Lifting of Corporate Veil
September 26, 2019
Once a business is incorporated according to the provisions laid out in the Companies Act of 2013, it becomes a separate legal entity. An incorporated company, unlike a partnership firm, which has no identity of its own, has a separate legal identity of its own which is independent of its shareholders and its members. This article will go over what this differentiation means, why this demarcation was brought about and how can the members be made personally liable for using the company as a vehicle for undesirable purposes.
What is Corporate Veil ?
A company is composed of its members and is managed by its Board of Directors and its employees. When the company is incorporated, it is accorded the status of being a separate legal entity which demarcates the status of the company and the members or shareholders that it is composed of. This concept of differentiation is called a Corporate Veil which is also referred to as the ‘Veil of Incorporation’.
Meaning of Lifting of Corporate Veil
The advantages of incorporation of a Company like Perpetual Succession, Transferable Shares, Capacity to Sue, Flexibility, Limited Liability and lastly the company being accorded the status of a Separate Legal Entity are by no means inconsiderable, under no circumstance can these advantages be overlooked and, as compared with them, the disadvantages are, indeed very few.
Yet some of them, which are immensely complicated deserve to be pointed out. The corporate veil protects the members and the shareholders from the ill-effects of the acts done in the name of the company. Let’s say a director of a company defaults in the name of the company, the liability will be incurred by the company and not a member of the company who had defaulted. If the company incurs any debts or contravenes any laws, the concept of Corporate Veil implies that the members of the company should not be held liable for these errors.
Development of the Concept of “Lifting of Corporate Veil”
Once a company is incorporated, it becomes a separate legal identity. An incorporated company, unlike a partnership firm which has no identity of its own, has a separate legal identity of its own which is independent of its shareholders and its members.
The companies can thus own properties in their names, become signatories to contracts etc. According to Section 34(2) of the Companies Act, 2013, upon the issue of the certificate of incorporation, the subscribers to the memorandum and other persons, who may from time to time be the members of the company, shall be a body corporate capable of exercising all the functions of an incorporated company having perpetual succession. Thus the company becomes a body corporate which is capable of immediately functioning as an incorporated individual.
The central focal point of Incorporation which overshadows all others is a distinct legal entity of the Corporate organisation.
Solomon v Solomon
What the milestone case Solomon v Solomon lays down is that “in inquiries of property and limitations of acts done and rights procured or liabilities accepted along these lines… the characters of the common people who are the organization’s employees is to be disregarded”.
Lee v Lee’s Air Farming Ltd
In Lee v Lee’s Air Farming Ltd., Lee fused an organization which he was overseeing executive. In that limit he named himself as a pilot/head of the organization. While on the matter of the organization he was lost in a flying mishap. His widow asked for remuneration under the Workmen’s Compensation Act. At times, the court dismisses the status of an organization as a different lawful entity if the individuals from the organization attempt to exploit this status. The aims of the people behind the cover are totally uncovered. They are made to obligate for utilizing the organization as a vehicle for unfortunate purposes.
“It is neither fundamental nor alluring to count the classes of situations where lifting the veil is admissible, since that must essentially rely upon the significant statutory or different arrangements, an outcome which is tried to be achieved, the poor conduct, the element of public interest, the impact on parties who may be affected by the decision, and so forth.”
This was reiterated in this particular case.
Circumstances under which the Corporate Veil can be Lifted
There are two circumstances under which the Corporate Veil can be lifted. They are:
1: Statutory Provisions
2: Judicial Interpretations
This particular section characterizes the distinctive individual engaged in a wrongdoing or a conduct which is held to be wrong in practice, to be held at risk in regard to offenses as ‘official who is in default’. This section gives a rundown of officials who will be at risk to discipline or punishment under the articulation ‘official who is in default’ which includes within itself, an overseeing executive or an entire time chief.
Reduction of membership beneath statutory limit: This section lays down that if the individual count from an organization is found to be under seven on account of a public organization and under two on account of a private organization (given in Section 12) and the organization keeps on carrying on the business for over half a year, while the number is so diminished, each individual who knows this reality and is an individual from the organization is severally at risk for the obligations of the organization contracted during that time.
In this case, the respondent documented a suit against a private limited company and its directors because he had to recover his dues. The directors opposed the suit on the ground that at no time did the company carried on business with individual count which was to go below the statutory minimum and in this manner, the directors couldn’t be made severely at risk for the obligation being referred to. It was held that it was for the respondent being dominus litus, to choose the people himself who he wanted to sue.
Misdescription of name: Under sub-section (4) of this section, an official of an organization who signs any bill of trade, hundi, promissory note, check wherein the name of the organization isn’t referenced in the way that it should be according to statutory rules, such official can be held liable on the personal level to the holder of the bill of trade, hundi and so forth except if it is properly paid by the organization.
Power of inspector to explore affairs of another company in the same gathering : It gives that in the event that it is important for the completion of the task of an inspector instructed to research the affairs of the company for the supposed wrong-doing, or a strategy which is to defraud its individuals, he may examine into the affairs of another related company in a similar group.
Subject to the provision of Section 278, this section provides that no individual can be a director of in excess of 15 companies at any given moment. Section 279 furnishes for a discipline with fine which may reach out to Rs. 50,000 in regard of every one of those companies after the initial twenty.
This Section emphasises and offers weightage to the existing proposal of the Company Law Committee: “It is important to see that the general notice which a director is bound to provide for the company of his interest for a specific company or firm under the stipulation to sub-section (1) of Section 91 which is ought to be given at a gathering of the directors or find a way to verify that it is raised and read at the following gathering of the Board after it is given. The section not only applies to public companies but also applies to private companies. Inability to consent and act in consonance to the necessities of this Section will cause termination the Director and will likewise expose him to punishment under sub-section (4).
Section 307 & 308 of the Companies Act, 2013
Section 307 applies to each director and each regarded director. The register of the shareholders should contain in it, not just the name but also how much shareholding, the description of shareholding and the nature and extent of the right of the shareholder over the shares or debentures.
The object of this section is to restrict a director and anybody associated with him, holding any business which provides compensation if the company supports it.
Pretentious Conduct: If over the span of the winding up of the company, it gives the idea that any business of the company has been continued with goal to defraud the creditors of the company or some other individual or for any deceitful reason, the people who were intentionally aware of this and still agreed to the carrying on of the business, in the way previously mentioned, will be liable on a personal level without incurring the liabilities of the company, and will be liable in a manner as the court may direct.
In Popular Bank Ltd, it was held that the Section 542 seems to leave the Court with attentiveness to make an assertion of risk, in connection to ‘all or any of the obligations or liabilities of the company’.
Judicial Interpretations and Pronouncements
Instances are not few in which the courts have resisted the temptation to break through the Corporate Veil. But the theory cannot be pushed to unnatural limits. Circumstances must occur which compel the court to identify a company with its members. A company cannot, for example, be convicted of conspiring with its sole director. Other than statutory arrangements for lifting the corporate veil, courts additionally do lift the corporate veil to see the genuine situation. A few situations where the courts lifted the veil are laid down below as per the following case law:
Dinshaw Maneckjee Petit, Re.
The court has the ability to slight and infer the corporate substance in case that it is utilized for tax avoidance purposes or to go around expense commitment. An unmistakable and appropriate description of this situation is given in Dinshaw Maneckjee Petit, Re. The assessee was an affluent man getting a charge out of tremendous profit and intrigue pay. He shaped four privately owned businesses and concurred with each to hold a square of speculation as an operator for it. Pay was credited in the records of the organization yet the organization gave back the sum to him as an imagined advance.
Further, he isolated his pay into four sections in an attempt to lessen his assessment obligation. It was held that the organization was shaped by the assessee absolutely and basically as a method for maintaining a strategic distance from super-charge and the organization was just the assessee himself. It did no business however was made essentially as a legitimate substance to apparently get the profits and interests and to hand them over to the assessee as imagined credits.
An organization may some time be viewed as an operator or trustee of its individuals or of another organization and may, accordingly, be esteemed to have lost its distinction for its head. In India, this inquiry has regularly emerged regarding Governmental organizations. Countless privately owned businesses for business purposes have been enrolled under the Companies Act with the president and a couple of different officials as the investors.
The undeniable preferred position of framing an administration organization is that it gives the exercises of the State “a tad bit of the opportunity which was appreciated by private partnerships and the legislature got away from the standards which hampered activity when it was finished by an administration division rather than an administration enterprise. At the end of the day, it gave the administration portion of the robes of the person”.
So as to guarantee this opportunity, the Supreme Court has repeated in various cases that an administration organization isn’t an office or an augmentation of the state. It’s anything but a specialist of the State. As need be, its representatives are not government workers and right writs can’t issue against it. In one of the cases, the court commented:
“The organization being a non-statutory body and one consolidated under the Companies Act there was neither a statutory nor an open obligation forced on it by a resolution in regard of which requirement could be looked for by methods for the writ of Mandamus”.
The Madhya Pradesh High Court regarded a Government company to be a separate entity for the purpose of enabling a Development Authority to subject it to development tax. The assets of a Government company were held to be not exempt from payment of non-agricultural assessment under an AP legislation. The exemption enjoyed by the Central Government property from State taxation was not allowed to be claimed by a Government company.
In this case, it was expressed that a company is likewise not permitted to file a case in the name of fundamental rights by calling itself a collection of individuals who possess the fundamental rights. When a company is framed, its business is the matter of an incorporated body therefore shaped and not of the people that it is composed of and the privileges of such body must be made a decision on that balance and can’t be made a decision on the supposition that they are the rights owing to the matter of the individual that are a part of the organisation.
In this case, the High Court of Delhi allowed to the offended party organization a stay order which restrained the company of the defendant from alienating the properties that they owned on the ground that the defendant had borrowed money fraudulently from the plaintiff companies and the defendant had purchased properties in the name of the defendant companies. The court in this case did not award protection under the piercing of the corporate veil.
Although the names of the petitioners of the case were not expressly mentioned, they were still held to be the parties to the proceedings. Also the managing directors couldn’t be said to be complete outsiders to the company petition although they in their individual limit might not be parties to such proceedings but in their official capacities, they are certainly capable of representing the company in such matters.
Approach of the Indian Courts in the 21st Century
In this situation, Hoax or façade is being talked about. A private coal company sold its real estate to the spouses of executives before nationalization of the company. Truth be told,archives were tweaked and back-dated to corroborate that the deal of the selling of the real estate to the wives of the directors was before nationalization of the company. Where such exchange is claimed to be a hoax and deceitful, the Court was supported in piercing the veil of incorporation to discover the genuine idea of the exchange as to realize who were the genuine parties to the deal and whether it was real and in good faith or whether it was between the married couples behind the façade of the different entity of the company.
This case is about a Subsidiary Holding Company. The court, to consider an objection of mistreatment held that the corporate veil can be lifted in the instances of not simply of a holding company, but also its subsidiary when both are belonging to the parent organisation.
The idea of corporate entity was advanced and endorsed to empower the trade,commerce and business scene and not to cheat the general population. In case where the court finds out that the corporate entity was not properly made use of, was set up only for illegal purposes, the court has every right to pierce the Veil and therefore see who actually was behind the Veil using the company as a vehicle for undesirable purposes.
Defendant no. 1 was a private limited company. Defendant no. 2 and 3 were the directors of that company. Defendant no. 4 was the husband of Defendant-3 and the sibling of Defendant -2. On the basis of alleged representation of Defendant-4 that Defendant-1 company was welcoming momentary deposits at great interest rates, the offended party deposited a sum of Rs. 15 lakhs in the company for a time of six months. At the point when the company neglected to pay the sum, the offended party sued it for the said sum alongside interest. Defendant-2 and Defendant-3 denied their risk on the grounds that they couldn’t have been made personally liable under any circumstance as the sum was deposited in the name of the company and not in the name of the directors of the company.
D-4 denied the risk on the ground that it had nothing to do with him as he was neither a director of the company nor a shareholder of the company so he had absolutely no role whatsoever in the case. It was held that Defendant-3 being a housewife had little task to carry out and hence couldn’t be made at risk. The offended party was looked to be put under the cloak of a corporate entity of Defendant-1 and, in this way, the corporate veil was lifted contemplating that Defendant-1 was just a family setting of the rest of the defendants. Defendant-2 was maintaining the business for the sake of the company. So Defendant-1 and Defendant-2 were both liable on a personal level.
It ought to be noticed that the rule of Salomon v. A. Salomon and Co. Ltd. is as yet the standard and the occasions of piercing the veil are the exemptions to this standard. The rule that a company has its very own different legitimate character of its own finds a significant spot in the Constitution of India too. Article 21 of the Constitution of India, says that: No individual will be denied of his life and individual freedom with the exception of as per procedure set up by law.
Under Article 21 a company likewise has the option to life and individual freedom as an individual. This was set down on account of Chiranjitlal Chaudhary v. Association of India where the Supreme Court held that fundamental rights ensured by the constitution are accessible not simply to singular natives but rather to corporate bodies also.
Along these lines, an organization can possess and sell properties, sue or be sued, or carry out a criminal offense in light of the fact that the partnership is comprised of and kept running by individuals, going about as operators of the company. It is under the ‘seal of the company’ that the individuals or shareholders submit misrepresentation.
It is conspicuously clear that incorporation of the company does not cut off personal liability at all times and in all circumstances. The sanctity of a separate corporate entity is upheld only in so far as the entity is consonant with the underlying policies which give it life.