This article is written by Saswata Tewari, from the University of Petroleum of Energy and Studies, Dehradun. This article does a case analysis on Workmen v. Associated Rubber Industries Ltd and explains the concept of the doctrine of the corporate veil.
Table of Contents
According to the Companies Act 2013, a company is a legal entity that has its separate existence as that of any juristic person and is different from its members. The Companies Act provides for the provisions including the incorporation and registration of a company which in turn gives the company a corporate personality that is distinct from its members and the company becomes capable of suing and being sued. The distinct personality of a company was established in the case of Solomon v. Solomon where it was observed that the company is a different person altogether from its members.
The distinct personality of a company is covered under the doctrine of the corporate veil. Courts are generally bound by this doctrine which highlights the point that a company should be seen existing differently from its members. But in certain circumstances, the Court will pierce through the corporate veil to reach the culprit person hiding behind the veil or to show the true form and character of the troubled company. Companies Act have laid down provisions describing the culprit person liable for the immoral activity as an officer who is in default as per Section 2(60) of the Companies Act 2013 and it involves those persons holding the posts of directors and senior managerial personnel.
If the Court finds out that an incorporated company has intentionally tried to evade legal obligations or tries to avoid any other obligations such as taxes or any other force of law, the Court will have the power to ignore the corporate personality of the incorporated company and find out the true affairs hiding beneath the distinct personality of the company. The corporate veil is also lifted in cases to hold a parent company liable for the unethical acts of its subsidiary.
The case of Workmen v. Associated Rubber Industries Ltd also deals with the doctrine of the corporate veil as it was seen that the management of the company was misappropriating the corporate personality of the company to evade tax obligations and increase their profits.
Facts of the case
A company named Associated Rubber Industries Ltd. had purchased shares of the company INARCO Ltd by investing an amount of Rs. 4,50,000. The company was receiving the annual dividends in respect of the shares in INARCO and the amount that was received was appearing in the profit and loss account of the company year after year. This amount was taken into consideration for calculating the bonus that was payable to the workmen of the company.
In the year 1968, the shares of INARCO Ltd. were transferred into the subsidiary named Aril Bhavnagar Ltd which was wholly owned by the Associated Rubbery Industry Ltd and the transferred shares of INARCO accounted as the only capital of Aril Bhavnagar Ltd. The shares of INARCO also created dividends which was the only source of income for Aril Bhavnagar as it had no business of its own. The dividend income generated from the shares was not being transferred to the Associated Rubber Industries Ltd and therefore, the amount that was previously shown in the profit and loss account was not there now and it resulted in reducing the bonus that was previously given to the workmen of the company. The workmen of the company were entitled to a bonus at the rate of 16% but they were given a bonus at the rate of 4%. The workmen of the company filed an industrial dispute claiming the rightful amount that they deserved as a bonus.
Industrial tribunal and the High Court of Gujarat held that the Associated Rubber Industry Ltd. and Aril Bhavnagar Ltd are two different legal entities having separate legal existence and as a result, the profits made by the Aril Bhavnagar can not be shown as the profits of Associated Rubber Industry Ltd for the effect of calculating the gross profits made by the Associated Rubber Industry Ltd.
An appeal was filed in the Supreme Court by the workmen of the Associated Rubber Industry Ltd under Article 133(1) of the Indian Constitution.
- Whether the transfer of shares of INARCO Ltd. by Associated Rubber Industry Ltd to Aril Holdings Ltd was a device to avoid payment of a higher bonus to the workmen of the company?
- Whether the companies, Associated Rubber Industry Ltd and Aril Holdings Ltd were two separate legal entities?
It was argued by the appellants that the transfer of shares of INARCO Ltd. by Associated Rubber Industry Ltd, was just the means to avoid paying the workmen of the company a higher bonus.
The Supreme Court said that it was obvious given the law that the companies Associated Rubber Industry Ltd and Aril Holdings Ltd. are two distinct legal entities having separate legal existence but the court must check if companies are avoiding the tax and welfare legislations. The Court has the power to disregard the corporate veil and discover the true state of affairs if the legal facade is being used by the company for tax evasion or to circumvent tax obligations. The case of McDowell and Company Limited v. Commercial Tax Officer was cited where the Supreme Court had said that it is on the Court to determine if legal devices are being used to avoid tax obligations.
The case of In CIT v. Meenakshi Mills was also observed and it was said that the whole juristic viewpoint of a company is that it is a separate legal personality which is entirely different from its members and a company can enjoy the rights and be subjected to duties which are different from those enjoyed by the members of the company. But in some exceptional situations, the Court has the power to lift the corporate veil and pay attention to the economic realities behind the legal front. For instance, the Court is entitled to disregard the veil of a corporate entity if it is being used for tax evasion or to circumvent tax obligation.
In the case of Apthorpe v. Schoenhofen Brewing Co, the Income Tax Commissioners had discovered the fact that all the property of New York company except its land had been transferred to an English company and that the New York company was holding the land as aliens were not allowed to do so in New York. The English company was holding the majority of shares of the New York company and the Commissioner had also acknowledged the fact that the business carried out by the New York company was as an agent of the English company. In the light of the findings of the case, the Court of appeal despite the argument based on the case of Solomon v. Solomon, held that the business carried in the city of New York was technically of the English company which was liable for the English company tax.
In the case of Firestone Tyre and Rubber Co. v. Llewellin, an American company had made setting with its distributors on the Continent of Europe by which they had obtained supplies from the English manufacturers, a subsidiary wholly owned by the American company. The American company was credited by the English company with the price which was received after deducting the cost in addition to 5 percent. It was accepted that the subsidiary was a separate legal entity and was not a mere emanation of the American company and the company was indulged in selling its goods as principal and not its parent’s goods as the agent. Nonetheless, these sales were a path by which the American company carried on its European business and it was held that the main reason behind the setting was that the American company traded in England through the agency provided by the subsidiary company.
The Supreme Court held that a new company was created which was wholly owned by the principal company, having no assets of its own leaving the shares that were transferred by the principal company, with no business to generate income other than receiving dividends from the shares transferred to it by the principal company. The facts were clear that the subsidiary was being used to lessen the gross profits of the principal company. There was no direct evidence to prove the fact that the subsidiary was formed as an instrument to lessen the gross profits of the principal company but what can be established is the fact that the bonus of the workmen of the company was reduced as a result. It was also held that in the year 1971, the Aril Holdings Ltd. was wound up and amalgamated with the Associated Rubber Industry Ltd and it was clear from this action as to why the subsidiary was created in the first place.
The Supreme Court took into account the amount of dividend that the Aril Holdings Ltd. received from the shares of INARCO for calculating the bonus that was rightly payable to the workmen of the Associated Rubber Industry Ltd and held that the workmen of the company are righteously entitled to get the bonus at the rate of 16 % for the year 1969.
The amount of dividend acquired by the new company should be taken into account to calculate the gross profit of the respondent company for the motive of assessing the rate of bonus payable to the workmen of the respondent company. Direct evidence cannot support the fact that the second company was made just to reduce the gross profit of the principal company for whatsoever purpose. But the fact is obvious that the second was made to reduce the amount to be paid by way of bonus to the workmen of the principal company. This fact is so clear that no evidence, direct or circumstantial is necessary to prove the allegation. The simple circumstance of subsequent winding up of the new company and the fact that it amalgamated with the principal company, without showing any reason for creation and winding up of the new company, has made it more clear that the new company was made as an instrument to avoid paying a higher bonus to the workmen of the new company.
Incorporation and registration of a company do not cut off their liability in all instances. The corporate veil of a company is protected till the time the company is following the guidelines set out by law. Companies should be following all the legal guidelines and should maintain proper accounts according to their capital structure. At times, Courts have looked upon these facts as evidence to establish the imposition of liability upon the company.
Courts have struggled to pierce the corporate veil of companies as there are not any particular tests given for situations demanding piercing the corporate personality. Every case that comes brings new facts and circumstances and a separate decision has to be taken, taking into consideration the facts that if the plaintiff has shown enough evidence to show the misuse of the corporate veil by a company. In the end, the Court gives the judgment based on factors that are essential to ascertain the decision of piercing the corporate veil of a company. However, at times, these factors may not be sufficient enough to pierce the corporate veil.
Piercing the corporate veil is considered one of the most disputed subjects in the arena of corporate law. It includes cases where crimes such as fraud, sham, agency, legal facades, unfairness, and group enterprises and these are contemplated as the most peculiar basis under which the Courts would pierce the corporate veil of a company. However, these crimes are only the guidelines supported by case laws and not an exhaustive evaluation of the concept.
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