What is Lifting of corporate veil?
A Company is an artificial person having separate legal entity, distinct from its members. However, the title given to a company of an artificial person having its own legalities does not take away the fact that it is not a human being capable of knowing whats rights and wrong. Company enjoys a separate position from that of position of it’s owners, but still it cannot act on it’s own. It goes to say, that there is some human agency involved behind the functioning of a company. A human agency works on in the name / behalf the company, for the company to achieve its objectives, maintain social order etc.. However, when this human agency has ill motives to defraud the company, the concept of lifting of corporate veil comes in to existence.
Under this concept, the company is treated as a distinct individual having no role to play in the acts undertaken by human agency. Here, human agency cannot take shield behind the Company being an artificial person, having separate legal entity. The human Agency is picked and punished, the grunt is not borne by the Company as a whole.
When directors, or whosoever in charge of the company, commits frauds, or illegal activities, or does any activities outside scope of the objects, memorandum, articles of the company, the principle of lifting of corporate veil is initiated. The concept of lifting of corporate veil scrutinizes, the human agency behind the scenes of the Company, to determine the real culprit committing such offences.
Courts have authority to ignore the corporate character and remove the veil against any person hiding behind the name of the Company, for fraud committed.
When is corporate veil lifted?
There are no hard and fast rules for the applicability of this doctrine, However, over a period of time, Courts and Legislatures throughout the globe have attempted to narrow down scope and applicability of the doctrine under following two heads:-
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” under Section 2(60) of the Act, and also includes people holding the positions of directors and key-managerial personnel’s. A few instances of lifting of the corporate veil cases are listed below:
A. Misstatement in Prospectus:
Under Section 26 (9), Section 34 and Section 35 of the Companies Act, it is a punishable offence to furnish untrue or false statements in prospectus of a company offering securities for sale. Prospectus issued under Section 26 contains key notes of the company containing details of shares and debentures, names of directors, main objects and present business of the company. 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.
B. Failure to return application money:
Under Section 39 (3) of the Companies Act,gives provision against allotment of securities. If the minimum stated amount has not yet been subscribed and the sum payable on application is not received within a period of thirty days from the date of issue of the prospectus, then the officers in default are fined with an amount of one thousand rupees for each day till the time the default continues or one lakh rupees, whichever is less.
C. Misdescription of Company’s name:
The name of the company is very important. Attention should be paid to every detail in the spelling and pronunciation of the name of company. Usage of approved name entitles the company to enter into contracts and make them legally binding. The name of the company requires prior approval as under Section 4 and printed under Section 12 of the Companies Act. Thus, if any representative of the company collect bills or sign on behalf of the company, and enter in incorrect particulars of the company, then he is personally liable.
Case Law: Hendon vs. Adelman, signatory directors were held personally liable for stating company’s name on a signed cheque as “L R Agencies Ltd” while the original name was “L & R Agencies Ltd.”
D. For investigation of ownership of company:
Under Section 216 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.
E. Fraudulent conduct:
Under Section 339 of the Act, in case of winding up of the company, it is found that company’s name was being used for carrying out a fraudulent activity, the Court is empowered to hold any such person be liable for such unlawful activities, be it director, manager, or any other officer of the company.
Case Law: Delhi Development Authority vs. Skipper Construction Company, 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.
F. Inducing persons to invest money in company:
Under Section 36 of the Companies Act, any person making false, deceptive, misleading or untrue statements or promises to any other person or concealing relevant data from other person with a view to induce him to enter into either of following:-
i. An agreement of acquiring, disposing, subscribing or underwriting securities.
ii. An agreement to secure profits to any of the parties from the yield of securities or by reference to fluctuations in the value of securities.
iii. Agreement to obtain credit facilities from any bank or financial institution.
In such circumstances, the corporate personality can be ignored with a view to identify the real culprit making him personally liable under Section 447 of the Act accordingly.
G. Furnishing false statements:
Under Section 448 of the Act, if in any return, report, certificate, financial statement, prospectus, statement or other document required, any person makes false or untrue statements, or conceals any relevant or material fact, then he is liable under Section 447 of the Act.
H. Repeated defaults:
Under Section 449 of the Act, if a company or an officer of a company commits an offence punishable either with fine or with imprisonment and this offence is being committed again within period of 3 years, such company and officer are to pay twice the penalty of that offence in addition to any imprisonment provided for that offence.
2) Judicial Pronouncements:
Apart from the mandatory statutory provisions provided by the Companies Act, 2013 with regards to offences behind lifting of Corporate veil, the Legislature has also played an important role to make sure guilty person is pointed to lift corporate veil. Following are few such scenarios where Court has without any doubt lifted the corporate veil:
A. Tax Evasion:
It’s the duty of every earning person to pay taxes. Company is no different than a person in eyes of law. If anyone attempts to unlawfully avoid this duty, he is committing an offence. What rule applies to a human being also applies to a company.
Case Law: DinshawManeckjee Petit, 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 rather held that purpose of founding these new companies was simple as means of avoiding super-tax.
Supreme Court of India had adopted the similar thinking in the case Tata Engineering And Locomotive Co. Ltd. vs. State of Bihar & Ors, where the corporations petitioning had joined together and claimed protection under Article 286 of Constitution of India for non-imposition of taxon the sale or purchase of goods, the Apex Court held that “If their contention is accepted, it would really mean that what the corporations or companies cannot achieve directly, they can achieve indirectly by relying upon the doctrine of lifting the veil.”
B. Prevention of fraud/ improper conduct:
It is obvious that no company can commit fraud on it’s own. Human agency involved commits such acts. Thus, one may make efforts to prevent upcoming frauds, but such efforts are in vain, when human agency here has ulterior motive.
C. Determination of enemy character:
The purpose of forming a company is prfit driven. A company will not attempt to do good towards society consciously. However, it may opt to cause damage instead.
Case law: Dailmer Co Ltd vs. Continental Tyres & Rubber Co Ltd. A Germany based company was incorporated in England to sell tyres manufactures in Germany. The German company had however held the bulk of shares in this English company. As World War I broke out, the English company commenced an action to recover trade debt. The question was brought before House of Lords which decided the case against the claimant, stating that, company is not a real person but a legal entity, it cannot be a friend or an enemy. However, it may assume an enemy character when persons in de facto control of it’s affairs are residents of the enemy territory. Thus, the claim was dismissed.
It was rather held in the case Sivfracht vs. Van UdensScheepvart that, if in such scenarios where a company is suspected to be of enemy character or is proved to be of enemy character, then such granted monetary funds would be used as machinery to destroy the concerned State itself. That would be monstrous and against public policy of that concerned State.
D. Liability for ultra-vires acts:
Every company is bound to perform in compliance of it’s memorandum of association, articles of association, and the Companies Act, 2013. Any action done outside purview of either is said to be “ultra-vires” or improper or beyond the legitimate scope. Such operations of the company can be subjected to penalty.
The doctrine of ultra-vires acts against companies was evolved in the case Ashbury Railway Carriage & Iron Company Ltd v. Hector Riche where a company entered into a contract for financing construction of railway lines, and this operation was not mentioned in the memorandum. The House of Lords held this action as ultra-vires and contract, null and void.
E. Public Interest/Public Policy
Where the conduct of the company is in conflict with public interest or public policies, Courts are empowered to lift the veil and personally hold such persons liable who are guilty of the act. To protect public policy is a just ground for lifting the corporate personality.
One such scenario is Jyoti Limited vs. Kanwaljit Kaur Bhasin & Anr., where it was held that corporate veil maybe ignored if representatives of the company commit contempt of the Court so punishment can be inflicted upon.
F. Agency companies:
Where it is expedient to identify the principal and agent concerning an improper action performed by the agent, the corporate veil maybe neglected. Such as in the case of Bharat Steel Tubes Ltd vs IFCI where it was held that it doesn’t matter and it isn’t necessary that Government should be holding more than 51% of the paid-up capital to be the principal. In fact, in the case New Tiruper Area Development Corporation Ltd vs. State of Tamil Nadu where Government was holding mere 17.4% of the investment funds, it was found that Area Development Corporation was actually a public authority through the Government. It was created under a public-private participation to build, operate and transfer water supply and sewage treatment systems.
G. Negligent activities:
Every company law distinguishes between holding and subsidiary companies. Holding companies under Indian company laware the companies which have right in composition of Board of Directors, or which have more than 50% of the total share capital of the subsidiary company. For example, Tata Sons is the holding company while Tata Motors, TCS, Tata Steel are it’s subsidiary companies.
In cases where subsidiary companies have been found with tainted operations, Courts have power to make holding companies liable for actions of their subsidiary companies as well for breach of duty or negligence on their part. Such as in the case of Chandler vs Cape Plc where an employee brought an action against holding company ‘Cape Plc’ for not taking proper health and safety measures, even though employee was employed in it’s subsidiary company.
Employee was appointed in the year 1959 in the subsidiary company while he had discovered the fact that he is suffering from asbestosis in year 2007. When he was aware of his condition it was that the subsidiary company was no longer in existence, thus, he brought action against the holding company, which was still in existence. This matter was held to be maintainable. Rather, holding company was held guilty and made liable as it owed duty of care towards employees. It was for the first time where a holding company, despite the fact that it’s a legal entity separate from that of its subsidiary, is however liable for actions of it’s subsidiary.
H. Sham Companies:-
The Courts are also empowered to lift the corporate veil if they are of the opinion that such companies are sham or hoax. Such companies are mere cloaks and their personalities can be ignored in order to identify the real culprit. This principle can be seen in the prior discussed case of Gilford Motor Co Ltd vs. Horne where it was held that the newfound company was mere cloak or sham, for purpose of enabling Sir Dinshaw to commit breach of his covenant against solicitation.
I. Companies intentionally avoiding legal obligations:-
Wherever an incorporated company is deliberately tries to avoid legal obligations, or wherever it is found that this incorporation of a company is being used to avoid force of law, the Courts have authority to disregard this legal personality of the company and proceed as if no company existed. The liabilities can be straight away imposed on persons concerned.
The doctrine acts as a watchdog over companies, which barks at and bites whosoever attempts to illegally trespass the owner’s house.