The transparent veil of companies: Principle of Lifting the Corporate Veil

INTRODUCTION

A company cannot act for itself without its constituent members acting on behalf of it. However, a company is considered a person in the eyes of law. It is not given the status of a real person but of a juristic person. The identity of a company is separate from its constituent members but is of a different nature. The relation between the identity of a company and the identities of its members, is the added protection which the former imparts to the latter. The company acts as a veil behind which the members of a company can hide their faces, this leads to the perpetuation of fraudulent and illegal activities by the members of a company under the name of a company, thereby firing while putting one’s gun on someone else’s shoulder. To prevent such undesirable situations, eventually, the Doctrine of Lifting the Corporate Veil was devised. This doctrine and its various facets are discussed below at length.

WHAT IS A ‘COMPANY’?

Before discussing the principle of lifting the corporate veil, it is important for us to understand the concept of a company, as the application of this principle is exclusive to the corporate world. The term ‘company’ is derived from the Latin term ‘companis’. If we break this term into its constituents, we get ‘com’ meaning ‘together’ and ‘panis’ meaning ‘bread’. Hence, it was used to denote a number of persons who dine together. This being the approach in the ancient times, has now been rendered irrelevant with times advancing. The said definition held good when human prospects were limited to filling their bellies. In the modern times, ‘company’ is recognized as a group of people working collectively for the fulfilment of a commercial activity.

STATUTORY DEFINITION

The term ‘Company’ is defined under Section 2 (20) of The Companies Act, 2013, wherein it is defined as, a “company incorporated under this Act or under any previous company law.” This definition is not exhaustive, but it is deliberately given an open-ended language to ensure its inclusivity.

A company has a personality of its own, notwithstanding the board of directors which manage any company. The feature of a company being a distinct legal entity on its own, separate from the identities of the members constituting it, was established by the Hon’ble Supreme Court of India in case of Rustom Cavasjee Cooper vs. Union of India.

WHAT IS THE PRINCIPLE OF ‘LIFTING THE CORPORATE VEIL’?

It is now established that a company has a distinct identity from its constituent members. Problems arise when this position of the company is misused, it is in such cases where the line between a company and its members, has to be blurred. It is logical to say that though a company has a separate legal identity, it cannot act on its own. There have to be certain human agencies performing the functions of a company. When such human agencies, while working under the name of a company, actuate fraudulent or illegal transactions, or activities outside the purview of the company’s prospects, the respective persons cannot seek exemption from legal action against them, in the garb of working under the image of a company.

EXAMPLE OF ‘LIFTING THE CORPORATE VEIL’

Suppose directors or any others in charge of the company, start committing frauds, illegal activities, or undertaking prospects outside the purview of the objective/articles of the company, the distinction between the identities of the members of a company and a company; is blurred and the principle of lifting the corporate veil is implemented. The people engaging in such activities are held liable in their respective personal capacities. The identity of a company is disregarded in such situations to find out the real culprit of any offence committed under the name of a company.

ORIGIN OF THIS DOCTRINE

The origin of this doctrine is in England. The English Law recognised the legal personality of a company in 1867, but it was in 1897 that the same was firmly established in the case of Saloman vs. Saloman & Co. Ltd.

• In the said case, Salomon was a shoe manufacturer. His business was in running in profits wherein he enjoyed substantial surplus over liabilities. He constituted a company named Saloman & Co. Ltd for the purpose of taking over his business and carrying it on.
• The seven subscribers to the Memorandum were Saloman himself, his daughter, his wife and four sons and they were the only members of the company thus constituted.
• Saloman, along with two of his sons, constituted the Board of Directors of the company. The business was transferred to the company for £ 40000. As payment, Saloman kept 20000 shares, valuing £ 1 each and debentures worth £ 10,000. These debentures were a proof that the company owed Salomon £ 10000 and created a charge on the company's assets.
•  A share each was given to all the remaining member of his family. The said company witnessed liquidation within a year. The company’s assets amounting to £ 6,000 were insufficient to pay off the debentures, as a result of which, the ordinary investors did not receive anything
• The liquidator insisted to get the debentures cancelled, for the reason that the company was merely an agent of Salomon.
• The unsecured creditors contended that solely because the company was incorporated under the Act, it cannot be denied that it had no individual existence, separate from Salmon’s identity, as Salmon being the sole person behind the veil of the company, he was the managing director, the other directors too were his sons and thus, were under his control.
• It was decided by the House of Lords that the company was merely one man show and its existence was contrary to the spirit of what a company is to have as per Company Laws. Thus, the colourable exercise of rights by Salomon, lead the House of Lords to devise the concept of the ‘Doctrine of Lifting the Corporate Veil’.

POSITION IN INDIAN LAW

A glaring majority of Indian company law has been borrowed from English law, it qualifies to be called a replica of English Law, in the context of Company Law. The Salomon's case which has been discussed above; has been considered an authority in India, since the advent of the Doctrine of Lifting Corporate Veil in India.

The Hon’ble Supreme Court of India in Tata Engineering Locomotive Co. Ltd. v. State of Bihar and others, stated that "the corporation in law stands equal to a natural person and is a legal entity on its own. The identity of a corporation is entirely separate from that of its shareholders; similarly, the creditors have no claim to assert over the assets of a company.

In LIC of India v. Escorts Ltd, Justice Chinnappa Reddy had emphasised on the corporate veil being lifted where the associated companies are inextricably intertwined. After the Bhopal Gas tragedy case, the implementation of the doctrine lifting of the corporate veil has been escalated.

The Doctrine of Lifting the Corporate Veil is not mentioned expressly in the text of Indian Company Law, but could be inferred from a number of provisions thereof. The doctrine has now become of precedential value, after being stated in a number of decisions by numerous courts of law in India.

WHEN CAN THE CORPORATE VEIL BE LIFTED? 

STATUTORY PROVISIONS

The Companies Act 1956, provides for the circumstances wherein the corporate veil will be lifted and the constituent members or directors will be accounted liable for certain transactions.

1) Reduction of Membership (Section 45)

ReferralSection 45 of the Act holds the members of a company individually liable for the payment of debts of the company if the number of members of the company is decreased below the statutory requirements i.e. two members for a private company and seven members for a public company. It is to be noted that section 45 does not destroy the separate identity of the company, it still remains a distinct legal entity. However, this provision applies only to those members who remain as members of the company continuously for a period more than 6 months after the membership falls below the defined statutory limits.

2) Failure to Deliver Share Certificate (Section 113)

Subsection (2) of Section 113 states that if a company fails to deliver the share/debenture certificate within a period of 3 months from allotment and/or within 2 months of application for transfer, the concerned company as well as every officer of such company, who is at fault, shall be liable for punishment with fine up to Rs. 5000 per day till such fault continues.

3) Holding and Subsidiary Company (Section 212)

Section 212 of the Companies Act, 1956, states that in relation to financial disclosure; a true and fair view of the overall status of the group is to be put forth. Hence, the parent company should present its own individual financial statement and financial statements of its subsidiaries as well. It is to prevent the company from presenting a misleading picture depicting the financial statements of the company alone.

The Companies (Amendment) Act, 2013

The amendment to The Companies Act, 2013, too, brought in a number of provisions wherein the Doctrine of Lifting the Corporate Veil could be applied.

• Misrepresentation in prospectus (Section 34 and 35)

When there is misrepresentation in a prospectus, every promoter, director and any other such person who authorizes the issuance of a prospectus with misrepresentation, incurs a liability towards the ones who subscribed for shares, believing on statements which turned out to be untrue.

• Failure to return application money (Section 39)

In the case of issuance of shares by a company, if minimum subscription as mentioned in the prospectus has not been received, then the directors shall be personally liable to return the money with requisite interest if the application money is not repaid within a prescribed time period.

• Fraudulent Conduct (Section 339)

In the case of winding-up of a company, when it appears that any business of the company has been done with an intent to defraud the creditors of the company or any other person, or for any other fraudulent objective, persons who are knowingly the parties to such conduct of business activities may, if the Tribunal thinks it just to do so, be made personally liable, in their respective individual capabilities, devoid of any limitation as to any liability of the company.

II)JUDICIAL INTERPRETATION

Under this subhead, the corporate veil is lifted by the courts in pursuance of 3 objectives.

1)Determination of character

The corporate veil has been lifted by courts of law in the past to decipher the enemy character of a company. A company acquires an enemy character if it is controlled by enemy aliens. Thus, courts will lift the veil to find out the actual persons conducting the affairs of a company. 

2)Determination of Residence for tax purpose

Courts hold the authority to disregard corporate entity if it is used to evade tax obligations. The is the case landmark example of this situation is seen in the case of Dinshaw Maneckjee Petit, where the assessee was a rich man enjoying high dividend and interest income. He created four private companies and agreed with each of them to hold a share of investment as an agent for it. The income so received was credited in the bank accounts of the company but the company handed over the money to the bank as a pretended loan, to evade tax liability.

3)Fraud

The corporate existence of a company cannot be permitted to perpetrate fraud. In cases where the corporate existence is used for fraudulent purposes, to defraud creditors or to avoid legal liabilities, the courts shall lift the corporate veil to determine the realities behind it and strike down such transactions.  

NEED FOR THE DOCTRINE OF ‘LIFTING THE CORPORATE VEIL’

The doctrine of lifting the corporate veil becomes inevitable when dishonest people start using the corporate veil as aid or instrument to conceal illegalities and frauds in a company's activities. Thus, it then becomes compulsory for the legislature and courts to evolve by disregarding the conventional distinction between the identity of a company and its constituent members and pinpoint people who cause such illegalities behind the veil of a company.

THE IDEOLOGY BEHIND THIS DOCTRINE

The concept of the corporate veil is a building block of Company Law. This principle extends protection to those who exist and function from behind the veil of a company. Pickering stated that there exist two main reasons as to why there are exceptions to the separate identity doctrine.

•   Firstly, he said that a company cannot be treated as an ordinary independent person in all circumstances, e.g. a company by itself cannot have a mens rea and therefore is not capable of committing any crime.

•   Secondly, if there would have been no exceptions to the separate entity rule, the board of directors and members would be allowed to hide behind the shield of the company’s identity, which could potentially lead to perversions of justice. Thus, the doctrine of lifting the corporate veil is established and actuated in times of need as a flexible tool to ensure justice.

CONCLUSION

The doctrine is a potent weapon at the disposal of the Judiciary to pinpoint the defaulters seeking refuge behind the veil of a company’s identity. Defaulting members of a company do not anymore have the option of blaming the company for fraudulent and illegal transactions carried out by them. Legislatures of various countries have formulated punishments for such fraudulent and illegal activities, further helping in increasing the efficacy of this doctrine. It is thus safe to say that this doctrine has come to the rescue of transparency in businesses and has upscaled work ethics among corporates.