In the case of Salomon v. Salomon & Company, the House of Lords established the principle that a company is a distinct legal person completely different from the members of that company. However, many times members of a company indulge in unlawful acts in the name of carrying on the business of the company. In such cases, courts have to ignore the principle of separate legal entities and punish the members of the company committing fraud or illegal activities.
The principle that the company is a separate legal entity of a company different from its members is called ‘the veil of incorporation’. Thus, there is a fictional veil between the company and its members. Solomon v/s Solomon & Co. Ltd established this principle and therefore all Courts are generally bound by this principle.
LIFTING OF CORPORATE VEIL:
The human tendency to cheat made the members of the company use the veil of corporate personality blatantly as a cloak for committing fraud or improper conduct. This made the courts to lift the corporate veil and look at the persons behind the company who are the real beneficiaries of the company.
Although a corporation is a distinct entity by the fiction of law, actually it is an association formed by some people who are the beneficial owners of the corporate property.
A company being an artificial person cannot do anything illegal or fraudulent, the face of corporate personality needs to be ignored to identify the guilty members of the company. This is known as ‘lifting of corporate veil’.
In the landmark case of Life Insurance Corporation of India v Escorts Ltd & Others, the Supreme Court of India observed that in some exceptional circumstances, the corporate personality of a company may be ignored and individual members may be recognized for who they are.
THE COURT MAY LIFT THE CORPORATE VEIL IN FOLLOWING CASES:
The situations that allow the Court to lift the corporate veil may be categorized into two headings:
Judicial interpretations and Statutory Provisions
- JUDICIAL INTERPRETATIONS-
- Prevention of fraud or improper conduct:-
The distinct legal character of the company may be ignored in the interest of justice where the mechanism of incorporation has been used for some fraudulent motives such as defrauding creditors or defeating the law. In cases where the company is formed for an unlawful purpose or to commit fraud or to avoid any legal obligation, the court may lift the veil of corporate character to punish the guilty members of the company for such illegal acts.
- Gilford Motor Co. v/s Horne– Mr. Horne was an ex-employee of The Gilford motor company and it was written in his contract of employment that he could not solicit the customers of the company. To beat this clause he incorporated a limited company in the name of his wife’s name and solicited the customers of the company. The company filed a case against him. The Court held that the Defendant Company incorporated by Mr. Horne was a mere cloak. Mr. Horne used the defendant company as a medium to take the advantage of the customers of the Plaintiff Company. The court observed that the defendant company was formed by Mr. Horne only for committing fraud and improper conduct therefore the Defendant Company should be restrained.
- Jones v/s Lipman– A man named Lipman had consented to sell his land to Mr. Jones. However, Lipman later changed his plan, and to circumvent the specific performance of the contract, he sold the land to a company which was incorporated only for this motive. The company had Lipman and a clerk as the only members. Mr. Jones took legal action for specific performance against Lipman and the company. The Court after finding out the reality ignored the transfer and ordered that the defendant company should handover the land to Jones.
- Punjab National Bank v/s Shital Jain- In the instant case, a person borrowed some money from a company and further invested it in three different companies. When the person defaulted on the repayment the lending company took action against him. The Court ordered that the lending company was authorized to attach the assets of these three companies as that these companies were formed only to cheat the lending company because the main motive of the borrower was fraudulent.
- Evasion of Taxes:-
The distinct corporate personality of a company may be ignored when the company is incorporated or used for tax evasion. Tax Planning when done within the framework of law is considered legal.
- Sir Dinshaw Maneckji Petit– An assesse, known as Mr. Dinshaw, was receiving a huge dividend and interest income. He transferred all his investments into four private companies incorporated for the motive of reducing his tax liability. These companies used to transfer the income as a pretended loan to Mr. Dinshaw. Legal action was taken against Mr. Dinshaw. The Court held that the companies were incorporated by Mr. Dinshaw only to avoid tax obligation and the companies were in reality assesse himself. These companies did no business and were made only to ostensibly receive the dividends and interests and to convey them to Mr. Dinshaw.
- Deciding whether a company is an enemy company-
A company takes an enemy personality when persons who are controlling the affairs of the company are residents in an enemy country. In such circumstances, the court may look into the enemy character of persons in real control of the company and declare the company to be an enemy company.
- Daimler Co. Ltd. v/s Continental Tyre & Rubber Co. Ltd.-
A company was incorporated in England for selling in England tires made in Germany by a German Company which held most of the shares in the English Company. Thus the persons controlling the company were all German residents. During the 1st World War when England was engaged in a war against Germany, the English company filed a legal case for the recovery of trade debt. The Court held that as the English company was an enemy company paying a debt to it means commercial trading with the enemy, so the Court allowed the company to proceed with the action.
- A company acting as an agent or trustee of the shareholders:-
In case of a company acting as an agent or trustee of its shareholders, the shareholders will be responsible and accountable for the acts of the company, and in case of a company being considered as agent or trustee of another company, the company, that is so regarded loses its individuality in favor of the mail company who is its principal. Thus the Court needs to consider the facts of each case to decide whether the company is acting as an agent for its shareholders or some other company. There may be an express agreement to this effect or agreement may be implied from the circumstances of each case specifically. An agent company may indulge in illegal activities as an agent for its parent company or all or any of the individual members if it is allowed to do so by the parent company or the members. In such cases, the parent company or the members will be liable for the illegal acts of its agent until those acts are within the actual or apparent scope of the authority.
- F.G.Films Ltd– A film called “Monsoon” was produced by an American Company in India. This was made under the name of a Company which was incorporated in England. The production of the said film was financed by the American Company. The president of the American Company was holding 90 percent of the capital of the British Company. The Board of Trade of Great Britain refused to register the film as a British film. The Court held that the decision was valid as the British company was acting merely as the nominee of the American Company.
- Smith Stone & Knight Ltd. v/s Birmingham Corpn– In this case, the Court held that was held in this case that when a company is acting as an agent or trustee of its shareholders or the members of the company the shareholders or members of the company will be held accountable for the acts of the company.
- Avoidance of welfare legislation:-
This is similar to avoidance of taxation and the attitude of the court in dealing with cases relating to such avoidance is generally the same as avoidance of taxation. Whenever a company is formed merely to avoid welfare legislation it is considered the duty of the Court to look beyond the corporate veil and punish the guilty members of the company.
- Protecting public policy:-
To prevent transactions contrary to the public policy the courts invariably lift the corporate veil to protect the public policy. Therefore, whenever there is a conflict with a public policy the Court always ignored the form and considered the substance.
2. STATUTORY PROVISIONS:
The Companies Act, 2013 has many provisions for the person liable for improper/illegal activity in the name of the company. These persons are commonly known as “officer who is in default” under Section 2(60) of the Act. This includes persons holding the designation of directors or key-managerial positions. Some instances of such laws are as follows:-
- Number of members below the statutory minimum required-
As per Section 45 of the Companies Act, in case of a public company carrying on its business for more than 6 months even after the number of its members has fallen below seven, in case of a private company the number has fallen below two every person aware of this fact and is also a member during the time the company so carries on business after the 6 months, is severely liable for the entire debts of the company contracted during that time i.e., after 6 months.
- Failure to refund application money–
As per Section 39 (3) of the Act, against allotment of securities, when the required minimum amount has not been subscribed and the amount payable on the application is not received within thirty days from the date of issue of the prospectus of the company, then the officers in default shall be fined with one thousand rupees for each day during which such default continues or one lakh rupees, whichever is less.
- Misdescription of company’s name-
As per Section 147 (4) of the Companies Act, where an officer or agent of a company without mentioning the full or correct name of the company or the address of its registered office, indulges in any act or enters into a contract shall be personally liable. Therefore, if any representative of the company collect bills or sign on behalf of the company, and writes in incorrect or incomplete particulars of the company, then such persons are to be held personally liable.
In Hendon vs. Adelman, the Court held signatory directors personally liable for writing the company’s name on a signed cheque as “L R Agencies Ltd” instead of the original name which was “L & R Agencies Ltd.”
- Fraudulent conduct/trading-
Under section 339 of the Act, while winding up of a company, it is seen that some business of the company has been carried on for defrauding creditors of the company or any other person or for carrying out any fraudulent motive, then the Court can hold any such person personally liable for such unlawful activities.
In Delhi Development Authority vs. Skipper Construction Company- In this case, the Court held that whenever the corporate personality of a company is used to commit frauds or illegalities, defraud creditors, evade obligations, attain or maintain monopoly or protect criminal activities, then the Court ignoring the distinct corporate character of the company directly look at the reality and lift the corporate veil to make appropriate orders to do justice.
- Inducing persons to invest money in the company by making deceptive promises:-
As per Section 36 of the Act, any person making false, deceptive, misleading statements or promises to any other person or conceals important information from another person to induce him to enter into either of the following:-
i. An agreement made for acquiring, disposing of, subscribing, or underwriting securities.
ii. An agreement made for securing profits to any of the parties from the yield of securities or by reference to fluctuations in the value of securities.
iii. An agreement made for taking credit facilities from any bank or financial institution.
In such situations, the corporate character of the company can be ignored to punish the real culprit by making him personally liable under Section 447 of the Act accordingly.
- Furnishing false statements:-
As per Section 448 of the Act, any person making false promises and statements, or conceals any material information in any return, report, certificate, financial statement, prospectus, statement, or other document required, then is personally liable under Section 447 of the Act.
- Repeated defaults:-
As per Section 449 of the Act, any company or an officer of a company committing an offence punishable either with fine or with imprisonment and this offence is being committed once again within three years, such company and officer have to pay twice the penalty of that offence along with any imprisonment provided for that offence.
From the above discussion, we can conclude that whenever the members of a company commit fraud or engage in illegal acts under the guise of the corporate veil, then the courts are empowered to ignore the principle of the separate legal existence of the company distinct from its members and look beyond the corporate veil to punish the real culprits and this is known as the lifting of the corporate veil. However, the doctrine of lifting the corporate veil is an exception and not a general rule and it shall be applied only to cases where it is proved that the company was bogus purposely incorporated to avoid liability or to commit fraud. Therefore, the courts need to look into the facts and circumstances of each case to find reality and punish the guilty.