In the landmark judgment of Saloman v Saloman Co. Ltd. (hereinafter refer as ‘Salomon case ‘), it was deduced that ‘company is a separate legal entity‘, having an identity of its own, which is independent and distinct form its members and shareholders. This is a well-settled principle recognized by many common as well as civil law countries around the globe. The case also states that once a company is incorporated, it becomes an ‘artificial person‘ and must be treated separately from its members. The company enjoys certain rights and obligations of its own, and has the power to sue or be sued. This ‘corporate personality‘ rule also gives the companies an advantage of perpetual succession.
According to the principle of perpetual succession, a company is considered to be solely dependent on itself and survives longer than any of its members, i.e. “members may come and members may go, but the company stays on until it‘s winded up by due process of law .” It can be stated that there exists a ‘veil‘ that separates the company and its members. Often the members of the company misuse this corporate veil to commit fraudulent activities and to protect themselves from any legal proceedings that is initiated against them for any mischief done. In such cases, courts disregard the corporate personality of the corporate body and pierce through the veil to find out the actual perpetrators, and initiate legal actions against them.
This principle of “lifting the corporate veil” by the courts, can be regarded as an ‘exception‘ to the corporate personality rule of corporate law. Since corporate personality forms the fundamental of a company, courts are often faced with a dilemma when it comes to lifting the veil, as misapplication of this rule may harm the business prospects of the company and give suboptimal outcomes
A company is seen as an individual person in eyes of law. A Company is treated as a significant human in legislation. There are various aspects and duties performed by employees of the company and Directors of the company under companies act, 2013. Responsibilities of directors stipulated by the Indian companies Act of 2013, under its section 166: A director of a company shall act in accordance with the Articles of Association (AOA) of the company. A director of the company shall act in good faith. A director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment. A director of a company shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company.
A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates. Company and its members have different persona, but every member that works under the company have similar intention to expand and establish it in renowned way. The members who perform unethically and in false way always choose the option to work unlawfully behind the company, from which whole company Is held liable for their immoral work.
Definition of a Company
The word company has no strictly technical or legal meaning. it may be described to imply an association of persons for some common object or objects. The word company, in simple term, may be described to mean a voluntary association of person who have come together for carrying on some business and sharing the profits there from.
A company form of business is regulated by the Companies Act 2013 and is defined under Section 2(20) of the Act as ‘a company incorporated under this Act or any previous company law’.
A company is not a natural person like a human being but is taken as a person in the context of law. It is an artificial person created by law having its own legal identity and a separate status where the company and its owners are not considered as same entities but two distinct personalities. As such, the company is held responsible for its own actions and practices and the members are merely acting on behalf of the company.
What is the Doctrine of Lifting the Corporate Veil?
According to law, every corporate body is identified as a separate entity with a distinct legal status from its members. This provides an imaginary veil that protects the corporates and members and is known as ‘the corporate veil’ in the legal parlance. It is under the shield of this corporate veil that a company can sue and be sued, own a property and enter into contracts like any other natural person.
However, this veil does not give an absolute cover and there are conditions or exceptions to this doctrine where the general rule or principle of artificial person and separate status shall not hold true. The Court may disregard the legal status of the company in situations where the Court thinks that the corporate identity has been used as a facade to navigate the attention from their illegal or unlawful activities. This is known as ’lifting’ or ‘piercing’ the corporate veil. When the veil is lifted, the company loses its status, and the owners or members are exposed to personal liability for the company’s acts and deeds.
The corporate personality of the company is used to commit frauds and improper or illegal acts. 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 corporate veil’.
It refers to the situation where a shareholder is held liable for its corporation’s debts despite the rule of limited liability and/or separate personality. The veil doctrine is invoked when shareholders blur the distinction between the corporation and the shareholders. A company or corporation can only act through human agents that compose it. As a result, there are two main ways through which a company becomes liable in company or corporate law: firstly, through direct liability (for direct infringement) and secondly through secondary liability (for acts of its human agents acting in the course of their employment).
There are two existing theories for the lifting of the corporate veil. The first is the “alter-ego” or other self-theory, and the other is the “instrumentality” theory.
The alter-ego theory considers if there is in distinctive nature of the boundaries between the corporation and its shareholders.
The instrumentality theory on the other hand examines the use of a corporation by its owners in ways that benefit the owner rather than the corporation. It is up to the court to decide on which theory to apply or make a combination of the two doctrines.
Statutory Provisions dealing with Lifting of Corporate Veil of the Companies in India-Section 5 of the Companies Act defines the individual person committing a wrong or an illegal act to be held liable in respect of offenses as ‘officer who is in default’. This section gives a list of officers who shall be liable to punishment or penalty under the expression ‘officer who is in default’ which includes a managing director or a whole-time director.
Section 45– Reduction of membership below statutory minimum: This section provides that if the members of a company is reduced below seven in the case of a public company and below two in the case of a private company (given in Section 12) and the company continues to carry on the business for more than six months, while the number is so reduced, every person who knows this fact and is a member of the company is severally liable for the debts of the company contracted during that time.
Section 147- Misdescription of name: Under sub-section (4) of this section, an officer of a company who signs any bill of exchange, hundi, promissory note, cheque wherein the name of the company is not mentioned is the prescribed manner, such officer can be held personally liable to the holder of the bill of exchange, hundi etc. unless it is duly paid by the company. Such instance was observed in the case of Hendon v. Adelman.
Section 239– Power of inspector to investigate affairs of another company in same group or management: It provides that if it is necessary for the satisfactory completion of the task of an inspector appointed to investigate the affairs of the company for the alleged mismanagement, or oppressive policy towards its members, he may investigate into the affairs of another related company in the same management or group.
Section 275- Subject to the provisions of Section 278, this section provides that no person can be a director of more than 15 companies at a time. Section 279 provides for a punishment with fine which may extend to Rs. 50,000 in respect of each of those companies after the first twenty.
Section 299- This Section gives effect to the following recommendation of the Company Law Committee: “It is necessary to provide that the general notice which a director is entitled to give to the company of his interest in a particular company or firm under the proviso to sub-section (1) of section 91-A should be given at a meeting of the directors or take reasonable steps to secure that it is brought up and read at the next meeting of the Board after it is given. The section applies to all public as well as private companies. Failure to comply with the requirements of this Section will cause vacation of the office of the Director and will also subject him to penalty under sub-section (4).
Sections 307 and 308- Section 307 applies to every director and every deemed director. Not only the name, description and amount of shareholding of each of the persons mentioned but also the nature and extent of interest or right in or over any shares or debentures of such person must be shown in the register of shareholders.
Section 314- The object of this section is to prohibit a director and anyone connected with him, holding any employment carrying remuneration of as such sum as prescribed or more under the company unless the company approves of it by a special resolution.
Section 542- Fraudulent conduct: If in the course of the winding up of the company, it appears that any business of the company has been carried on with intent to defraud the creditors of the company or any other person or for any fraudulent purpose, the persons who were knowingly parties to the carrying on of the business, in the manner aforesaid, shall be personally responsible, without any limitation of liability for all or any of the debts or other liabilities of the company, as the court may direct. In Popular Bank Ltd., In re it was held that section 542 appears to make the directors liable in disregard of principles of limited liability. It leaves the Court with discretion to make a declaration of liability, in relation to ‘all or any of the debts or other liabilities of the company’. This section postulates a nexus between fraudulent reading or purpose and liability of persons concerned.
Judicial Interpretations of Lifting of Corporate Veil of the Companies in India
1. State of U.P. v. Renusagar Power Co. (1988)
- Facts and issue – The State of Uttar Pradesh taxed electricity duty on Renusagar Power Co., which was a wholly owned subsidiary of Hindalco. Pleading from the premise that Renusagar was not an independent company but an organ or an instrument of Hindalco, it contended that Hindalco was liable to pay the electricity duty.
- Judgement order – In this case, the Supreme Court did not Pierce the Veil as it held that Renusagar was a bonafide independent legal entity and not merely an agent or a corporate sham of Hindalco. The court found that Renusagar was established for valid business purposes and, therefore, had a legal existence.
- Consequences – This case demonstrated that it is important for the instance of fraud or improper conduct to be sufficiently evident to lift the corporate veil.
2. Vodafone International Holdings BV v. Union of India (2012)
- Facts and issue – This was a tax dispute where the situation revolved around the attempt made by the Indian tax authorities to raise taxes on Vodafone for the purchase of shares of a company based in the Cayman Islands who itself is an owner of shares of an Indian company. Indian authorities contended that the transfer involved Indian assets and was thus taxable by Indian tax authorities.
- Judgement order – The court ruled that the corporate veil was not pierced and determined that the transaction involved two foreign entities, making Indian law not directly applicable to taxation. The court also established that the corporate structure was commercially viable under these arrangements.
- Consequences – This case made it clear that courts would not lift the corporate veil when the corporate structure was valid and had been established for genuinely valid purposes of business, rather than as a device for tax evasion.
3. Tata Engineering and Locomotive Co. Ltd. v. State of Bihar (1964)
- Facts and issue – Bihar State had levied sales tax on sales of products manufactured by Tata Engineering and Locomotive Company Limited (TELCO). TELCO contended that it was not liable to pay the tax since the sales were made by the distributor instead of the company itself.
- Judgment order – The Supreme Court upheld its ruling against TELCO and pierced its corporate veil to discover the actual relationship between the company and its distributor. In consequence, the court ruled that the distributor was not an independent body but only an agent for TELCO.
- Consequences – This case means that corporate structures are open to courts to look beyond them and decide on the real nature of business transactions, especially if it deals with tax evasion cases.
4. Life Insurance Corporation of India v. Escorts Ltd (1986)
- Facts and issue – In this case, the Indian company Escorts Ltd. issued shares to foreign investors despite the failure of the company to get its decision approved by the RBI. LIC argued that foreign investors were attempting to take control of the company through its corporate structure.
- Judgement order – The Supreme Court has ruled that LIC cannot challenge the foreign investment strictly on its grounds of shareholder status as the company was lawfully issuing shares. The court also refused to set aside the corporate form because the plaintiff had no intent to commit fraud or improper action.
- Consequences – This case established that structures of company forms should be disregarded only in the clear evidence of fraud and, therefore, brought to the limelight the independence of companies in matters of internal management.
5. National Textile Workers’ Union v. P.R. Ramakrishnan (1983)
- Facts and issue – The case was one of applying to represent the workers’ interest before the process of winding-up could take place in a company. Here, the court had to determine whether, in the light of the status given to such a company as a legal entity distinct from its owners, on their own being stakeholders, the workers had a right to participate in the process.
- Judgement order – On these facts, the Supreme Court held that the corporate veil could be pierced to allow workers to appear before the court in winding-up proceedings while placing emphasis upon the need for justice to listen to employees who were critical stakeholders to the matter as the court observed.
- Consequences – This case further expanded the application of the doctrine and brought it forward to protect the rights of employees during insolvency or winding-up proceedings by lifting the corporate veil.
