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Incorporating a company is critical for the start-up of a business and creating a separate legal entity. Offenders have long exploited the idea of a separate legal entity. The principle of lifting the corporate veil is a clause that allows the court, authorities, and others to identify violators and the legitimate people in charge of the company’s day-to-day operations.
Table of Contents
Section 2(20) defines a company as one formed under the Companies Act, 2013 or any prior Companies Act. In general, a company is a legal organisation represented by a group of members or an association of individuals with defined interests. The company’s business structure might be corporation, partnership, or sole proprietorship. These are the fundamental structure and kinds that determine the company’s ownership.
As per Justice Marshall, “A company is an artificial person with no actual existence.” It is both intangible and invisible. It exists solely in the contemplation of the law.”
According to Justice James, a company is “an Association of individuals united for a common objective.”
According to Justice Lindley, “a company is a group of people who contribute financially or money’s worth to common stock.” The money provided in the form of common stock is referred to as the company’s capital, and the individuals who contributed the capital are referred to as Members of the business. The capital is put to use in some trade or enterprise, and the members share the gains and losses equally. The percentage of capital whereby each member is entitled is referred to as his share; shares are always transferable, but the right to transfer is sometimes restricted.”
A legal principle of the corporate veil distinguishes the conduct of corporations and companies from the actions of shareholders. It safeguards the stockholders from liability for the company’s behaviour. It is not an absolute right; the court might decide whether the shareholder is responsible based upon the case’s facts and circumstances.
“Shareholders may shelter behind the principle of the corporate veil, certain that their obligation does not extend beyond the value of their shares,” according to the Cambridge Dictionary.
Corporate personality is the legal fact that a company is recognised as a legal entity apart from its individuals. A corporation with such recognition and personality would be treated as a distinct legal entity with its own legal identity apart from the members of the firm. A corporation has its own name and its own set of rights, duties, obligations, and liabilities. As a result, the corporation and its members are clearly distinguishable, which is usually referred to as a Corporate Veil.
The independent legal entity is the essential element on which company law is based. The firm’s legal entity determines how a company comes into being and how it is handled and operated. The notion of a separate legal body is not new, and there are several instances and litigation on the subject and its jurisdiction. There are two landmark decisions on separate legal entities, one of which is Salomon vs. Salomon and the other is Lee vs. Lee, both foreign yet relevant and acknowledged globally.
Facts – Salomon was a solo owner running a boot and leather merchant business when he decided to establish his company, Salomon Ltd., with members consisting of his own family and himself. The company had collapsed and was losing money. The firm fell into liquidation after its business collapsed. Salomon’s right of recovery, backed by a floating charge on debentures, had priority over the business’s creditors, who claimed that Salomon and his company, “Salomon Company”, were the same person. On behalf of unsecured creditors, the liquidator claimed that the business was a fabrication and that it was simply a Salomon agent.
As the principal of the Co., Salomon was held responsible for the company’s debt and unsecured creditors. As a result, the question was if he would be personally responsible for the business’s debt, regardless of whether the firm was a separate legal entity.
Held – It was held that the firm was determined to be a legitimate and legal entity that complied with all legal criteria. It had a distinct identity from its members, so unsecured creditors were to be paid ahead of secured debentures.
Facts – Lee, a licensed pilot who established Lee’s Air Farming Ltd. to continue on the business of aerial top-dressing. The share capital of the company was made up of 3000 shares, each worth one Euro. Lee held 2999 of the 3000 shares in the company.
Lee was also the company’s director. He had unlimited authority over the company’s operations. He was the one who made all of the company’s contract judgments. For the insurance of its employees, the firm engaged in many arrangements with other companies, insurance agencies, and so on. For the personal insurance held and taken by Lee, the premiums were paid from the company’s bank account, and that sum was deducted from Lee’s account in the company’s book.
Lee was a pilot in addition to being the company’s director, and he died while flying the plane during an aerial top-dressing mission. His widowed wife sought reimbursement under the New Zealand Workers’ Compensation Act of 1992 for her husband’s death while on the job. The firm argued that because Lee was the company’s owner and held the most shares, his wife was not entitled to any compensation.
Held – The court decided that Lee was a different person from the firm he established, and therefore his widow should be properly compensated. This decision is significant in terms of the Indian Companies Act 2013 because it establishes the precedent that a company is a distinct legal entity capable of contracting with its own members.
A company is seen as a distinct legal entity apart from its members; however, in reality, it is an association of people who are the beneficial company owners and its corporate property. This illusion is established through a veil, which is referred to as the Corporate Veil. Piercing /lifting of the corporate veil entails disregarding the notion that a corporation is a separate legal entity with its own identity (Corporate personality). This idea disregards the business’s distinct identity & focuses on the actual owners or real people in control of the organisation.
A company’s distinct personality is a statutory privilege that should be used exclusively for a lawful purpose. Persons shall not be able to escape behind the curtain of corporate personality anytime a fraudulent or dishonest use of the legal organisation is done. The competent authorities will pierce the company’s shell and sue the persons who have done or committed such a crime or offence. The breaking of the curtain is referred to as a Lifting of the Corporate Veil.
Numerous sections of the Companies Act 2013 have been amended that aim to identify the individual who is accountable for any such improper/illegal action. Those individuals are most commonly referred to as “officers in default” u/s 2(60) of the Companies Act and cover those in positions like directors or senior management roles. Below mentioned are a few examples of such frameworks:-
In certain cases, the corporate personality might be neglected to identify the guilty party and hold him solely accountable.
It comes as no surprise that no company can conduct fraud on its own. To conduct such crimes, a human agent must be engaged with it. As a result, measures can be made to avoid future fraudulent practices.
The courts also have the authority to remove the corporate veil if they believe the businesses are a hoax or a “Sham”. Companies like these are only cloaks, and their characteristics may be overlooked in order to find the true offender.
Facts – Mr Horne served as the former Managing Director of Gilford Motor Home Company Ltd. His employment contract included a clause prohibiting him from soliciting the company’s clients after he left. Mr Horne was dismissed from his employment and post. Following that, he formed a competitive firm with his wife, himself, and one of his friends as the only owners. Horne’s business is less expensive than Gilford’s. The stockholders began approaching Gilford Motor Company’s consumers. Gilford had no legal rights against Horne’s firm, only against Horne himself. Gilford sued or started legal action against Horne, alleging that his firm was an attempt to avoid legal duties by recruiting consumers.
Held – According to the court, the Corporation was put up to avoid Horne’s contractual accountabilities and was utilized as a fraud tool to hide Mr. Horne’s illegal acts. The court also ordered an injunction against him, piercing the corporate veil.
Facts – An American business sponsored the production of a movie in India under the name of a British company, and the president of an American company owned 90% of the shares in the British firm. The corporation had no additional assets beyond its registered office and no employees. Following that, the Board of Trade declined to register the movie as a British film since the British business was only acting as an agent for an American corporation.
Held – The ruling was upheld due to the fact that the British firm was only acting as a nominee for the American corporation. Here, the court ordered the lifting of the corporate veil, and it was determined that the theory of a distinct legal entity does not imply that the business would operate as a simple agent of the shareholders.
Facts – In this matter, the actions done by the company’s members prompted the court to invoke the principle of lifting of corporate veil in order to penalize the offenders since the firm was created to carry out an activity that was against public policy. The concept was used on the managing director, who abused his position by acting in a way that was against public policy.
Held – Since the people were de facto residents of Germany, which was at war with the British at the period, the House of Lords ruled that the firm was an enemy company. The alien firm was not permitted to continue with the act because it was regarded against state policy because it directly or indirectly involved sending money to the enemy.
Determining the True (enemy) Character of the Company / Avoid Welfare Legislation
Where the goal of forming a business is to solely make profits. A corporation will not intentionally try to do good for society. It may, although, choose to inflict harm instead.
Facts – A German business formed a private company in England for selling motor tyres made in Germany. The German firm owns virtually all of the business’s shares, and all of the company’s directors are Germans.
Held – The House of Lords held that the firm was an enemy company for the purpose of trade since its effective control or administration was in the arms of Germans. The court determined that if there is a trade between them, it would be against the public policy, and so the firm will not be permitted to proceed with the action.
Held – If a corporation is created only to avoid paying taxes, then the principle of lifting of the corporate veil may be invoked. The Supreme Court decided in the case of Income Tax Commissioner, Madras vs Sri Meenakshi Mills, Madurai, that the Income Tax authorities had the power to pierce the corporate veil in this instance.
Every corporate entity establishes a distinction between holding and subsidiary companies. Under Indian company law, holding companies are the ones that have a say in the constitution of the Board of Directors or own more than half of the entire share capital of a subsidiary company. For instance, Tata Sons is the holding company, with Tata Motors, TCS, and Tata Steel as subsidiaries.
Like all other natural persons, a business has a legal personality; the only distinction is that a company, even with its legal personality, cannot manage or conduct its activities in the same way that a natural person may. The corporation operates under the idea of the corporate veil, which, when abused for fraudulent purposes, reveals the company’s true identity and genuine benefactors, resulting in the lifting of the corporate veil. The courts used this rule occasionally, making a few modifications that were appropriate for the circumstances and future reference.
It is a legal concept that allows the courts to disregard a company’s separate legal entity status and hold its members personally liable for the company’s actions. It is invoked when the company is used for fraudulent or illegal purposes, and the true individuals behind the company’s operations need to be identified and held accountable.
The Corporate Veil can be pierced in several situations, including cases of fraud, where the company is deemed to be a “sham” or merely a cloak for the true offenders.
The Principle of Agency comes into play when it is necessary to identify the principal and agent involved in an inappropriate activity undertaken by the company.
Yes, the Companies Act of 2013 includes various provisions that allow the authorities to identify the individuals accountable for improper actions.
The courts can lift the corporate veil on various grounds, such as when a company is sham or fraudulent, to avoid welfare legislation, to determine the true character of a company, or to protect revenue from tax evasion. The judicial grounds are applied based on the specific circumstances of each case.
Read our article:Recent trends of Oppression and Mismanagement Cases
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