HomeLegal ColumnsCorporate Veil under Companies Act

Corporate Veil under Companies Act

Introduction

In this era globalisation and fee enterprise , business associations have emerged as an distinct and powerful force at the global level. Wielding enormous economic power , they have the potential  to influence the lives of human beings socially, politically and economically . Of all business associations, a corporation with limited liability offers maximum advantage and is considered ideal carrying on business activities of a a large magnitude. This is due to the fact that it is a legal person having a personality of its own . it also has its independent and perpetual existence . The corporate has emerged as a social entity capable of actions independent of readily identifiable human agents.

Separate Legal Personality (SLP) is the basic tenet on which company law is premised. Establishing the foundation of how a company exists and functions, it is perceived as, perhaps, the most profound and steady rule of corporate jurisprudence. Contrastingly, the rule of “SLP” has experienced much turbulence historically, and is one of the most litigated aspects within and across jurisdictions[1] Nonetheless, this principle, established in the epic case of Salomon v Salomon[2], is still much prevalent, and is conventionally celebrated as forming the core of, not only the English company law, but of the universal commercial law regime.

In the landmark case of solomon v solomon dealt with claims of certain unsecured creditors in the liquidation process of Salomon Ltd., a company in which Salomon was the majority shareholder, and accordingly, was sought to be made personally liable for the company’s debt. Hence, the issue was whether, regardless of the separate legal identity of a company, a shareholder/controller could be held liable for its debt, over and above the capital contribution, so as to expose such member to unlimited personal liability.

the House of Lords’ unanimous unanimously held that, as the company was duly incorporated, it is an independent person with its rights and liabilities appropriate to itself, and that “the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are”.3 Thus, the legal fiction of “corporate veil” between the company and its owners/controllers4 was firmly created by the Salomon case.

“The company is at law a different person altogether from the subscribers to the Memorandum and, although it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or the trustee for them. Nor are subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act.”

                                                                                      -Lord McNaughten-

 

Corporate veil – The principle of veil of incorporation is a legal concept that separates the personality of a corporation from the personalities of its shareholders and protects them from being personally liable for the company’s debts and other obligations.

 

However at several instances  it  happened that the corporate personality of the company is us committed 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. Hence came the concept of lifting the corporate veil.

However this lead to the confusion all over that when should be the companies held liable and when should not be held liable.

In 2013 there was a systemic review of these authorities in Prest v Petrodel Resources Ltd[3] and Lord Sumption distinguished between cases of truly “piercing the corporate veil” and situations where it was held that the company was essentially an agent for a wrongdoer or held property on trust.

However the fact cannot be denied that inspite of a company being a separate entity it has human agents behind it who make it work and hence everytime the levay should not be given to the companies to escape by hiding behind the corporate veil. 

Analysis

Application of principle in UK

As mentioned before after the Landmark case of Solomon v. Solomon principle of corporate veil was well established

However, several exceptions to this principle was introduced. In these cases courts ‘lift the corporate veil’ to make members liable for the actions of the company. This undermines the notion that Salomon occupies the centre stage in corporate law in UK.

Few of the exceptions are:-

  • Statute

S.213 Insolvency Act, 1986 states that if, while winding up a company, the company’s business is carried on with intent to defraud the company’s creditors, a court may order any person knowingly carrying on the business to contribute to the company’s assets. This goes against Salomon, as it holds the company’s members responsible for its debts.[4]

S..214 Insolvency Act 1986 states that if, while winding up a company, a director ought to have seen that there was no reasonable prospect of avoiding insolvency but continued to carry on business, then a court may hold them liable.

  • War

Courts may also ignore the corporate veil during wartime.The House of Lords stated that whether a company was an enemy in wartime depended upon those who were in control of the company. This goes against the principle of separate corporate personality and weakens the idea that solomon is always to be followed.[5]

  • Sham

Courts have also ignored the corporate veil where a company is a sham designed to commit fraud or avoid an existing contractual obligation.[6].

However, courts will not lift the veil if the company is set up to avoid future liabilities[7]

  • Agency

Courts have also ignored the veil where they have found an agency relationship existed.[8]

Another exception to Salomon involves tortious liability. In Chandler v Cape the claimant had also contracted an asbestos-related disease while working for a subsidiary of the parent company. This time the Court of Appeal held the parent liable in the tort of negligence. The court held that the parent would be liable if the parent and subsidiary were in the same business, the parent had superior knowledge of health and safety in that industry, the parent ought to have known the subsidiary’s system of work was unsafe, and the parent ought to have foreseen that the subsidiary would rely on the parent’s superior knowledge.

The principle of separate corporate personality and the corporate veil recognised in Salomon v Salomon remains central to corporate law despite several challenges. However, there are certain exceptions when the veil will be lifted. Most notably these include under statute, during wartime, and where the company is a sham. It is less likely to be lifted where it is argued that an agency or trust relationship existed between the company and its controller. Where groups are involved, Salomon remains the starting point. However, courts have been more willing to lift the veil recently, especially where personal injury is involved or justice demands it, even if they do not say so explicitly. This seems fair, as otherwise shareholders enjoy double protection.

United States

Florida courts require a showing of three factors in order to pierce the corporate veil:[9]

  1. The corporation was dominated and controlled by its shareholder(s) in such as way that it was merely an “alter ego” used for the shareholders’ benefit,
  2. Some sort of improper conduct in either the formation or the use of the corporate form,[10] and
  3. The improper conduct imposed an injury on the claimant.

Most courts tend to focus the analysis on the second element: “A critical issue in determination of whether the corporate veil will be pierced for imposition of personal liability is whether corporate entity was organized or operated for an improper or fraudulent purpose”[11]

US law has elaborated a doctrine whereby  a director or officer who usurps the company’s opportunities and diverts them to do business himself, so curtailing the company’s operation, can be sued for damages[12]

Environmental cases

Congress’ response to the problem was the Comprehensive Environmental Response, Compensation and Liability Act (CERCIA o and the Resource Conservation and Recovery Act (RCRA), which impose strict liability upon broad classes of persons for cleanup costs. In situations where the liable corporation is insolvent or defunct, recent court decisions construing CERCLA and RCRA have sliced through the corporate entity and have imposed both derivative (“piercing”) and direct liability on officers and shareholders of corporations. Additionally, the decisions suggest that the courts are willing to extend liability to successor/purchaser corporations for the acts of the predecessor/seller corporations under certain condition

In conclusion, while the principles outlined herein have universal application, there are differences from state to state. Specifically, some states, such as Florida and Delaware, are conservative with respect to traditional protections and remain reluctant to pierce the corporate veil. By contrast, more liberal states—notably, California and Massachusetts, put greater emphasis on equity and readily set aside corporate protections where there is evidence that the company is formed or used for some illegal, fraudulent, or unjust purpose and/or the company is merely the alter-ego of its owner(s).

China

The notion of piercing the corporate veil did statutory law prior to 2006. The new Company pierce the corporate veil under certain circumstances. Chinese corporate law more closely.

Article 12 of the law states states: “Where any of the shareholders payment of its debts by abusing the independent the shareholder’s limited liabilities, and thus any creditors, it shall bear joint liabilities for addition, article 64 provides a veil-piercing shareholder LLCs. It states: “If the shareholder company is unable to prove that the property company is independent from his own property, for the debts of the company.”[13]

Formally recognizing veil piercing ends more over whether Chinese judges can pierce corporate is incomplete and introduces new problems. SPC or the State Council should issue additional veil-piercing doctrine. Specifically, directives that courts may consider in veil-piercing cases balanced in a “totality of the circumstances” consider expanding veil piercing to antitrust would bring China’s veil-piercing doctrine practice.

The concept in India

In india the courts have accepted the  the concept of lifting the corporate veil if doing so serves the public interest . If other concerns such as society or assosiation, firm are used in order to facilitate evasion of legal onligation like payment of direct and indirect taxes or denial of statutory benefits to workmen , the courts have to disregard the separate legal entity or a company.

It is however tested that that whether the method adopted for evasion of legal obligations would subvert public interest.[14]

In the case of Delhi Development Authority v. Skipper Construction [15]the court held that-

“A corporation will be looked upon as a legal entity as a general rule , but when the notion of legal entity is used to defeat public convenience ,justify wrong, protect fraud, or defend crime the law will regard the corporation as assosiation of persons”

 

In the case where previously the subsidiary company was a private limited company which later converted to public limited company and became a subsidiary of holding company, with different directors and no denial that the secured creditors of the holding company and subsidiary company were different , the court while deciding the question whether workmen and the employees of the subsidiary company could be treated as such of holding company did not prefer to lift the corporate veil of the subsidiary company.[16]

 

Sections in 1956 act which provide for circumstances when corporate veil will be lifted and the individual members would be held liable.

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. In the case of Madan lal v. Himatlal & Co.[17] the respondent filed suit against a private limited company and its directors for recovery of dues. The directors resisted the suit on the ground that at no point of time the company did carry on business with members below the legal minimum and therefore, the directors could not be made severally liable for the debt in question. It was held that it was for the respondent being dominus litus, to choose persons of his choice to be sued.

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.[18]

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.

 

Not a stagnant concept

The concept of lifting the corporate veil is  not a stagnant concept but an evolving one.[19]Also it is not open to a company to ask for unveiling its own cloak and examine  as to who are directors and shareholders and who are in reality controlling affairs of a company.[20]If the veil is to be lifted, it should be done in the interests of third parties who would otherwise suffer as a result of the choice.[21]

Beneficial lifting of the corporate veil

It is not always true that lifting of the veil always works disadvantageously for the company it at times works advantageously too. In case where the veil was lifted in order to know that whether the appellant company had the the required experience in printing of telephone directories and the results were favourable for the company , non acceptance of its tender on ground of no experience was considered unjustified.[22]

Rationale

The rationale behind such instances of beneficial lifting of the corporate veil is to uphold the purpose of the principles of separate corporate personality which was to encourage industrialisation, hence veil should not only be pierced in cases of fraud but also where such piercing would promote growth of industry.[23]

Holding- subsidiary relationship

Companies act all over the world have statutorily recognised subsidiary companies as separate legal entity. A holding company may control a number of subsidiary companies and work as they are merely departments of one large undertaking owned by the holding company, however the business of the subsidiary company is not the business of the holding company.

Conclusion

 It should be noted that the principle of Salomon v. A. Salomon & Co. Ltd[24] is still the rule and the instances of piercing the veil are the exceptions to this rule. The legislature and the courts have in many cases now allowed the corporate veil to be lifted. The principle that a company has its own separate legal personality of its own finds an important place in the Constitution of India as well. Article 21 of the Constitution of India, says that: No person shall be deprived of his life and personal liberty except according to procedure established by law. Under Article a company also has the right to life and personal liberty as a person. This was laid down in the case of Chiranjitlal Chaudhary v. Union of India[25] where the Supreme Court held that fundamental rights guaranteed by the constitution are available not merely to individual citizens but to corporate bodies as well except where the language of the provision or the nature of right compels the inference that they are applicable only to natural persons.

So, a corporation can own and sell properties, sue or be sued, or commit a criminal offence because a corporation is made up of and run by people, acting as agents of the company. It is under the ‘seal of the company’ that the members or shareholders commit fraud or such acts and therefore the company should also be liable as it also a person which is accorded fundamental rights under Article 21 of the Constitution of India.

The other side of this coin can be that, as the company is privileged to have its own right to life and personal liberty, how can its fundamental right be taken away by disregarding its corporate entity for the wrongs committed by its members and not the company itself.

As a result of incorporation, an incorporated company wears a ‘corporate veil’ and thus acquires the ‘corporate personality’, behind which there are shareholders who have formed the company. Although in law the company has an independent personality, it is an artificial person and hence, behind the corporate curtain, there are natural persons, i.e. shareholders who have associated themselves into a company. So if this corporate personality is uncovered or unveiled, the shareholders or the directors mostly are found to be behind the veil.

 

——————————————————————————–

 

[1] Max Radin, ‘The Endless Problem of Corporate Personality’ (1932) 32 Colum. L. Rev. 643

[2] (1897) A.C 22 (H.L)

[3] [2013] UKSC 34

[4] Re Patrick and Lyon Ltd [1933] Ch 786 (Ch).

[5] Daimler Co Ltd v Continental Tyre and Rubber Co (Great Britain) Ltd, [1916] 2 AC 307 (HL).

[6] Gilford Motor Co v Horne, [1933] Ch 935 (CA).

[7] Adams v Cape Industries Plc [1990] Ch 433 (CA

[8] In Re FG Films Ltd, [1953] 1 WLR 483 (Ch).

[9] Mullin v. Dzikowski, 257 BR 356 (SD Fla. 2000)

[10] Ally v. Naim, 581 So. 2d 961, 962 (Fla. 3d DCA 1991).

[11] Kanov v. Bitz, 660 So. 2d 1165 (3d DCA 1995)

[12] “Lifting the Veil” in Four Countries: The Law of Argentina, England, France and theUnited States

Author(s): Juan M. Dobson

Source: The International and Comparative Law Quarterly, Vol. 35, No. 4 (Oct., 1986), pp.839-863

[13] 2006 P.R.C. Company Law art.

[14] Ramaiyya book, page 509

[15] (1997) 89 Comp.Cas.362(SC)

[16][16] Krishi Foundary Employees Union v Krishi Engines Ltd., 2003 CLC 547,556-557

[17] [2009] 99 Comp. Cas. 266 (M.P)

[18] Hendon v. Adelman [1973] New Delhi LR 637

[19] State of U.P v. Renusagar Power Co..[1991] 70 Comp Cas. 127(SC)

[20] Singer India Ltd. V. Chander Mohan Chadha[2004] 122 Comp.Cas 468(SC)

[21] Kosmopoulos v. Constitution Insurance Co.[1987] 1 SCR 2

[22] New Horizons Ltd. v. Union of India [1998] 15 SCL 148 (SC)

[23] Tax mann book

[24] Supra note. 2

[25] [1951] 21 Comp. Cas. 33

 

close

Don’t miss out on anything, get latest notifications by subscribing to our newsletter!

We don’t spam!

Law Wire Team
Law Wire Teamhttps://lawwire.in/
Law Wire Team attempts to delve into pertinent (and sometimes not immediately pertinent) questions regarding socio-politics, Law and their interesting matrix.
RELATED ARTICLES

LEAVE A REPLY

Please enter your comment!
Please enter your name here

Most Popular