be expanded. It is not to be limited within the four walls.

Knowing that a company is a legal personality does not make it a natural person. The people who are behind the name of the company do not get to use the privilege of separate legal entity in misrepresenting the people. Thus, in cases where the court feels that it is necessary to understand the intent of the beneficiaries of the company, they use the doctrine of piercing the corporate veil.

Piercing of Corporate Veil Under the Companies Act, 2013

The Companies Act, 2013, through its various provisions, provides for the lifting of the corporate veil. Following are some provisions which help the courts to pierce through the veil:

  • Under Section 7 (7) (Incorporation of a Company) the veil of a company can be lifted if it is found that the company has furnished any false or incorrect information; has suppressed material facts or misrepresented any information in any of the documents filed for incorporation.
  • Under Section 35, there is a provision of civil liability in case of misstatements in the prospectus because of which a person has sustained loss or damage. In these cases, the key managerial personnel, like the director, promoter of the company, are held liable.
  • Section 39, which deals with “Allotment of Securities by Company” provides for the liability of the company along with the liability of the persons behind it as well.
  • The Central Government has the power to appoint inspectors under Section 216 to investigate and report on the matters of the company to determine whether a company has a façade. This section is also one of the prime examples of a piercing of corporate veil.
  • Section 251 (1) is another provision which fixes liability on the persons in charge of the management of the company in case it is found that a fraudulent application for removal of a name from the register of the companies to deceive the creditors or any other persons.
  • Under Section 339 (Liability for Fraudulent Conduct of Business), if, while winding up of a company, it is found that the business was carried on with the intent to defraud the creditors or any other persons of the company, the persons involved in the carrying of the business can be personally held liable, without any limitation of liability.
  • Section 464 (3) holds every member of an association or partnership, personally liable if such association or partnership exceeds the prescribed numbers of persons to carry on the business.

Piercing of Corporate Veil by Judicial Pronouncements

Apart from the provisions under the Companies Act, the courts, through their various judgements, have also made sure to lift the corporate veil whenever required. Some of the instances are:

In re: Dinshaw Maneckjee Petit vs Unknown[6] case, Mr Dinshaw who formed four sham companies just to evade tax. Whatever he earned used to be credited to the accounts of these four companies which in turn were paid back to him under the pretence of loan. Because of these loans, Mr Dishaw had some tax benefits. So, the whole and sole point of the incorporation of those four companies was to evade tax which was clearly seen by the court when it lifted the corporate veil.

In Tata Engineering and Locomotive vs State of Bihar & Ors.case[7], the Supreme Court held that the concept of lifting the corporate veil should not be misused. The court contended that in this case, that corporation is the association of shareholders and members. So, in order to achieve anything, it is not the corporation only can do, but it can be indirectly achieved through its members. So, this is how the doctrine of the corporate veil can be used and find out the members behind the company.

The Supreme Court in Shubhra Mukherjee vs Bharat Coking Coal Ltd[8], while talking about the façade of a company, pointed out the importance of lifting of the corporate veil. Further, the court held that it is justified to lift the corporate veil in order to look at the realities of the situation and to know the real state of affairs behind the façade of the principle of the corporate personality. In this case transaction of the sale took place which found to be suspicious and collusive. Here, the sale of immovable property is made by a company in favour of the wives of directors of the company. The court used the principle of piercing the veil to find out the true nature of transactions and to find out the real parties behind the transaction.

Conclusion

The rule of Salomon vs Salomon is still very much important. The companies are considered as a distinct legal identity from its members even today. It is important for that corporate veil to be there so that the company can function smoothly. Similarly, the principle of piercing the corporate veil is equally important. The legislatures, as well as the courts, have the responsibility to make sure that the corporations and companies do not hide their true intentions and do not misguide the people involved with the company. The doctrine of piercing the corporate veil has evolved over time, and companies, and people are more vigilant so as to avoid any activity which can invite liabilities. Every company has a different story, so it is important for the courts to look into the facts of each of the case so as to understand whether it requires the lifting of the corporate veil or not. As mentioned above, a company enjoys a distinct legal personality, so the principle of piercing the veil should only be used when necessary.


[1]Companies Act, 2013; Section 2(40)

[2] [1896] UKHL 1, [1897] AC 22 

[3] Hemant More, Independent Legal Existence of a Company, The Fact Factor , last updated on August 31, 2019, available at  https://thefactfactor.com/facts/law/civil_law/company-law/separate-legal-existence/2896/

[4]Piercing the Corporate Veil, Available on the website of CHP Law firm, last updated on 20th January 2020, available at <https://www.chplaw.id/single-post/2015/10/19/Is-Filing-for-Bankruptcy-the-Right-Option#:~:text=Black%20Law’s%20Dictionary%20defines%20Piercing,for%20the%20corporation’s%20wrongful%20acts.%E2%80%9D>

[5]AIR 1988 SC 1737

[6](1927) 29 BOMLR 447

[7] Tata Engineering and Locomotive vs State of Bihar & Ors., AIR 40, SCR (6) 885

[8]Civil Appeal No. 2595 of 1998

Hey there!

come here often?

Login To Come In