Introduction
The corporate veil is a key concept in company law. It refers to the legal separation between a company and its shareholders. This doctrine upholds the notion that a company has its own legal identity, separate from the people who own or manage it. This separation allows shareholders to limit their financial risk to the amount they invest in the company, without being personally liable for the company's debts. However, there are circumstances where the legal protection afforded by the corporate veil can be misused to commit fraud, evade legal obligations, or perpetrate injustices. In such cases, courts can step in to "lift" or "pierce" the corporate veil. This means that the individuals behind the company can be held personally responsible for its actions. Understanding the grounds and circumstances under which the corporate veil can be lifted is vital to maintaining the integrity of corporate structures. It ensures that the corporate form is not exploited for improper purposes.
What is Lifting the Corporate Veil?
The main feature of the company is its character as a separate legal entity from the individual who controls the company. In reality, the company is a legal person and is the creation of legal fiction. The company cannot make decisions on its own and cannot operate on its own, it is operated by humans and is formed for profit purpose except for companies provided in section 8 of the Companies Act which are for charitable purposes. The individuals are the real one who are the beneficiaries of the business of the company.
Therefore, because human nature is selfish and greedy, it may happen the corporate personality may be used by individuals to commit fraud or illegal or improper acts. Therefore, to identify such an individual, the facade of the corporate personality may be removed to catch the guilty person. This is known as the 'Lifting of the Corporate Veil'. Courts generally do not interfere with the settled principle of separate legal personality as established in Soloman's case and adopted in India with the case of LIC v Escort, but to protect the interest of the members of the company or in the interest of the public at large, the court might step in and punish the person responsible for the wrong conduct of the company.
Categories of Lifting the Veil
There is a shift in the position of the court regarding the lifting of the corporate veil. Earlier in Solomon v. Solomon & Co. Ltd. case, the separate legal entity concept of the company became a well-settled principle. Then there is a shift in the judicial approach and the concept of lifting the corporate veil to punish the person who in the garb of a separate legal entity using it for their selfish interests. However lifting the corporate veil is not always detrimental to the interest of the company, it can result in the benefit of the company because it reveals the true nature of the company.
S. Ottolenghi in his article titled "From Peeping Behind the Corporate Veil, to Ignoring it Completely" talked about the 4 different kinds of attitudes of the court toward the company and each one is used in different circumstances and for different reasons.
- Peeping Behind the Veil
This is the first category of the theory with respect to separate legal entity and this is the least offensive. In this case, the veil of a corporate entity is not pierced to punish the individual responsible for the wrongdoing in the company, but this is only the initial point. At this stage, the veil is lifted for the purpose of getting information about the company, its members, who control the company, who are shareholders, the proportion of the shareholding, etc. Once such information is gathered, the veil is immediately pulled down and the company becomes a separate legal entity again. After collecting all this information, the court decides whether to be satisfied with it and adjudicate on the company alone, or to move up the ladder of lifting the veil and, to more serious repercussions. Therefore, in simple words, in the first stage, the court limits itself to the collection of the information of the company and finding the true nature and character of the company.
- Penetrating the Veil
This category of the lifting the corporate veil is more operative as compared to the first one because in this category the court reach through the veil and grasp the controlling shareholder of the company. personally. The purpose of penetrating the veil is to impose the responsibility on the shareholders of the company for the act of the company. If we take an example of Section 3A of the Companies Act, 2013, it clearly imposes the liability on the member of the company severally on the basis of the requirement of the minimum number of members in the company. It provides that when the number of members of the company is reduced below the minimum criteria (7 for Public company and 2 for private company) and the company continues to operate for more than six months with the reduced number, then the member who is cognizant of this fact and continues above six months then such member will be held severally liable for the payment of the whole debts of the company contracted during that time.
Another aspect of lifting the corporate veil is establishing an agency relationship between the shareholder and the company. In the Soloman Case, however, the House of Lords denied the existence of agency relation because the company has no personality of its own and because the agent has a personality of its own therefore, the company is not an agent and there can be no such relation between the shareholders and the company.
Now, the current position is that the agency is one of the cases in which the court can lift the corporate veil. When in consequence of the peeping behind the veil, the court will find that whether there is an agency relation between the shareholder and the company. Agency is the means by which the court will lift the corporate veil. This agency must be based on factual findings of the case and not merely on the basis of shareholding. Such relationships are made by the court with the aim to find the principle responsible for the act of his agent. Here the agent is the company, and the principle is the shareholder which can manipulate his agent to act according to its whims.
Another aspect of penetration of the corporate veil is by making it resemble as a partnership and paralleling the relation between the partner to that of shareholders. This mode of penetration is manifest in the winding up cases. The court examines whether the liquidation order would have been given if this had been a partnership. Equating the relationship which exist between the partners with the shareholder will actually amount to penetration of the veil. Lord Wilberforce says in Ebrahimi v Westbourne Galleries Ltd, that a company, however small, however domestic is a company and not a partnership and the obligation common to partnership may come in by the virtue of just and equitable clause.
- Extending the Veil
This is the third technique of lifting the corporate veil. In this case, when there is a group of legal entities conducting the common activity, instead of referring to each one separately, it can be regarded as one under one extended veil of incorporation. Now the attention is shifted from a single entity to a bunch of entities.
This technique can be used in other circumstances in which the distinction between the company and the shareholder is removed and the veil is not only limited to fixing liability on the individual but also extending the same to the company as well. This point is highlighted in the case of Gilford Motor Co. Ltd v Horne, where a managing director entered into a covenant not to solicit customers from his employers. Thereafter, he formed the company of his own and used it to solicit customers instead of covenant. The Court of Appeal held that the company was a mere sham to cloak his wrongdoing. Thereafter, the court issued order against him and also pass an order of injunction against the company also. This extends the veil and does not make any distinction between the company and the defendant.
Generally, the veil is extended in the case of several companies. The courts have taken this approach to the group of companies without attributing too much importance to the separate legal entity. This has been done when the group was identically or wholly owned. When the court is satisfied that a subsidiary is not fully controlled by the parent company, it treats it as a separate entity. In the case of DHN Food Distribution Ltd. v London Borough of Tower Hamlets, the company claimed compensation for the disturbance caused because of the expropriation of the land. The land belongs to another company and the shareholders of which are identical to another two companies. The court in this case treated the three companies as one and ignored the separate legal entity concept.
- Ignoring the Veil
This is the most extreme form of lifting the corporate veil because in such cases the court completely do away with the concept of a separate legal entity and ignores the veil completely. Courts ignore the veil when the company is not found in any commercial terms and the only purpose of its formation is to defraud the creditors or evade the laws. The court uses various terms like Clock, sham, scheme, puppet, etc. for the companies that are involved in such a fraudulent activity or circumventing the statutes.
Circumstances Leading the Court to Lift the Veil
The circumstances under which the courts may lift the corporate veil may broadly be grouped under the following two heads: —
A. Under statutory provisions.
The concept of a separate legal entity may not be considered in various situations as provided under the Companies Act, 2013 and the individual responsible may be held accountable for their conduct.
- Misstatement in Prospectus
Section 34 and 35 of the Companies Act impose liability on the individual if he is involved in the misrepresentation in a prospectus. Section 34 provided the punishment for fraud as provided under section 447 of the Companies Act to every person who authorizes the issue of such prospectus with misleading information unless he proves otherwise that he has reason to believe that the statements in the prospectus are true.
Section 35 of the Companies Act provides that where a person subscribed to the securities issued acting on the misleading prospectus and has sustained loss or damage then the company and every director, promoter, expert, and every other person, who authorised such issue of prospectus shall be liable to compensate the loss or damage.
- Failure to Return Application Money
Section 39 of the Companies Act provides that when a company has issued shares to the public and if the minimum amount of subscription is not received and the sum payable on the application is not received within a period of 30 days from the date of issue of prospectus or any other period which SEBI specifies, application money shall be returned within 15 days from the closure of the issue and if any such money is not so repaid within such period, the directors of the company who are officers in default shall jointly and severally be liable to repay that money with interest at the rate of fifteen percent per annum.
- Misdescription of the Name
Section 12 (3)(d) provides that a company shall have its name printed on hundies, promissory notes, bills of exchange and such other documents as may be prescribed. Thus, where an officer of a company signs on behalf of the company any contract, bill of exchange, hundi, promissory note, cheque, or order for money, such person shall be personally liable to the holder if the name of the company is either not mentioned or is not properly mentioned. Section 12 (8) also provides that if any default is made in complying with the requirements of this section, the company and every officer who is in default shall be liable to a penalty of one thousand rupees for every day during which the default continues but not exceeding one lakh rupees.
- For Investigation of Ownership of the Company
Under Section 216, the Central Government may appoint one or more inspectors to investigate and report on the membership of any company for the purpose of determining the true persons who are financially interested in the company and who control its policy or materially influence it.
- Fraudulent Conduct
Section 339 of the Companies Act provides that 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 may 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.
B. Under judicial interpretations.
Another method or ground for lifting of the corporate veil is provided by the interpretation of the court. There are numerous circumstances where the court will lift the corporate veil. Amongst those grounds, some cases instance will be discussed here to get a basic idea of the situation where the court will lift the veil.
- Prevention of fraud or improper conduct
When the company as a means is used for fraudulent purposes or improper conduct, in such cases the court has lifted the corporate veil to make the wrongdoer accountable.
In the case of Gilford Motor Company v Horne, Horne was employed by the Gilford Motor Company under a contract that prevented him from soliciting the company’s customers or competing with the company for a certain period after leaving his job. After leaving the company, Horne set up a new company that operated a competing business. He made sure that all the shares of this new company were owned by his wife and an employee, who were appointed as its directors. The court found that Horne was actually in control of the new company and had created it as a disguise to break his agreement with the Gilford Motor Company. Therefore, the court issued an injunction preventing Horne and his new company from soliciting customers of the Gilford Motor Company.
- Where the company is used to avoid welfare legislation
Where it was found that the sole purpose for the formation of the new company was to use it as a device to reduce the amount to be paid by way of bonus to workmen, the Supreme Court upheld the piercing of the veil to look at the real transaction.
In the case of Workmen of Associated Rubber Industry Ltd. v Associated Rubber Industry Ltd., "A Ltd." had purchased shares of "B Ltd." for Rs. 4,50,000 and received annual dividends from these shares, which were included in "A Ltd.'s" profits for calculating worker bonuses. In 1968, "A Ltd." transferred these shares to its wholly owned subsidiary, "C Ltd.," which had no other capital, business, or income except the dividends from "B Ltd." The dividends from "B Ltd." were no longer included in "A Ltd.'s" profits, reducing the bonus payable to its workers. The Industrial Tribunal and High Court ruled that "A Ltd." and "C Ltd." were separate legal entities, so the profits of "C Ltd." could not be considered as profits of "A Ltd."
The Supreme Court, however, determined that "C Ltd." was created solely to reduce "A Ltd.'s" profits and the bonuses payable to workers. The Court ruled that the dividends received by "C Ltd." should be included in "A Ltd.'s" profits for calculating worker bonuses, effectively piercing the corporate veil to address the misuse of the subsidiary structure.
- Where the company is used for some illegal or improper purpose
Courts have shown themselves willing to lift the veil where a device of incorporation is used for some illegal or improper purpose. In PNB Finance Limited v Shital Prasad Jain, Shital Prasad ("S") requested a Rs. 50 lakh loan from a financing company, promising to use it to buy property in Delhi. The company's directors approved the loan, secured by property title deeds and a promissory note from "S." However, "S" did not repay the loan or interest and instead diverted the funds to three public companies he and his son controlled. These companies used the money to buy properties in Delhi.
The court ruled in favor of the financing company, restraining "S," his son, and the three companies from transferring, selling, or encumbering the properties purchased with the loan money. This decision effectively lifted the corporate veil to prevent misuse of the incorporated entities.
- To punish for contempt of Court
In Jyoti Limited v Kanwaljit Kaur Bhasin, two partners who owned a firm agreed to sell two floors but later cancelled the agreement, leading to litigation. The High Court restrained the firm from selling the property. The partners then formed a private company, transferred the property to it, and sold the floors despite the court's order.
In contempt proceedings, the partners argued that the sale was made by the company, not the firm. The court held that lifting the corporate veil revealed the partners' control over the company, showing they had disobeyed the court's order. The partners, as the sole shareholders and directors, were responsible for the company's actions, thus violating the court's injunction.
- Where the company is a mere sham or cloak
In Delhi Development Authority v Skipper Construction Company (P.) Ltd, the Supreme Court held that the fact that the director and members of his family had created several corporate bodies did not prevent the court from treating all of them as one entity belonging to and controlled by the director and his family, if it was found that these corporate bodies were mere cloaks and that the device of incorporation was a ploy adopted for committing illegalities and/or to defraud people.
- For determination of technical competence of the company
In New Horizons Ltd. v Union of India, the Department of Telecommunications in Hyderabad invited tenders for printing and supplying telephone directories, requiring tenderers to have experience with systems over 50,000 lines. New Horizons Ltd. (NHL), a joint venture, and others submitted tenders. Respondent No. 4's offer was accepted. NHL challenged this decision, arguing their joint venture's combined experience should count, but the High Court dismissed their plea, stating NHL itself had no experience.
The Supreme Court ruled that lifting the corporate veil was necessary to consider the experience of NHL’s collaborators. The Tender Evaluation Committee had erroneously ignored the experience of NHL’s constituents. The Court found that both joint venture groups contributed expertise and resources, so NHL’s experience should include its collaborators' experience. The Supreme Court held that the Tender Evaluation Committee's refusal to consider NHL’s tender was arbitrary and irrational.
Conclusion
Therefore, during the course of time, the attitude of the law has changed drastically. The concept of the Separate Legal entity, which was prevalent and established rule earlier, the concept of Lifting the corporate veil is also as established as the doctrine of separate legal entity now. For the purpose of protection of the members of the company and the larger public interest court has time and again ruled in favour of lifting the corporate veil and held the wrongdoer accountable for his misconduct in the garb of the company by taking advantage of the separate legal entity concept. Lifting the corporate veil ensure transparency and accountability in the complex corporate structure.