The concept of separate legal entity w.r.t companies was firmly established in the famous case of Salomon v. Salomon & Co. Ltd. [(1897) A.C. 22]. Wherein the House of Lords while dealing with an appeal held that Salomon & Co. Ltd. was not a sham; Mr. Salomon cannot be held liable for the debts of the company since both were two separate legal entities; and that once the artificial comes into existence, “it shall be recognized like any other independent person with its rights and liabilities appropriate to itself.” Salomon & Co. Ltd. purchased the manufacturing business of Salomon, a sole trader, in exchange for all but six shares in the company, and received debentures worth 10 thousand pounds. The subscribers to the memorandum included his wife and five children, each owned one share. The business subsequently collapsed, and Salomon made a claim, on the basis of the debentures held, as a secured creditor. The liquidator argued that Salomon could not prioritized over other creditors they were one and the same–or alternatively, that the company carried on business on Salomon’s behalf.
As Lord Macnaghten observed:“The company is at law a different person altogether from the subscribers to the memorandum, and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them.”
Exceptions to the Separate Entity Principle As early as Salomon, precedents have indicated possible exceptions to the principle of separate legal entity. Lord Halsbury recognized such principle providing there was “no fraud and no agency and if the company was a real one and not a fiction or myth.”
As opined by Lord Denning in Littlewoods Mail Order Stores Ltd. v. IRC [{1969) 1 W.L.R. 1241, 1254], the incorporation fully:“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.”Similarly, in United States v. Milwaukee Refrigeration Transit Company [142 F.247 (1906)], the Circuit Court (E.D. Wisconsin) decided:
“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.”Lifting of Corporate Veil:
Post- incorporation, a company enjoys the benefit of separate legal entity and distinct from its members. It possesses a corporate personality of its own including rights, duties and liabilities distinct from those of its individual members. Thus, a veil of incorporation exists between the corporation/company and its members and due to this a company is not identified with its members. In order to protect themselves from liabilities of the company, its members often take shelter of the corporate veil. The corporate veil is often used as an efficient tool of fraud or evasion of tax and statutory provisions. The veil can be lifted in certain circumstances to prevent unjust and fraudulent acts by looking into the misconduct or legal façade and to hold the individual members of company liable for its acts or liabilities. The Corporate veil is generally lifted under the following circumstances:
i. Under Judicial Precedents
ii. Under Statutory Provisions
Lifting of Corporate Veil under Judicial Precedents:a) Determination of Character: In order to determine the enemy character during misconduct, the court has lifted the corporate veil. The veil is lifted for finding out the person who in reality controls the company’s affairs and check if the same is/was controlled by enemy aliens, it will assume the enemy character.
b) Determination of Residence for Tax Purposes: As the tax assessment is generally done on the basis of residential status, it is pertinent to determine the residence. The residence of any company is determined through the office where its central management and control is situated. The court may lift the veil to ascertain the residence (generally it is the place where the meetings of the Board of directors are held). According to S.6 (3) of the Indian Income Tax Act, 1961, a company is said to be resident in India in any previous year if:
i. It is an Indian Company, or ii. During that year, the control and management of its affairs are situated wholly in India.
For this purpose, the expression “control and management” means de facto control and management and the place of the control and management of the affairs of a company is the place where the meetings of the directors are held.
c) Fraud and Evasion of Contractual Obligation: The corporate existence cannot be utilized as a tool for committing fraud. In cases where the said act is done to defraud creditors or to avert legal obligation, the court has the discretion to lift the corporate veil to check the realities and strike down the transaction, if required.
d) Evasion of Statutory Provision – Inference of Agency to prevent it: Wherever a corporation is acting as agent for its shareholder, the shareholders are going to be accountable for the misconduct of the corporation. It depends upon an issue of fact in every case whether or not the corporation/corporate entity is acting as associate agent for its shareholders. There could be an Express or implied agreement to this effect based on the facts and circumstances of the case. Considering the case of F.G. Films Ltd., Re, where an American company financed the production of a film in India in the name of a British company. The majority of the stake in the British Company was held by the President of the American Company. However, the issue was that the Board of trade of Great Britain denied registration of the film as a British film. The Court affirmed the same as the British company acted merely as the nominee of the American Company.
e) Trustees: As a general rule, a company is not entitled to hold its property on trust for its members or for another company but the said rule was relaxed by the court in some exceptional cases and allowed. Therefore, the principle of trust is used as a tool by the courts to pierce the corporate veil.
a) Reduction of the Number of Members: If at any point of time the quantity of members of company goes below the minimum requirement i.e. (seven in case of public company and two in case of private company) and still the company operates the business beyond 6 months, in case company’s debts arising at that particular period, all the members of the company shall be held liable for the payment of company’s debts incurred during that period.
b) Misrepresentation: As per section 62 & 63 of the Companies Act, 1956 in case of any misrepresentation made in the prospectus of the company, the Promoter, Directors and every other person who is authorized to issue such prospectus shall be liable for payment of losses to those people who have subscribed for share believing such misrepresentation to be true.
c) Failure to Return Application Money: In case the company fails to receive a minimum subscription, it should refund the entire application money within 10 days. However, if the company fails to return the said amount within 10 days, 6% interest per annum shall be applicable on the said amount.
d) Misdescription of the Name: When any officer of the company signs on the behalf of the company any contract, promissory note or cheque, that person/ officer’s liability extends to the holder if the name of the company is not mentioned properly or it is not mentioned at all.
e) Holding and Subsidiary Company: The accounts of a subsidiary company shall be disclosed to the members of its holding company As per Sec. 212 of the Companies Act, 1956 every holding company is required to attach to its balance sheet, copies of the balance sheet, profit, and loss account etc., in respect of each subsidiary company.
The courts in India have also been following the International law on lifting the corporate veil. While it is not possible to examine all the judgments the view of the courts in India which is illustrative is as follows:
“The doctrine of lifting up of corporate veil becomes relevant when by a fiction of law, a Company is seen as a distinct entity separated from its members, but in reality, it is an association of persons who, in fact, are the beneficial owners of the Company and its corporate property. This fiction is created by a veil and is called the Corporate Veil. Lifting or piercing of corporate veil means ignoring the fact that a Company is a separate legal entity and has a separate identity of Corporate personality. This concept disregards the separate identity of the Company and looks behind the true owners or real persons who are in control of the Company.
17. The separate personality of a Company is a statutory privilege and it must be used for a legitimate purpose only. Whenever and wherever a fraudulent or dishonest use is made of the legal entity, the individuals will not be allowed to hide behind the curtain of corporate personality. The court or appropriate authority will break this shell of the Company and sue the individuals who have done or committed such a crime or offence. This lifting of the curtain is called a Lifting of the Corporate veil.
18. The doctrine of lifting the veil has been developed as a device to avoid the hardship of the doctrine of corporate personality. It may be understood as the identification of a Company with its members. In order to protect themselves from the liabilities of the Company, its members often take the shelter of the corporate veils. Sometimes these corporate veils are used as a vehicle of fraud, or evasion of tax. To prevent unjust and fraudulent acts, it becomes necessary to lift the veils to look into the realities behind the legal facade and to hold the individual member of the Company liable for its acts. The corporate veil has been lifted by the courts and legislatures in the interest of equity, justice and good conscience.
19. The doctrine of lifting up of corporate veil seeks to strike a balance between the interest of the public and the concept of a separate personality. The doctrine is essentially used as a flexible tool to ensure justice. It would defeat the object of the device if it were to be applied rigidly with no scope at all left for judicial discretion. The doctrine can be applied only by legislature, courts of law and statutory and executive authorities. If parties to contracts or parties bound by mutual liabilities and obligations are permitted to claim that he/it has lifted the veil of the corporate body with whom he/it has such contractual relations/obligations and found the corporate body to be another entity, and hence is no more bound by his/its liabilities and obligations, it would result in chaos in the fields of contracts. Lifting up of corporate veil can be done only by the State. Citizens and private bodies who question the identity of corporate bodies can resort to lifting up of corporate veil only through courts of law.”
The Hon’ble Supreme Court of India in the matter of State of Karnataka and Ors. vs. Selvi J. Jayalalitha and Ors. (14.02.2017 – SC) : MANU/SC/0157/2017 held as follows:
“LIFTING of CORPORATE VEIL of THE COMPANY
188. In Aron Salomon (Pauper) v. A. Salomon and Co. Limited 1897 AC 22, the House of Lords accentuated the distinctive entity of a company qua its subscribers as elucidated hereunder:
The company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation, the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them.
The caveat of Lord Halsbury L.C. in this context, as extracted hereinbelow, however is revealing:
I am simply here dealing with the provisions of the statute, and it seems to me to be essential to the artificial creation that the law should recognize only that artificial existence – quite apart from the motives or conduct of individual corporation. In saying this, I do not at all mean to suggest that if it could be established that this provision of the statute to which I am adverting had not been complied with, you could not go behind the certificate of incorporation to show that a fraud had been committed upon the officer entrusted with the duty of giving the certificate, and that by some proceeding in the nature of scire facias you could not prove the fact that the company had no real legal existence.
189. While elaborating on the same theme, the Supreme Court in Delhi Development Authority v. Skipper Construction Co. (P) Ltd. and Anr. MANU/SC/0497/1996 : (1996) 4 SCC 622, noted that the above legal proposition was, however, subject to several exceptions amongst others, when the corporate personality is blatantly used as a cloak for fraud or improper conduct, as scripted by Gower – Modern Company Law – 4th Edn. (1979) (page 137).
190. The following passage from Company Law by Pennington – 5th Edition 1985 at page 53 was also quoted with approval:
The concept of ‘piercing the veil’ in the United States is much more developed than in the UK. The motto, which was laid down by Sanborn, J. and cited since then as the law, is that ‘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’. The same can be seen in various European jurisdictions.
This Court also in that decision, referred to the following synopsis on the subject as entered by the American Professor L. Maurice Wormser in his Article “Piercing the veil of corporate entity”:
When the conception of corporate entity is employed to defraud creditors, to evade an existing obligation, to circumvent a statute, to achieve or perpetuate monopoly, or to protect knavery or crime, the courts will draw aside the web of entity, will regard the corporate company as an association of live, up-and-doing, men and women shareholders, and will do justice between real persons.
191. It was finally held that the concept of corporate entity was evolved to encourage and promote trade and commerce and not to commit illegalities or to defraud people and thus when the corporate character is employed for the purpose of committing illegality or for defrauding others, the Court ought to ignore the corporate character and scan the reality behind the corporate veil so as to enable it to pass appropriate orders to do justice between the parties.
In the matter of Uflex Ltd. vs. Government of Tamil Nadu and Ors. (17.09.2021 – SC) : MANU/SC/0654/2021 the Hon’ble Supreme Court declined to lift the Corporate Veil and held
“49. A lot of emphasis has been placed by the Courts below in seeking to go into the financial linkages between the two companies, i.e., Uflex and Montage. The correct way of examining this issue should have been that whether under the terms of the NIT, any of the aspects which were examined by the Courts could be said to be a disqualification. In our view, the answer to the same was in the negative. One company had invested in another through certain preference shares without having any controlling interest, this cannot be the basis of judicial scrutiny. The present case is not one of an intercorporate battle or of minority shareholders claiming the rights or any debts due, where the principle of lifting the corporate veil should be applied.
CONCLUSION
The doctrine of lifting the corporate veil is not subject to any bright-line tests. There are several court decisions and analysis on the said claims. However, every new action brings a distinct set of facts and circumstances into the equation and a separate determination shall be made as to whether or not the complainant has furnished sufficient evidence of control and domination, improper purpose, or use and resulting damage. The decision whether to pierce the corporate veil may be assisted, at least in part, upon the opinion of qualified experts. In particular, expert testimony would be useful to the trier of fact in determining whether the company has been reasonably capitalized for its intended objective. Ultimately, however, the judgment whether to disregard the corporate entity will be based upon a balancing of various factors all or some of which are necessary but may not be sufficient to pierce the veil.
Drafted and Settled by
Mr. Varun S. Ahuja
Partner
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