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All you need to know about the lifting of the Corporate Veil

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What is the Corporate Veil?

Lifting of the corporate veil means disregarding the corporate personality and looking behind the real person who is responsible for the control of the company. In easy words, where fraudulent and dishonest use is made of the legal entity, the individuals concerned will not be allowed to take shelter behind the corporate entity. In this aspect, the court will break through the corporate shell and apply the principle of what is known as “lifting or piercing through the 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 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.

There are two existing theories for the lifting of the corporate veil.

  1. Alter- ego or other self-theory
  2. Instrumentality theory

The alter ego theory considers if there is a distinctive nature of 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.

Circumstances in which courts may lift the corporate veil

The conditions under which the courts may pierce through the corporate veil can be classified under the following two heads:

Statutory provisions

Section 5 of the Companies Act defines the individual person committing a wrong or an illegal act to be held liable in respect of offences 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 are reduced below seven in the case of a public company and the company continues to carry on business for more than six months.

Under Other Statutes

Besides the Act, directors and other officers of the company may be held personally liable under the provisions of other statutes. For example, under the Income-tax Act, 1962  where any private company is wound-up and if tax arrears of the company in respect of any income of any previous year cannot be recovered, every person who was director of that company at any time during the relevant previous year shall be jointly and severally liable for payment of tax. Similarly, under the Foreign Exchange Regulation Act, 1973, the directors and other officers may be proceeded individually or jointly for violation of the Act.

Under Judicial Interpretation

Though initially court using the principle and the concept of a separate entity and a district corporate personality refused to lift the corporate veil, however, with the growth of corporations and the increasing conflict between companies and its various stakeholders, courts have adopted a pragmatic approach and lifted the corporate veil.

Doctrine’s Applicability

The doctrine is very much applicable in Indian Law. It can be traced to Common Law, as Indian Laws are heavily reliant on Common Law. In Life Insurance Corporation of India v. Escorts Ltd, 1the Supreme Court held that “While it is firmly established ever since in Solomon v. Solomon that a company is an independent and legal personality distinct from the individuals who are its members, the corporate veil may be lifted, the corporate personality may be ignored and the individual members recognized for who they are in certain exceptional circumstance

There are various instances where the courts of the country have pierced through the corporate veil. It can be done due to provisions in the various statutes or to prevent fraud and misrepresentation or evasion of taxing provisions or a beneficent statute is sought to be escaped or where associated companies are inextricably connected as to be, in reality, part of.

The concept of lifting the corporate veil is a very dynamic concept. The veil of corporate

personality, even though not lifted sometimes, is becoming more and more a transparent form of ensuring smooth business practices in modern jurisprudence.

Piercing the Corporate Veil

Scenarios under which the Courts consider piercing or lifting the corporate veil are as below:

To Determine the Character of the Company

There are cases where the Courts need to understand if the company is an enemy or friend. In such cases, the Courts adopt the test of control. The Courts usually avoid piercing the corporate veil, unless the public interest is in jeopardy. However, to ascertain if a company is an enemy company, the Court might choose to do so.

To Protect Revenue or Tax

In matters concerning evasion or circumvention of taxes, duties, etc., the Court might disregard the corporate entity.

If trying to avoid a Legal Obligation

Sometimes the members of a company can create another company/subsidiary company in order to avoid certain legal obligations. In such cases, piercing the corporate veil allows the Courts to understand the real transactions.

Forming Subsidiaries to act as Agents

Sometimes, the basis of the formation of a company is to act as an agent or trustee of its members or of another company. In such cases, the company loses its individuality in favour of its principal. Also, the principal is liable for the acts of such a company.

A company formed for fraud or improper conduct or to defeat the law

In cases where a company is formed for some illegal or improper purposes like defeating the law, the Courts might decide to lift or pierce the corporate veil.

Subject of the doctrine

The doctrine of lifting/ piercing the corporate veil has been the subject of drastic change. Though this doctrine was primarily applied in cases of tax evasion and non-compliance of the provisions of the Companies Act, however, the Courts have broadened the concept and applied the same in the following scenarios:

  1. Where group companies/companies have been used to perpetuate a fraud or illegality, as in Delhi Development Authority v. Skipper Construction. 2
  2. Where execution proceedings have been initiated, the Court always has the power of lifting the corporate veil which is used as mere cloaks where a device is employed and the properties have been acquired fictitiously in the name of other persons for the purpose of committing illegalities or for defrauding others, so as to enable it to pass appropriate orders to do justice between the parties concerned, as in Formosa Plastic Corporation Ltd. v. Ashok Chauhan. 3
  3. Where business realities of the situation require the veil to be pierced, as in DHN Food Distributors v. Tower Hamlets London Borough Council. 4
  4. Where there is the involvement of industrial law and human rights and also where the requirement of justice so requires, as in Kapila Hingorani v. State of Bihar. 5
  5. Where associated companies are inextricably connected as to be in reality part of one concern, as in Life Insurance Corporation v. Escorts. 6

 Identity of the Corporate after lifting of Corporate Veil

In the case of the State of U.P. and Ors. v. Renusagar Power Co. and Ors7, the Court held that a holding company and subsidiaries are incorporated companies, and, in this context, each has a separate legal entity. Each has a separate corporate veil. But that does not mean that the holding company and the subsidiary company within it all constitute one company. However, once the corporate veil is lifted it appears that the associated/ subsidiary companies are inextricably connected as to be, in reality, part of one concern.

It is relevant to point out that ‘lifting of the veil’ by the Court does not change the treatment afforded to such involved companies by stakeholders not a party to the proceeding in which the corporate veil is lifted. While the corporate veil was lifted in Renusagar (supra), its companies, namely, Hindalco Industries Ltd. and Renusagar Power Co. Ltd. continued to have a separate legal existence in respect of continuity and succession after the judgement of the Court was passed. Thus, even though the doctrine of corporate veil is applied, the separate identity of the company from its directors is not totally discarded. 

Leading case laws on Lifting a Corporate Veil

Macura Vs. Northern assurance company Ltd8

It was decided by the jury that insurers will not be held liable under the contract for insurance on any property that was insured by the plaintiff but which was owned by the company in which the plaintiff has all the paid shares. The House of Lords held that only the company can have a separate legal owner of the property and not the plaintiff have an insurable interest. The plaintiff being a shareholder did not have any insurable interest in the property as he was the only shareholder of the company.

Lee vs. Lee Air farming9

It was held by Privy Council that Lee is a separate entity from the company which was controlled by Lee who would be an employee of the company so the wife of Lee can claim compensation for his death under the workmen compensation act

Industrial equity vs. Blackburn10

The high court held that principle operates to prevent the holding company being treated as wholly owned and subsidiary profits if it’s own. Therefore it can be said that there is the highest authority for the separate entity concept.

Conclusion

A company refers to a legal person which has been given personification by law. It acts not according to its own idea of being an artificial person but according to the people behind the operations of the corporation. This veil when overlooked to understand the true nature and real beneficiaries of a company it is called lifting of Corporate Veil. This doctrine has primarily emerged to strike a balance between the needs of corporate independence and public interest. However, a rule of caution must be adopted by the courts in applying this doctrine. Though the horizons are expanding, it can’t be applied in every situation. The act of piercing the corporate veil until now remains one of the most controversial subjects in corporate law. There are categories such as fraud, agency, sham or facade, unfairness and group enterprises, which are believed to be the most peculiar basis under which the Law Courts would pierce the corporate veil. But these categories are just guidelines and by no means far from being exhaustive.

Endnotes

1.  [1986] 59 Comp. Cas. 548

2.  (2000) 10 SCC 130

3.  1999 (1) AD (Delhi)

4.  (1976) 1 WLR 852

5.  (2003) 6 SCC 1

6.  (1986) 1 SCC 264

7.  (1988) 4 SCC 59

8.  [1925] AC 619 

9.  [1960] UKPC 33

10.  (1977) 137 CLR 567 

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Vani Parashar

Student, Amity University NOIDA

Vani Parashar is a 3rd-year law student at Amity University, Noida. As a law student, She has taken part in different fields like youth parliaments, debates, MUNs and event organisation. She is a well-rounded individual who lives with passion, dedication and grace and this is what sets her apart from anybody else.

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