All about Principle of Lifting of Corporate Veil under Companies Act, 2013

The incorporation of a company is critical for the start-up of a business and the creation of a separate legal entity. Offenders have long exploited of the idea of separate legal entity. The principle of lifting of corporate veil is a clause that allows the court, authorities, and others to identify violators as well as the legitimate people in charge of the company’s day-to-day operations.

Meaning of Company

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.”

A company, according to Justice James, 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.”

Meaning of Corporate Veil

A legal principle of corporate veil distinguishes the conduct of corporations and companies from the actions of shareholders. It safeguards the stockholders from liability for the company’s conduct. It is not an absolute right; the court might decide whether the shareholder is responsible or not based upon the facts and circumstances of the case.

“Shareholders may shelter behind the principle of corporate veil, certain that their obligation does not extend beyond the value of their shares,” according to the Cambridge Dictionary.

Company: A Separate Legal Entity

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 essential element on which company law is based is the independent legal entity. The legal entity of the firm determines how a company comes into being, as well as 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 of which are foreign yet are relevant and acknowledged globally.

Case – Salomon vs. Salomon & Co. Ltd. (1897) A.C. 22

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 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, and as a result, unsecured creditors were to be paid ahead of secured debentures.

Case – Lee vs. Air Farming Ltd. (1960) AC 12

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 into 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 bank account of the company, 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, 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.

The Principle of Lifting of Corporate Veil

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 corporate veil entail 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 behind the actual owners or real people in control of the organisation.

A company’s distinct personality is a statutory privilege which should be used for a lawful purpose exclusively. 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.

Statutory Provisions relating to Lifting of Corporate Veil

Numerous sections of the Companies Act, 2013 has 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 covers those in positions like directors or senior management roles. Below mentioned are   few examples of such frameworks:-

1. Misstatement in Prospectus of the Company – Companies offer securities for sale by publishing prospectuses. The prospectus produced u/s 26 provides essential notes about the firm, like facts about shares and debentures, the names of directors, the company’s principal goals and current activity. If someone attempts to provide misleading or untrue/ inaccurate representations in a prospectus of the Co., he is liable to the penalty, imprisonment, or both stipulated u/s 26 (9), 34, and 35 of the Act, depending on the circumstances.

2. Reduction of No. of members below the statutory minimum – If the minimum number no. of members of a company falls below 2 (for private companies), or below 7 (for public companies), the company can continue to operate for a period of 6 months while the number is so reduced, and every person who is a member of the company during that time, knowing that the minimum number of members has been reduced. If the grace period of 6 months has expired, the corporation and its members will be held accountable and can claim for the sum they earned during those 6 months, or the firm may be sued severally.

3. Failure to refund application fees – According to Section 39 (3) of the Act, if the directors of the company fail to repay the application money (without interest) within 120 days when the Co. fails to allot shares, they will be jointly and severally accountable to pay back the money alongwith interest of 6% p.a. from the date of expiry of 130 days.

4. Misperception of the name of the company – According to section 12, an officer of an corporation which signs any bill of trade, hundi, promissory note, or check where the name of the organisation is not referenced in the recommended way could be held personally accountable to the holder of the bill of trade, hundi, etc. unless it is appropriately paid by the company.

5. Fraudulent trading – Section 339 of the Companies Act, 2013 If, during the course of a company’s winding-up, it seems that any business of the company was conducted with the intension of defrauding the company’s creditors or any other persons, or for any illegal purpose, the Tribunal, on the application of the Official Liquidator, the Company Liquidator, or any creditor or contributory of the company believes it is appropriate, may proclaim that any individual who is or has been a company’s director, manager, or officer, or any individuals who were intentionally parties to the carrying on of the business in the manner aforesaid will be responsible personally, with no limitation of liability, for all or all of the company’s debts or other liabilities, as directed by the Tribunal.  Every individual having knowledge of that fraud shall be punished with imprisonment for period upto 2 years or fine of upto Rs. 50,000/-, or both.

6. For investing ownership of the company – According to Section 216 of the Act, the Central Government may appoint Inspectors to examine and report on the company’s membership in order to determine the real persons who are financially engaged in the firm and who influence its policies. As a result, the Central Government might ignore the corporate veil.

7. Inducing persons to invest funds in the company – According to Section 36 of the Act, anyone who makes false, fraudulent, misleading, or inaccurate representations or promises to another person or hides relevant material from another person in order to induce him in doing any of the following:-

• An agreement to acquire, disposes of, subscribe to, or underwrite securities.
• An agreement to guarantee gains to any of the parties based on the return of securities or on changes in the value of securities.
• An agreement to receive credit from any bank or financial organisation.

In certain cases, the corporate personality might be neglected in order to identify the actual guilty party and hold him solely accountable.

8. To furnish false statements – Under Section 448 of the Act, if any person makes false or untrue representations in any necessary return, report, certificate, financial statement, prospectus, statement, or other document, or hides any relevant or material truth, he is responsible u/s 447 of the Act. The corporate veil must be lifted in order to find the true guilty individual who authorised such documents to be disclosed in the name of the firm.

9. Repeated defaults – According to Section 449 of the Act, if a company or an officer of a company commits an offence shall be punished by fine or imprisonment and commits the same offence within three years, the company and officer must pay twice the penalty in addition to any custodial sentence imposed for such offence.

10. In case of Ultra-Virus Acts – Every company is required to operate in accordance with its AoA, MoA, and the Companies Act, 2013^[1]. Any activity performed outside jurisdiction of either is considered to be “ultra-virus” or inappropriate or beyond the certified scope. Penalties may be imposed if the company’s operations are found to be illegal. Directors and other officers of a corporation will be personally liable for all acts performed on its behalf if they are ultra-virus the corporation.

11. In case where companies internationally avoiding legal obligations – Wherever it is discovered that an incorporated company is attempting to escape legal responsibilities, or that the incorporation of a company is being exploited to avoid the force of law, the courts have the right to reject the business’s legal identity and continue as if it never existed. Liabilities might be imposed on the people involved.

Judicial Grounds of Lifting of Corporate Veil

• Sham Company (Fraud)

It comes as no surprise that no company can conduct fraud on its own. To conduct such crimes, there must be a human agent 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.

Gilford Motor Company vs. Horne (1933) T CH 935

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 – The Corporation was put up to avoid Horne’s contractual accountabilities and was utilised as a fraud tool to hide Mr. Horne’s illegal acts, according to the court. The court also ordered an injunction against him, piercing the corporate veil.

• Invocation of the Principal of agency

The principle of corporate veil may be disregarded when it is necessary to identify the principle and agent in connection with an inappropriate activity undertaken by the agency.

RG Films Ltd. (1953)

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 lifting of corporate veil and it was determined that the theory of distinct legal entity does not imply that the business would operate as a simple agent of the shareholders.

• Against Public Policy

When a company’s actions are in violation of public policy or the public interest, courts have the authority to pierce the veil and hold those who are personally accountable. The right basis for piercing the corporate personality is to safeguard public policy.

Connors Bros vs. Connors (1940)

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 upon the managing director who abused his position by acting in a way that was against public policy.

Held – Since the people who 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.

Daimler Co. Ltd. vs. Continental Tyre and Rubber Co. Ltd. (1916)

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.

• Tax Evasion (Protection of Revenue)

It is the responsibility of every earner to pay their fair share of taxes. In the perspective of the law, a corporation is no different from a person. Anyone who tries to escape this responsibility in an illegal manner is considered to be committing an offence.

CIT vs. Meenakshi Mills Ltd. AIR 1967 SC  819

Held – If a corporation is created only to avoid paying taxes, then the principle of lifting of 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.

• Negligent Activities

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.

Conclusion

Read our article:Recent trends of Oppression and Mismanagement Cases