Lifting of Corporate Veil under the Companies Act, 2013

Abstract

With the growing economy and trends in the corporate sector, the corporate sector has faced many frauds, insider trading, and false claims, etc. The doctrine of the lifting of the corporate veil plays an important role in identifying the offenders who do these crimes and hide behind the curtains of the company. The doctrine of a separate legal entity plays the same role as that of the lifting of the corporate veil but in a much broader sense. The concept of a separate legal entity itself is the cause of action or reason behind the members of any given company or an organization commit the crimes and hide behind the curtains of the company. This notion of hiding behind the walls of the company was removed and the true meaning of a separate legal entity was seen in many historical cases, which led to the establishment of new laws and acts. This article concentrates on what is the meaning of separate legal entity, corporate veil, and lifting of the corporate veil. The article also focuses on what circumstances the corporate veil was lifted with relevant case laws, what are the statutory provisions and judicial interpretation of the corporate veil (grounds under which corporate veil is lifted).

Introduction

Incorporation of a company is very important for the commencement of business and to have a separate legal entity. This doctrine of separate legal entity has always been exploited by the offenders. The lifting of the corporate veil is the provision available to the court, authorities, etc. to identify the offenders and also to find the true persons who control the daily affairs of the company.

Meaning and Definition of Company

Company under section 2(20) means a company incorporated under the Companies Act, 2013 or under any previous Companies Act. Company is generally a legal entity represented by a set of members or association of people, with specific objectives. The line of business structure of the company can be corporation, partnership, or proprietorship. These are the basic structure and types which decide the ownership of the company.[1]

According to Justice Marshall, “a company is an artificial person, has no physical existence. It is invisible and intangible. It exists only in contemplation of law”.

According to Justice James, “a company is an Association of persons united for a common object”.[2]

According to Justice Lindley, “a company is an association of persons, these persons contribute money or money’s worth to common stock. The common stock so contributed is money is called Capital of the company, the persons who contributed the capital are called as Members of the company. The capital is employed in some trade or business, the members share the profits and losses arsing from such business. The proportion of capital to which each member is entitled is called as his share, the shares are always transferable although the right to transfer is often more or less restricted”. [3]

Meaning and Definition of Corporate Veil

A corporate veil is a legal concept that separates the acts done by the companies and organizations from the actions of the shareholders. It protects the shareholders from being liable for the actions done by the company. This is not an absolute right the court depending on the facts of the case can take the decision whether the shareholder is liable or not.

According to the Cambridge Dictionary, “shareholders may hide behind the corporate veil, assured that their liability does not extend beyond the value of their shares”.[4]

 Company: A Separate Legal Entity (Corporate Personality)

Corporate personality is the reality expressed by the law that a company is perceived as a legal entity distinct from its members. A company with such recognition and personality will be considered as a separate legal entity having an independent legal existence from the members of the company. A company is known by its own name and has its own right, duties, obligations, and liabilities. Therefore, there is a clear difference between the company and its members, this is commonly called a Corporate Veil as discussed above.

The separate legal entity is the basic feature on which company law is premised. Establishing how a company comes into existence and how it is managed and functioned all depends on the legal entity of the company. The concept of a separate legal entity is not new and contrastingly there are many cases and litigation on this topic and on its jurisdiction. There are two very important judgments on separate legal entity one of them is Salomon vs Salomon and Lee vs Lee, both cases are foreign but are applicable and accepted universally.

1. Salomon vs Salomon & Co Limited (1897)

Facts

• Salomon was running a business of boot making and leather merchant as a sole proprietorship and transferred his business to Salomon Ltd, incorporated with members comprising of his own family and himself.
• The value paid to Salomon for such exchange (transfer) was made with the assistance of shares and debentures having a floating charge on the resources of the company.
• The business was failed and was incurring losses. When the company’s business failed it went into liquidation. Salomon’s right of recovery secured through floating charge against debentures stood at a priority against the creditors of the company, they contended that Salomon and his company “Salomon Company” are one and the same.
• The liquidator on behalf of unsecured creditors, alleged that the company was fiction and was (the company) essentially an agent of Salomon.
• Salomon being the principal was made liable to pay the unsecured creditors. In simple words, the liquidator disregarded the separate personality of Salomon Ltd., particularly from its members making him liable personally for the acts of the company.
• As Salomon was the major shareholder of the company, he was made personally liable for the company’s debt. Hence, the issue was whether he is personally liable for the company’s debt, regardless of the separate legal entity of a company.

Judgement 

It was held that the company is a real and legal company, fulfilling all legal requirements. It had an identity different from its members and therefore, the unsecured creditors were to be paid at priority from the secured debentures.[5]

2. Lee vs Lee Air Farming Limited (1960)

 Facts

• Lee was a qualified pilot and formed a company named Lee’s Air Farming Ltd. for the purpose of carrying the business of aerial top-dressing with 3000 shares, 1 Euro each forming the share capital of the company. 2999 shares out of 3000 shares were owned by Lee himself.
• Lee was the director of the company also. He exercised unrestricted power to control the affairs of the company. He made all the decisions in relation to the contracts of the company.
• The company entered into many contracts with other companies, insurance agencies, etc for insurance of its employees. The premiums for these policies were paid from the companies’ bank account for the personal policies owned and taken by Lee and the amount was debited in the account of Lee in the companies’ book.
• Lee apart from being the director of the company was also a pilot. Lee died while piloting the aircraft during the course of aerial top-dressing.
• His widow wife claimed compensation under the New Zealand Workers’ Compensation Act, 1992 for the death of her husband in the course of his employment.
• The company claimed that Lee was the owner of the company and had the maximum number of shares in the company so his wife is not entitled to compensation.

Judgement

It was held by the court that Lee was a separate person from the company he formed and his widow wife is entitled to get the compensation. This Judgement is very important with respect to Indian companies act as it lays the precedent that a company has a separate legal entity and it can enter into contracts with its own members.[6] 

Lifting of Corporate Veil (Piercing the Corporate Veil)

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 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 (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.

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 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.

Grounds under which Corporate veil is Lifted

1. Where the Company is a Sham (Fraud): Gilford Motor Company vs Horne (1933)

• Mr. Horne was a former Managing Director of Gilford Motor Home Company Ltd. His employment contract stipulated a condition that he should not solicit customers of the company once he leaves his job.
• Mr. Horne was fired from his position and job. Thereafter, he established a competing company with his wife, himself, and one of his friends, who were the sole shareholders. The company established by Horne has lower price tags than that of Gilford’s company.
• The shareholders started soliciting the customers of Gilford Motor Company. Gilford did not have any legal restraints against Horne’s company, only Horne himself.
• Gilford filed or commenced proceedings against Horne individually, claiming that Horne’s company was an attempt to evade legal obligations through soliciting customers.

It was held that the company was set up to evade Horne’s contractual obligations and was used as an instrument of fraud to conceal Mr. Horne’s illegitimate actions. The court pierced the corporate veil and ordered an injunction against Horne.[7]

2. Invocation of the principal of agency: RG Films Ltd (1953)

• An American company financed the production of a film in India in the name of a Britain company.
• 90% of the shares in the British Company was held by the president of an American Company. The company had no business other than its registered office and it had no staff also.
• Thereafter, the film at the time of release was refused by the Board of Trade to register it as a British film because the British company acted merely as an agent of an American company.

It was held that the decision was valid in the view of the fact that the British company acted merely as a nominee of the American company. In this case, the Corporate veil was lifted and declared that the doctrine of separate legal entity does not mean that the company will act as a mere agent of the shareholders.[8]

3. Public Policy: Connors Bros vs Connors (1940) 

• In this case the acts done by the members of the company led the court to lift the corporate veil to punish the offenders as the company had been formed to accomplish an act that is against the public policy.
• The principle was applied against the managing director who made use of his position to contrary to the public policy.

The House of Lords determined the character of the company as an enemy company because the persons who were de facto who were residents of Germany, which was at war with the British during that time.

The alien company was not allowed to proceed with the action, which was directly or indirectly meant giving money to the enemy, thus was considered against the public policy.[9]

4. Determining True Character of the Company: Daimler Co. Ltd vs Continental Tyre and Rubber Co. Ltd (1916)

• A private company was incorporated in England for the purpose of selling motor tires manufactured in Germany and was a German company.
• The German company has almost all of the shares in their position and all the directors of the company were Germans.
• During the First World War, the English company commenced an action for recovery of Trade debt.
• The House of Lord held that the company was an enemy company for the purpose of trading because its effective control or the management was in the hands of Germans.

The court held that it would against public policy if there is a trade among them and hence it was decided that the company will not be allowed to proceed with the action.[10]

5. Protection of Revenue (Tax Evasion): CIT vs Meenakshi Mills Ltd 

The corporate veil may be ignored if the company is formed merely to evade tax. In Income Tax Commissioner, Madras vs Sri Meenakshi Mills, Madurai, the Supreme Court held that the Income Tax authorities have a right in this case to lift the corporate veil.

Sir Dinshaw Maneckji Petit (1927)

• In this case the assessee was a wealthy man enjoying large dividends and interest income. He formed 4 companies and agreed with each other to hold a block of investment as an agent for it.
• Income revived was credited in the accounts of the company but the company handed back the amount to him as a pretended loan, like this, he divided his income into 4 parts so that he can easily escape the tax liability.

It was held that the company was formed only with an intention to evade tax and the company was nothing but the assessee himself. It did not do any business, except for helping the assessee to evade tax and to have a separate legal entity to superficially receive the dividends and interest and then to hand it to them to the assessee as pretended loans.[11]

Statutory Provisions in support of Lifting the Corporate Veil 

1. Reduction of number of members below the statutory minimum: If at any time the minimum number of members of a company falls below two, in case of Private company or below seven, in case of Public company; then the company can carry on the business for a period of six months while the number is so reduced, every person who is a member of the company during the time that it still continues to carry on the business, knowing the fact that the minimum number of members is reduced and the grace period of six months is also finished, then as the case may be, the company and its members will be held liable and can sue an amount which they made during those six months or else the company may be severally sued, therefore.
2. Failure to refund application fee: The directors of the company shall be jointly and severally liable to repay the money (application money) with an interest of six percent per annum from the date of expiry of one hundred and thirtieth day if they fail to repay the application money without interest within one hundred and twenty days when the company fails to allot shares.

3. Misdescription of company’s name: An officer of an organization (company) who signs any bill of trade, hundi, promissory note, check wherein the name of the organization isn’t referenced in the recommended way, such official can be held personally liable to the holder of the bill of trade, hundi, etc. except if it is properly paid by the company. 

4. Fraudulent trading: Under section 339 of the Companies Act, 2013, If in the course of the winding-up of a company, it appears that any business of the company has been carried on with intent to defraud creditors of the company or any other persons or for any fraudulent purpose, the Tribunal, on the application of the Official Liquidator, or the Company Liquidator or any creditor or contributory of the company, may, if it thinks it proper so to do, declare that any person, who is or has been a director, manager, or officer of the company or any persons who were knowingly parties to the carrying on of the business in the manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the Tribunal may direct. Every person who had the knowledge of such fraud will be punishable with imprisonment for a term which may extend to two years or with a fine which can extend up to fifty thousand or with both.[12] 

5. For investigating company’s ownership: Under section 216 of the Companies Act, 2013, the Central Government may appoint Inspectors to investigate and report on the membership of the company for the purpose of determining the true individuals who are financially interested in the company and who control its policy. Thus, the Central Government may ignore the Corporate veil.

Conclusion

A company has a legal personality just like all other natural individuals, the only difference between the two is that a company even with its legal personality cannot run or conduct its affairs as a natural person does. The company acts on the concept of the corporate veil, this veil when misused for fraudulent acts will reveal the true nature and real beneficiaries of the company, thus, called the lifting of the corporate veil. The courts from time to time implemented this rule and also brought in a few changes suitable for the situations and for future reference.

[1] Corporate Veil Definition: Protecting the Corporate Veil, The Strategic CFO (2019), https://strategiccfo.com/corporate-veil/ (last visited Dec 18, 2020).

[2] Company Law, excellentcareersolution, http://excellentcareersolution.com/images/note/Company Law BCOP-302.pdf (last visited Dec 18, 2020).

[3] Kashish G, Joint Stock Company: Definition, Features, Advantages and Disadvantages Essays, Research Papers and Articles on Business Management (2018), https://www.businessmanagementideas.com/joint-stock-company/joint-stock-company-definition-features-advantages-and-disadvantages/18068 (last visited Dec 18, 2020).

[4] CORPORATE VEIL: meaning in the Cambridge English Dictionary, Cambridge Dictionary, https://dictionary.cambridge.org/dictionary/english/corporate-veil (last visited Dec 18, 2020).

[5] Salomon v Salomon – Case Summary, Law Teacher (2018), https://www.lawteacher.net/cases/salomon-v-salomon.php (last visited Dec 18, 2020).

[6] Rahul Sharma, Case Summary: Lee vs. Lee Air Farming Limited, 1960 LawLex.Org (2020), https://lawlex.org/lex-bulletin/case-summary-lee-vs-lee-air-farming-lee-limited-1960/24542 (last visited Dec 24, 2020).

[7] Gilford Motor Co Ltd v Horne [1933] Ch 935, Law Case Summaries (2019), https://lawcasesummaries.com/knowledge-base/gilford-motor-co-ltd-v-horne-1933-ch-935/ (last visited Dec 18, 2020).

[8] Rebecca Furtado, Lifting the Corporate Veil iPleaders (2016), https://blog.ipleaders.in/lifting-corporate-veil/ (last visited Dec 18, 2020).

[9] Connors Bros. Ltd. And Others v. Bernard Connors, CaseMine, https://www.casemine.com/judgement/in/56b49627607dba348f0170e6 (last visited Dec 18, 2020).

[10] Shashi Aggarwal, DAIMLER CO LTD V CONTINENTAL TYRE RUBBER CO LTD COMPANY LAW (2019), https://www.gargshashi.com/2019/08/daimler-co-ltd-v-continental-tyre.html (last visited Dec 18, 2020).

[11] Sir Dinshaw Manockji Petit v Commissioner of Income-tax on 29 November 1926 – Judgement – LawyerServices, The Tech Solution, https://www.lawyerservices.in/Sir-Dinshaw-Manockji-Petit-Versus-Commissioner-of-Income-tax-1926-11-29 (last visited Dec 18, 2020).

[12] THE COMPANIES ACT, 2013, mca.gov.in, https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf (last visited Dec 18, 2020).