Lifting up Corporate Veil

by Abha Kashyap Managing Patner

Introduction

In usual manner of conducting a business, a corporate is considered as a separate identity from its owners, viz, its shareholders. Now, this is good in usual business conduction but in certain cases there is a need to hold the shareholders responsible for the conduct of the corporate so that to serve justice where there is a possibility of intentional fraud and the general public is harmed. To put in simple terms, it is the process by which the separate identity of the corporate is removed so that its shareholders can be held liable for the acts of the corporate. This is also called “Piercing the Corporate Veil” or “Lifting the Corporate Veil”.

Separate Identity of a Company

The concept is pretty simple and is also put down under Section 9 of the Companies Act, 2013. After a company is incorporated under the provisions of the Companies Act, it is given recognition that is separate from its owners. That means, the company becomes an artificial person in the eyes of law, having the capacity to sue and be sued by other artificial or natural persons. The company after gaining its separate identity gains rights and liabilities that are different from those of its shareholders. Though it is a separate identity, there are certain cases in which its officers can be held liable and these are listed in the Companies Act.

Doctrine of Lifting up of Corporate Veil

This doctrine ensures that in cases of fraudulent acts done by certain persons who are involved in the operations of the business of the company, those persons can be held liable instead of the company itself. So, in simple terms, in case a person makes a false or deceptive utilization of the separate legal identity of the company and tries to hide behind the said identity using it as a shield, that person can be brought forward through this doctrine. The courts would go through the corporate identity and apply the doctrine of lifting of corporate veil to find the true culprit and hold him/her responsible. But courts are usually hesitant to go for this doctrine as it can result in many problems, so it is only done where there is a strong need to reach to an appropriate result.

Situations where the Corporate Veil can be lifted

The situation in which the courts may opt for lifting the corporate veil can be grouped under two heads, being “Statutory Provisions” and “Judicial Interpretations”.

1. Statutory Provisions

1.1. When membership is reduced (Section 45)

When membership in the company is reduced below the required number and even after 6 months of such event, the company is continuing to carry on its business with the other members having knowledge of the fact.

1.2. Improper use of Name [Section 147(4)]

When an officer of the company signs any financial document on behalf of the company but not in the prescribed format.

1.3. Fraudulent Conduct

In the process of winding up of the company, any fraudulent act is disclosed.

1.4. Failure to refund application money

In case allotment has not been made within 130 days from the date of issue of prospectus, the directors are held liable for repayment. Though this does not really affect the existence of the company, it is an essential part of the situations.

1.5. Holding Subsidiary Companies

A holding should disclose all the accounts of the subsidiaries to its members. And through this the subsidiaries disclose all reports and financial statements. This affects the separate existence of the subsidiary and is hence, taken under lifting of corporate veil.

1.6. Others

For facilitating the task of an inspector investigate the affairs of the company, For investigation of ownership, Liability for ultra vires acts, Misrepresentation in prospectus, etc.

2. Judicial Interpretation

2.1. Protection of Revenue

If it is vital to lift the corporate veil for protection of the revenue that is the tax from a corporate in this scenario, the courts may do so. The famous case for this is the Dinshaw Maneckjee Petit Case. In this case, the respondent was a well-off man. He shaped four privately owned businesses and concurred with each to hold a square of venture as a specialist for it. The wage was credited in the records of the company yet the company given back the sum to him as an imagined advance. Along these lines he isolated his pay into four sections in an offered to decrease his tax liability. It was held that, “The Company was found by the defendant purely as a means of avoiding super tax and the company was nothing but the respondent itself. It was simply created as a legal entity to receive the dividends and interest.”

2.2. Fraudulent Conduct

The corporate identity of a company of its own is unable or incapable of being held liable to an illegal/fraudulent act as it is still operated by natural persons in a collective. There are two classically famous cases for fraud exception, Gilford Motor Company Ltd. V. Horne and Jones V. Lipman. The first case being the most important one, is relevant to be discussed. In that, Mr. Horne was an ex-employee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company. In order to defeat this he incorporated a limited company in his wife’s name and solicited the customers of the company. The company brought an action against him. The Court of appeal was of the view that “the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne. “In this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud.” Thus, the court of appeal regarded it as a mere sham to cloak his wrongdoings.

2.3. Character of the Company

Here the word character is used to figure out the true motive behind the company’s acts, whether it is an adversary company and so on. Therefore, to determine the character of a company, the courts may have to use the doctrine of lifting up of corporate veil in order to examine as to who has the control and power over the company. Sometimes it may happen that the true control over a company may be with an enemy nation or perhaps the company is working adversely to the economy of the country for certain unknown reason.

Conclusion

The main goal of the doctrine of lifting of corporate veil is to ensure that the persons acting fraudulently while hiding behind the shield of “separate legal entity” of a company, are punished for their acts. It is abundantly clear from the case laws and the provisions of law that the doctrine is well applied and not used for just any reason. In fact, courts are hesitant to apply it as it does not respect the separate identity of a company, which is one of the major advantages of forming a company. All in all, the doctrine is a beneficial doctrine for the public and for those engaging in a contract with a company. And, as seen the courts have made sure that the persons operating the companies are now being more diligent so as to avoid the application of this doctrine.

Originally posted on www.kpalegal.com on 5th May 2020