Lifting of the corporate veil: Critical analysis in the light of companies act, 2013.

CRITICAL ANALYSIS OF LIFTING OF THE CORPORATE VEIL: IN LIGHT OF COMPANIES ACT, 2013

Author: Aayush Akar, NLUO

INTRODUCTION

The concept of the corporation, as a commercial body and one of the most beneficial types of the company organization, is founded on multiple definitions – the nature of the most relevant as a “separate legal agency”. By this concept we mean that the organization is an autonomous being, separate from its people, i.e. it has its personality and, thus, no one else should be held responsible for the actions committed by that being. Generally speaking, members may come and go, but the company stays forever. Currently the idea of “separate legal body” is based on the assumption that in the eyes of the law, the corporation is an entirely different individual, independent from its representatives and shareholders. It can sue under its name and it will be sued. This also results in an assumption that the company will own property under its name and also sell a property.

Such natural persons’ properties cannot be put to court through the unlawful actions of a “separate legal body”, unlike sole possession or a corporation that is not formed. An exception to this theory was created when the courts ruled that in some cases executives should be found individually responsible for any unlawful acts involving the organization as a whole, instead of the idea of a “separate legal body” must be removed to make him responsible for any misconduct. Usually, this phenomenon is called “Corporate Veil Lifting”. It means that under certain rare cases, the courts will disregard the ‘separate legal party’ principle and will investigate who the actual persons behind a particular action are and hold them responsible instead of the entire business.

The Companies Act, 2013 has introduced numerous regulations that allow special liability to the management, violating the principle of independent identities. “Section 2(60) makes the defaulting officer liable for his act; section 7(6) makes the suppression of material facts punishable; section 34 makes them liable for misrepresentation in the prospectus; section 36 makes directors liable for inducing an individual to invest money in the company; section 339 makes directors liable for fraudulent trading and section 447 liable for other forms of fraudulent activity”.[1]

DISTINCT LEGAL PERSONALITY OF A COMPANY

The company has been deeply established as a distinct body in “Salomon v. Salomon & Co[2],” which is the landmark decision. Solomon, a sole trader, sold Salomon & Co for his manufacturing business. In consideration for all but six shares in the company, Ltd. (a company that it incorporated) received debentures worth 10 thousand pounds. The other memorandum subscribers were his wife and five children each making up one share. The company failed later, and Salomon made a lawsuit as a secured creditor on the grounds of the debentures holding. The liquidator claimed that Salomon should not be listed in favour of other investors because the firm and Mr Salomon were essentially the same or rather the firm conducting business on behalf of Salomon.

The Salomon & Co was ruled by the House of Lords at appeal. Ltd. was not a sham; that the company’s debts were not Mr Salomon’s debts, because they were two separate legal entities; and that if the artificial entity was formed, “it must be regarded as any other individual person with their rights and obligations equal to itself”.

In Macaura v. Security Northern Co. Ltd.[3], “the House of Lords decided that the insurers would not be liable under a property insurance contract insured by the plaintiff but owned by a company in which the plaintiff held all the fully paid shares.The House of Lords held that only the corporation as the property’s independent legal owner, and not the claimant, had the insurable interest that was necessary”. As a creditor, the complainant has no legitimate or economic interest in the property simply because of his shareholding. In “Lee v. Lee’s Air Farming[4],” the Privy Council held that Lee could be an employee of that company as a separate and distinct entity from the company that he controlled so that Lee’s wife could claim compensation for workers after the death of her husband. In “Hobart Bridge Co. Ltd. v. FCT[5]relying on the judgment by Lord Sumner in Gas Lighting Improvement Co. Ltd. v. IRC[6], Justice Kitto summarizes the position in the following manner”: “Between the investor, who participates as a shareholder, and the undertaking carried on, the law imposes another person, real though artificial, the company itself, and the business carried on in the business of that company, and the capital employed is its capital and not in either case the business or the capital of the shareholders. Assuming, of course, that the company is duly formed and is not a sham.” More recently, the High Court in “Industrial Equity v. Blackburn”[7] held that the concept functions to prohibit a holding from considering the profits of a wholly-owned company as its own. It can, therefore, be seen that the single entity concept has been, and still is, the highest authority.

However, the drawbacks of the separate entity concept which fully excludes the validity of the corporate organization as a separate legal individual from its owners, shareholders, or management have to be acknowledged. Judgments as early as the Salomon case also shown that the courts acknowledged exceptions to the separate party concept. It is possible to recognize the independent corporation if there is “no scam and no organization, even whether the company was a true one and not a hoax or a myth.” According to Lord Denning in Littlewoods Mail Order Stores Ltd. v. IRC, incorporation will not fully “cast a veil on the identity of a private partnership that the courts are unable to see through. The courts will, and sometimes do, take off the cover. We try to see what exists under it. A corporation must be treated as a legal entity as a general rule, even where the legal entity principle is removed”.[8]

The two important reasons why there are exceptions to the separate entity principle are that, firstly, although a corporation is a legal person, it cannot always “be treated like any other independent person.” For example, a corporation can not commit torture or a crime requiring proof of men’s rea unless the courts disregard the separate entity and determine the intention. Secondly, because involved parties may “cover” under the umbrella of limited liability, strict enforcement of the concept could result in an unfair or deceptive outcome. Judicial jurisdiction and even statutory intervention provide for the violation of the distinct agency concept if any wrongdoing is perceived or may lead to a third party (internal or external to the company) with which the company is concerned.

LIFTING OF CORPORATE VEIL: MEANING AND SCOPE

Corporate veil lifting is one of the disadvantages of having incorporation. Through invention in the statute, an organized corporation is adorned with a distinct identity. But in practice, it is a group of individuals who are, in a sense, the beneficial owners of the body corporate property. A corporation being an artificial entity cannot act alone, it can act only through the real persons.[9]

A company’s legal entity doctrine is still the underlying concept upon which all corporate law is established. But the company’s separate personality, being a statutory privilege, it must always be used only for legitimate business purposes. Where a corporate body’s legal structure is misused for false and unethical reasons, it would not be able to take refuge behind the corporate identity of the individual involved. In these cases, the court must crack through the corporate shell and enforce the “cover or pierce the corporate veil” theory, i.e. the court must look behind the corporate body.

In the case of Salomon v. Salomon, it was decided that in “questions of property and capacity, of acts done and rights acquired or, liabilities assumed thereby… the personalities of the natural persons who are the company’s corporators is to be ignored.”[10]

A similar approach has been adopted by the Supreme Court and in some cases has been seen through the corporate veil. Thus, in “Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly[11]”, the Apex Court, while considering whether the appellant was a state agency or instrumentality under “Article 12 of the Indian Constitution”, observed inter-alia: “For the purpose of Article 12, one must necessarily see through the corporate veil to ascertain whether behind that veil is the face of an instrumentality or agency of the State.”

“Again, in State of Uttar Pradesh. v. Renusagar Power Company[12], the Supreme Court observed”: “The veil of corporate personality even though not lifted sometimes, is becoming more and more transparent in modern company jurisprudence.”

This corporate organization theory is also the fundamental premise upon which all corporate law is based. There are not a few instances in which the courts have resisted the temptation to break through the corporate veil with success.

Lee has incorporated a company in the case of “Lee v. Lee’s Air Farming Ltd”[13], of which he was the managing director. As such he appointed himself as the company’s pilot. He was killed whilst at the firm’s company in a flying crash. Under the Workers’ Compensation Act, his widow received insurance. “In effect, the magic of corporate personality enabled him of directors and shareholders consent to the misuse of the company’s money, they can be prosecuted for the theft because the consent of the whole number may not be the consent of the company”.[14]

The findings of the supreme court in “Life Insurance Corporation of India v. Escorts Ltd.[15],” are worthy of notice as to when the corporate curtain is raised. While it has been deeply founded since the Salomon case. Restricted, it has been determined that a corporation has an autonomous and legitimate identity separate from the individuals who are its members that a corporate curtain can be lifted, corporate history can be overlooked and its members remembered as pioneers in many special situations.

In the case of “State of Uttar Pradesh v. Renusagar Power Co.”[16], the Supreme Court has referred “Corporate veil” as a changing concept: “The concept of lifting the corporate veil is a changing concept. The veil of corporate personality even though not lifted sometimes is becoming more and more transparent in modern company jurisprudence. It is high time to reiterate that in the expanding of the horizon of modern jurisprudence, lifting of corporate veil is permissible, its frontiers are unlimited. But it must depend primarily on the realities of the situation.”

LIFTING OF CORPORATE VEIL AS PER STATUTE

UNDER STATUTORY PROVISIONS–

• “NON-COMPLIANCE OF REQUIREMENTS OF INCORPORATION”- As per Section 464 is to revoke the benefits of incorporation if the provisions of incorporation are not followed.[17]
• “MISREPRESENTATION IN THE PROSPECTUS”- As per Section 34, in the event of any kind of misrepresentation in the prospectus, every owner, promoter and any other person approving any question of the prospectus shall be liable to those who have subscribed to the false declaration for shares.[18]
• “FAILURE TO RETURN APPLICATION MONEY”- As per Section 39, if the company fails within 120 days of the issuing date of the prospectus, the full application funds shall be returned within 10 days. The subscription fee must be paid in the next 10 days. In the event of any default, the company and its default officer shall be liable for a penalty of one thousand rupees for each day during which such default continues, or one lakh rupees, the lesser of whichever.[19]
• “MIS-DESCRIPTION OF NAME”- As per Section 12, when the name of the company is not properly indicated during the transaction of any kind of business in the name of the company, the signatory directors shall be held liable.[20]
• “FRAUDULENT CONDUCT”- As per Section 339, when the company is closed, it seems that any business of the company has been carried out to defraud the creditors of the company or any other entity, liability shall be incurred if it is proven that the business of the corporation has been carried out to defraud the creditors.[21]
• “FOR INVESTIGATING THE ACTUAL OWNER OF THE COMPANY”- Under section 216, the Central Government may nominate one or more inspectors to inspect and report on the membership of any corporation to decide the true persons acting on behalf of the corporation.[22]
•  “LIABILITY FOR ULTRA VIRES ACT”- The object clause in the memorandum describes the boundary within which the corporation operates. Any act not approved by the object clause shall be ultra vires for which the members/directors are liable.

BY JUDICIAL INTERPRETATION–

• “Protection of Revenue”- In the case of Re Sir Dinshaw Maneckjee Petit[23], the assessee was a millionaire who earned big dividend and interest profits. He told four private companies, and in exchange for their shares, he moved his assets to each of these firms. The dividends and interest profits that the corporation earned were handed back as a pretended loan to Sir Dinshaw. It was held that the assessee told the company directly and honestly as a way of tax evasion and the company became nothing more than an assessee himself.
• “Fraud”- Mr Horne was an ex-employee of The Gilford motor company in the case of Gilford Motor Company Ltd v. Horne[24] and his terms of employment meant that he did not draw clients of the firm. To counter this, he formed a limited corporation in the name of his aunt and asked the company’s customers. The company has brought charges against him. In the view of the Court of Appeal, “the corporation was created as a trap, a stratagem, to conceal Mr Horne’s successful conduct of business in this case, it was clear that the key aim of forming the new corporation was to commit fraud. And it was seen by the court of appeal as a pure deception to hide his wrongdoings.

In another case, Jones v. Lipman[25], a man agreed to sell his property and then changed his mind to prevent an obligation of particular results, which he sold to a corporation. Russel Judge expressly referred to the decisions in Gilford v. Horne and ruled that the business here was “a mask that (Mr. Lipman) keeps in front of his face to escape scrutiny by the gaze of equity.”

• “DETERMINATION OF THE ENEMY CHARACTER OF A COMPANY”- In the case of Daimler Company Ltd v. Continental Tire & Rubber Co.[26], a German company was formed in London for the objective of exporting German-made tires. Most of them were Germans. War was declared between Germany and England, and because the main owners belonged to the enemy German company, the economic debt was excluded on the basis that the payment amounted to exchange with the enemy company.
• “WHERE THE COMPANY IS A MERE SHAM OR A CLOAK”- In the case of the Delhi Development Authority v. Skipper Construction Company Pvt. Ltd,[27] the Top Court held that the fact that the directors and family members had formed a vast number of corporate bodies did not dissuade the court from considering all of them as one body owned and operated by the director and his family because it was found that these corporate bodies were pure cloaks and there was the only person in charge of them.
• “IN THE CASE OF ECONOMIC OFFENSES”– In the case of “Santanu Ray v. Union of India”[28], Delhi High Court has maintained that it was just after the corporate body mask was stripped, the adjudicating authority can decide which of the directors is concerned with escaping the excise duty on the grounds of bribery, conspiracy or intentional misrepresentation or omission of evidence, or breach of the evidence
• “WHEN PURPOSE IS TO AVOID WELFARE LEGISLATIONS”- When the object of an entity’s establishment or life is to circumvent welfare laws, then the courts will raise the corporate curtain, as was the case for “Workmen Working in Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd”[29]. In this instance, the holding firm has earned dividends on the subsidiary’s equity assets. When the above profit was attached to the company’s profits when measuring the employees’ compensation under the 1965 Allocation of Incentive Act, the holding firm created its separate wholly-owned subsidiary and passed the entire dividend income to the newly established subsidiary. Consequently, the income available to employees for compensation payment has been reduced, thereby reducing the number of employee incentives. Justice K. Reddy, while lifting the corporate veil, said: “A new corporation is formed, wholly owned by the primary company with no assets of its own except those transferred to it by the principal company, with no business or revenue of its own except to earn dividends from shares transferred to it by the principal company and serving no reason whatsoever except to minimize the gross profits of the principal company”.
• “CONTEMPT OF COURT”- In “Jyoti Ltd. v. Kanwaljit Kaur Bhasin”[30], the Court ruled that it was necessary to lift the corporate curtain to punish for Court contempt. While there are very few such cases of disrespect and those that do not fall firmly into the framework, an exception to the general rule of “separate legal body” cannot be made.
• “MERE AGENCY OF THE HOLDING COMPANY”– In the case of “Smith Stone & Knight Ltd. v Birmingham Corporation”[31], a local firm had an order to compulsorily purchase a property purchased by the appellants, SSK, the landmark decision as to whether a subsidiary should be regarded as a parent’s agent and thereby considered liable was issued. The aforementioned appellants sold this property to the BWC, its affiliate, and therefore, when the local company (the respondents) decided to buy the same property, the appellants claimed they did not own the same land. The Court recognized that the aforementioned agreement was being conducted for the benefit of its principal by the appellant’s representative. The Court lifted the curtain of the business and made the holding firm responsible.

In the “Adams v. Cape Industries Plc”[32], it was held that the affiliate was promoting the parent company’s economic cause, the Court did not raise the veil. In “Royal Industries Ltd. v. Kraft Foods, Inc.[33], the Court said”, “Suing a parent corporation on agency theory is quite different from attempting to pierce the corporate veil. In the first instance, the claim against the parent is premised on the view that the subsidiary had the authority to act, and was, in fact, acting, on the parent’s behalf – that is, in the name of the parent“. Therefore, through using the exception of this department, the courts were still very careful about how the company fulfills all the conditions to be considered a department and why, if it is fulfilled, the Court lifts the corporate veil.

• “ACTING AGAINST PUBLIC POLICY”- The Court applied the concept of ‘dropping the corporate curtain’ to reach the ends of justice in the case of “PNB Finance Ltd. v. Shital Prasad Jain”[34]. Nonetheless, because of its vagueness, this condition for raising the corporate curtain has always been in doubt. The field of “’public policy” is so broad that it can include so many issues. An exception to the general “separate legal body” principle cannot go so far as to ignore the principle in its entirety. The exception’s ambit can always be held as low as possible so that a straight distinction can be drawn between the theory and the exception.
• “NEGLIGENT ACTIVITIES”: In such cases where the Court is convinced that the holding company has a duty of care while the activities of the affiliate are at issue, the former can be found responsible for the acts of the latter, by raising the corporate curtain, by violating the duty of care, i.e. the negligent conduct of the holding company, e.g. in the case of “Chandler v. Cape Plc”[35]. In this case, the plaintiff was an employee of the defendant’s company. When operating for the aforementioned company, because he was exposed to asbestos, the complainant contracted some diseases which he later came to learn about as the symptoms were evident. The division had already been shut down at that time, and he accused the aforementioned parent company of negligence.

CONCLUSION

By looking over all the rulings on the issue, it can be seen that the courts have exercised a very broad discretion to decide whether or not to pierce the curtain and to make the participants accountable for a specific case. Bearing in mind it has led to uncertainty and lack of predictability that the primary objective of corporate law should be clarity and predictability concerning regulatory criteria to raise the veil. The judges will use whichever theory they use, or sometimes occasionally concoct their hypothesis to fasten the blame for reasonable purposes.

This is now very clear, however, that incorporation does not necessarily and under all cases shut off personal responsibility. Thus, the sanctity of a distinct organizational name is retained only insofar as the company conforms to the fundamental principles that give it life. The courts also used other evidence to validate the owners’ claim of responsibility.

This should often be recognized that whilst the courts have often turned to the various legal principles, they also often applied them without much explanation or conviction, and the courts have broad discretion as to whether or not to lift the corporate curtain in a given case.

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[1] ‘CompaniesAct2013.Pdf’ <https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf> accessed 5 June 2020.

[2] Salomon v A Salomon and Co Ltd [1897] AC 22.

[3] Macaura v Northern Assurance Co Ltd [1925] AC 619.

[4] Lee v Lee’s Air Farming Ltd [1960] UKPC 33.

[5] Hobart Bridge Co. Ltd. v FCT [1951] HCA 33.

[6] Gas Lighting Improvement Co. Ltd. v IRC [1923] AC 723.

[7] Industrial Equity v Blackburn (1977) 137 CLR 567.

[8] Littlewoods Mail Order Stores Ltd. v IRC [1969] 1 WLR 1241.

[9] ‘Lifting of Corporate Veil’ <https://taxguru.in/corporate-law/lifting-corporate-veil.html> accessed 5 June 2020.

[10] Daimler Co. Ltd v Continental Tyre & Rubber Co. Ltd, [1916] 2 AC 307.

[11] Central Inland Water Transport Corporation Ltd. v Brojo Nath Ganguly 1986 SCR (2) 278.

[12] State of Uttar Pradesh v Renusagar Power Company AIR 1988 SC 1732.

[13] Lee v Lee’s Air Farming Ltd [1960] UKPC 33.

[14]Attorney-General’s Reference of 1984 (No 2 of 1983), (1984) 2 QB 456.

[15] Life Insurance Corporation of India v Escorts Ltd 1984 SCR (3) 643.

[16] State of Uttar Pradesh v Renusagar Power Co. [1991] 70 Comp. Cas. 127.

[17] Indian Companies Act 2013, s 464.

[18] Indian Companies Act 2013, s 34.

[19] Indian Companies Act 2013, s 39.

[20] Indian Companies Act 2013, s 12.

[21] Indian Companies Act 2013, S 339.

[22] Indian Companies Act 2013, S 216.

[23] Re Sir Dinshaw Maneckjee Petit (1927) 29 BOMLR 447.

[24] Gilford Motor Company Ltd v Horne [1933] Ch 935.

[25] Jones v Lipman [1962] 1 WLR 832.

[26] Daimler Company Ltd v Continental Tire & Rubber Co. [1916] 2 AC 307.

[27] Delhi Development Authority v Skipper Construction Company Pvt. Ltd. 1985 (1) S.C.R.598.

[28] Santanu Ray v Union of India (1989) 65 Comp. Cas. 196 (Delhi).

[29] Workmen Working in Associated Rubber Industry Ltd. v Associated Rubber Industry Ltd AIR 1986 SC 1.

[30] Jyoti Ltd. v Kanwaljit Kaur Bhasin 1987 CriLJ 1282.

[31] Smith Stone & Knight Ltd. v Birmingham Corporation [1939] 4 All ER 116.

[32] Adams v Cape Industries Plc [1990] Ch 433.

[33] Royal Industries Ltd. v Kraft Foods, Inc. 926 F. Supp. 407.

[34] PNB Finance Ltd. v Shital Prasad Jain 19 (1981) DLT 368.

[35]Chandler v Cape Plc [2012] EWCA Civ 525.