The Concept of Corporate Veil

Author: Ria Mittal,

4th year student,

ChanderPrabhu Jain College of Higher Studies.

A company is an entity that engages in a business. In India, doing business in the form of Company is considered to be one of the best ways of structuring the business. Every type of company is governed by Companies Act 2013 (previously Companies Act, 1956). The Act defines company under section​ 2(20) as “a​ company incorporated under the Companies Act 2013 or any previous company law.” Thus, once a company is registered as per the provisions of the Companies Act, it becomes a separate legal entity in the eyes of law. It becomes an artificial person with legal personality. All the shareholders who pool in their capital are called “members” of the company and not its owners. No single member can bring an end to a company, except by way of a legal procedure. Thus, a company has its own existence and identity, distinct from its members. This distinction of entities has given rise to the concept of “Corporate Veil” in law relating to Companies.

Veil, in ordinary parlance, means a cloak, camouflage, mask or a screen. It is a legal concept that separates the personality of a corporation (Registered Company) from its shareholders, and protects them from being personally liable for the company’s debts and other obligations. A company, being a legal person, is competent to take its own decisions through its members. Such legal clothing of a corporate personality grants several benefits. 

1.     A company can enter into contracts in its own name

2.     It can sue and be sued in its own name

3.     It can take up loans or grant advances in its own name

4.     A company continues to exist even if the entire original membership of the company changes. This is called “Perpetual succession”.

5.     The liability of members is limited to the extent of shares held and unpaid by them.

They cannot be made personally liable for the debts and loans of the company. 

In simpler terms, we can say that a company interacts with outsiders in its own name, unaffected by its membership. This can be explained through following graphical representation. It is this independence which enables assets and liabilities of a company to be separated from personal assets and liabilities of members and directors. This protection granted by the company makes this mode of structuring the business as most favoured one. 

In the historic landmark judgement of Saloman​ vs A Saloman & Co Ltd (1897)​[1]​, the House of Lords held that there is separation of a company and its shareholders, ‘even when shareholders belonged to one single family and had complete control over the affairs of the company. 

However, this complete separation led to frustration amongst the lenders and provided blanket protection to the members to run the company in any manner as they fancy. This led to an increase in malpractices by the members, who demanded protection behind the company’s veil. Gradually, through judicial decisions, it became clear that this veil is not impenetrable. If the situation demands, the corporate veil of the company can be lifted to identify the real actors behind an artificial person. 

Disregarding the separate corporate personality is often referred to as lifting or piercing the veil. This means the ‘possibility of looking behind the company framework to make the members liable’ whereas usually members are shielded behind the corporate shell. While a company is a separate legal entity, the fact that it can only act through human agents that compose it, cannot be neglected. Since an artificial person is not capable of doing anything illegal or fraudulent, the façade of corporate personality might have to be removed to identify the persons who are really guilty. This is known as lifting of the corporate veil. Once this veil is lifted, the members of a company, who were the real decision makers and actors for the company, are made personally liable. When the true legal position of a company and the circumstances under which its entity as a corporate body will be ignored and the corporate veil is lifted, the individual shareholder may be treated as liable for its acts. It acts as an exception to the general rule of “Separate legal entity”. 

Due to increasing complexities and dynamic changes in real business world, it is neither desirable nor possible to list every circumstance in which Corporate veil of a company can be lifted. This has also been held by the Supreme Court in​ Life​ Insurance Corporation of India v. Escorts Ltd​[2]​. The Court said that lifting of corporate veil must​ necessarily depend on the relevant statutory or other provisions, the object sought to be achieved, the impugned conduct, the involvement of the element of public interest, the effect on parties who may be affected, etc.

The circumstance in which corporate veil can be pierced can be divided into two broad categories- Statutory provisions and Judicial Decisions and Interpretation.​           

a.     By Consent– The​      justification to pierce the corporate veil may be found in the wording of the contract where shareholders and directors give consent to give up their right of limited liability in case of default by the company. For example- when any bank grants loan in the name of a company, they also secure “personal guarantee” of the directors or other shareholders through a separate contract, that- in case the company is unable to pay its debt, the directors will have to personally pay off the debt of the company. However
, to interpret such clauses, the judiciary usually adopts a cautious approach to pierce the veil of a company

b.     By provisions of statute– There​ are various statutory provisions which also make the directors, shareholders or other officers of the company personally liable. Section​ 2(60)[3]​ of the Companies Act, 2013, integrated with various provisions, points out the person liable for any such improper/illegal activity as “officer who is in default” and also includes people holding the positions of directors and key-managerial personnel.  

Some of these provisions are discussed below

●      Misstatement in Prospectus-​ Under​ Section 34[4]​ and Section 35[5]​ of the Companies Act, it is a punishable offence to furnish untrue or false statements in prospectus of a company offering securities for sale. If any person attempts to furnish false or untrue statements in prospectus, he is subject to penalty or imprisonment or both, as prescribed under the aforesaid sections.

●      Failure to return application money-​ If the stated minimum amount of subscription has not been received, then whatever amount has been received has to be returned in specified period. In case of default in returning the amount, the company and its officer who is in default shall be liable to a penalty, for each default, of one thousand rupees for each day during which such default continues or one lakh rupees, whichever is less under section 39[6]​

●      For investigation of ownership of a company-​ Under Section 216[7]​ of the Act, the Central Government has authority to appoint inspectors to investigate and report matters relating to the company, and its membership for the purpose of determining the true persons, financially interested in the success or failure of the company; control or to materially influence the policies of the company.

●      Fraudulent conduct-​ Under Section 339[8]​ ​, 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, then every person who was involved in such fraudulent activity 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. In Delhi​ Development Authority vs. Skipper Construction Company​[9]​, the Court determined that, where, corporate character is employed for the purpose of committing illegality or for defrauding others, the court would ignore the corporate character and will look at the reality behind the corporate veil.

●      Furnishing False statements-​ Section 448[10]​ of the Act provides that if any person furnishes any false information or omits any material information in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of this Act shall be liable under section 447

2. Judicial Interpretation​

When the company acts in a different manner against the law or public policy then the court is bound to disregard its distinct feature and lift up the veil. 

 a. Tax evasion- In Re. Sir Dinshaw Maneckjee Petit​ ​[11]

In this case, the founding person of 4 new private companies, Sir Dinshaw, was enjoying huge dividend and interest income, and in order to evade his tax, he thus found 4 sham companies. His income was credited in the accounts of these companies and these amounts were repaid to Sir Dinshaw but in form of a pretended loan. These loans entitled him to have certain tax benefits. It was held that the purpose of founding these new companies was as simple as means of avoiding super-tax. The court lifted the corporate veil to determine the real purpose of the 4 companies. Similarly, In​ the case of CIT​ v. Sri Meenakshi Mills Ltd​[12]​ ​. ​where the veil had been used as a means of tax evasion, the court upheld the piercing of the veil to look at the real transaction.

b. Determination of Enemy Character- Daimler​       co. Ltd .v. Continental Tyre and Rubber co.​[13]

The true character of a company lies in the nationality of the persons who are de facto owners of the company. 

In the above mentioned case, in a company incorporated in England for the purpose of selling tyres manufactured in Germany by a German company, all the shares except one were held by the German subjects residing in Germany. The remaining one share was held by a British subject who was the secretary of the company. Thus the real control of the English company was in German hands. During the First World War, the company commenced an action to recover trade debts. The question therefore was whether company had become an enemy company consequent to world war first. The House of Lords, inter alia observed: A company incorporated in United Kingdom is a legal entity, a creation of law with the status and capacity which the law confers. It is not the natural person with mind or conscience. It can be neither friend nor enemy. But it can assume enemy character when persons in de facto control of its affairs are residents in any enemy country or, wherever resident, are acting under the control of enemies. 

 c. Prevention of fraud or improper conduct- Gilford Motor Co. ltd vs Horne​ ​[14]

When a person does any fraud or carries out an illegal activity behind the mask of “corporate entity”, the Court lifts the corporate veil to identity the true culprits. In this case, H was employed by the plaintiffs as their managing director. In contract of employment, there was a restrictive covenant, that, after his employment had ended, he would not solicit the customers of the plaintiff. After leaving the company, he formed a company of which he was an employee and all the shares had been issued to his wife and another employee, who were the only directors. The Court of Appeal regarded this company as a ‘cloak or sham‟, formed merely as a ‘device or stratagem‟ in order to ‘mask the solicitation‟. An injunction was granted against both H and the company from acting in breach of the covenant. Thus the court lifted corporate veil to prevent fraud or breach of contract. 

 d. Company working as an agency- In Re F.G. Films Ltd​ ​[15]

If one looks beyond the corporate personality of a company, it is, in reality, an agency for the shareholders. Thus, to know for whom the company acts as an agency, separate leg
al personality of the company is, sometimes, disregarded by the Courts.  In this case, an American company produced film in India technically in the name of a British Company, 90% of whose capital was held by the President of American Company which financed the production of the film. The Board of Trade refused to register the film as a British film and stated that English company acted merely as the nominee of the American company. 

Conclusion– What is the relevance of Corporate Veil in 21st Century

The centuries old law of “separate legal entity” of a company, established in Salomon case is still valid and will remain so because it allows the true owners of the company to keep their

liability limited. However, with corporate governance becoming a key concern for

controlling the recent corporate scams and multifold increase in diligence and liability of the officers of a company, the concept of separate legal personality has faded in the light. Courts have always asserted that there cannot be clearly marked boundaries to lift or not to lift the corporate veil. It will depend upon balancing of various factors. Though the basic premise in Salomon vs. Salomon remain the same, liability of the owners has gone beyond the limited scope, especially in cases of fraud, tax evasion, money laundering etc. In summary, it could be said that the courts will never lift the veil to impose liability on a shareholder for the company’s debts. Nor they will lift the veil to benefit shareholders who would discover that trading as a company would be a disadvantage. In some (rare) instances, the courts will have a look at the substance rather than the form to deny benefits of corporate status which they

think should not be enjoyed.

  

[1]     Salomon vs Salomon & co- [1897] A.C 22

[2]     Life Insurance Corp ltd vs Escorts ltd & Anr. – 1986 AIR 1370

[3]     Section 2(60), companies Act 2013- http://www.mca.gov.in/SearchableActs/Section2.ht​           m

[4]     section 34, Companies Act 2013- http://www.mca.gov.in/SearchableActs/Section34.ht​              m

[5]     Section 35, Companies Act 2013-http://www.mca.gov.in/SearchableActs/Section35.ht​               m

[6]     Section 39, Companies Act 2013- http://www.mca.gov.in/SearchableActs/Section39.ht​             m

[7]     Section 216, Companies Act 2013- http://www.mca.gov.in/SearchableActs/Section216.ht​         m

[8]     Section 339, Companies Act 2013- http://www.mca.gov.in/SearchableActs/Section339.ht​         m

[9]     Delhi Development Authority vs Skipper Construction Company ltd- 1996 SCC (4) 622

[10]  Section 448, Companies Act 2013- http://www.mca.gov.in/SearchableActs/Section448.ht​         m

[11]  In Re Sir Dinshaw Maneckjee Petit- (1927) 29 BOMLR 447

[12]  CIT v. Sri Meenakshi Mills Ltd​         -​ 1967 SCR (1) 934​       

[13]  Daimler Co Ltd v Continental Tyre and Rubber Co [1933] Ch 935​     

[14]  Gilford Motor Co. vs Horne- [1933]​               Ch 935

[15]  In Re FG Films ltd- [1953] 1​              WLR 483