In this article, Ashwini Gehlot of Institute of Law, Nirma University and Anjana Reghunath, University of Kerala, pursuing a Diploma in Business Laws from LawSikho. They discuss Lifting of The Corporate Veil.
Introduction
Incorporation of an organization by registration was presented in 1844 and the precept of limited liability of an organization followed in 1855. In this manner in 1897 in Salomon v. Salomon and Company, the House of Lords influenced these establishments and solidified into English law the twin ideas of limited liability and corporate entity. All things considered, the pinnacle Court set out the rule that an organization is a distinct legitimate person altogether not the same as the members of that organization. This guideline is alluded to as the ‘veil of incorporation’.
The main preferred standpoint of incorporation from which all others follow is the separate entity of the organization. As a general rule, be that as it may, the matter of the legitimate person is constantly carried on by, and for the advantage of, a few people. In a definitive investigation, some individuals are the real beneficiaries of the corporate preferences, “for while, by the fiction of law, an enterprise is an unmistakable distinct entity, yet in all actuality, it is a relationship of people who are in certainty the beneficial proprietors of all the corporate property.
“And what the Salomon case decided is that ‘in questions of property and limit, of acts done and rights gained or, liabilities expected in this manner… the personalities of the natural persons who are the organizations’ corporators are to be overlooked”.
This hypothesis of corporate, entity is, in fact, the essential guideline on which the entire law of corporation is based. The cases are not few in which the Courts have effectively opposed the compulsion to get through the corporate shroud.
However, the hypothesis can’t be pushed as far as possible. “There are circumstances where the Court will lift the veil of incorporation keeping in mind the end goal to analyze the “realities” which lay behind. Now and again this is explicitly approved by statute… and sometimes the Court will lift its own particular volition”.
Dynamic developments in the economy have laid the basis for various benefits in the private sector. Yet this has also led to a substantial increase in the recurrence of criminal activity, insider trading and other illicit actions that have a direct effect on the business world. The identity of the company is distinct from that of its board members, and the corporate personality of the company is often misused by such directors, promoters and other members as a veil to cover when engaged in illegal activities. In such situations, it is important to bring out individuals who are hiding under the veil of corporate personality and keep them accountable for their conduct, and to that end, the corporate veil is lifted. The goal of this article is to discuss various aspects of the concept of lifting of the corporate veil.
Meaning of lifting or piercing of the Corporate Veil
Corporate veil is a legal term which distinguishes a company from its shareholder. According to it the individual members shall not be personally responsible for the debts and obligations of the company. However, they began to abuse it as a mask for fraud and unethical conduct. It is therefore necessary for the courts to break through the corporate shell and look behind the corporate body as if there is no independent existence of the organization from its members.
Thus where a fraudulent use is made of the business entity, the individuals concerned will not be allowed to be protected under its corporate personality. Furthermore, if found guilty of any wrongdoing, members can be held responsible for the acts of the company, including any unpaid debts. This is termed as the lifting of the corporate veil.
There are two principles on lifting of corporate veil namely the “alter-ego” theory and “instrumentality” theory. The alter ego theory takes into account whether the boundaries between the company and its shareholders are distinctive in nature. On the other hand, the theory of instrumentality explores the use of a business by its owners in ways that favour the owner instead of the company. It is up to the court to determine which principle to enforce or merge the two doctrines with one another.
The human resourcefulness, however, began utilizing the veil of corporate personality explicitly as a shroud for misrepresentation or despicable direct. In this way, it ended up noticeably important for the Courts to get through or lift the corporate veil and take a gander at the people behind the organization who are the real beneficiaries of the corporate fiction.
The lifting of the corporate veil implies neglecting the corporate personality and looking for the genuine individual who is in the control of the organization. At the end of the day, where a false and deceptive utilize is made of the legitimate entity, the people concerned won’t be permitted to take shield behind the corporate personality. In this respects, the court will get through the corporate shell and apply the guideline of what is known as “lifting or piercing the corporate veil.” And while by the fiction of law an organization is an unmistakable element, yet truly it is an association of people who are in reality the beneficial proprietors of all the corporate property. In United States V. Milwaukee Refrigerator Co., the position was summed up as follows:
“An organization will be looked upon as a lawful entity as a general rule…… however when the idea of the legitimate element is utilized to vanquish public convenience, defend crime or protect fraud, justify wrong, the law will view the enterprise as a relationship of people.”
In Littlewoods Mail Order Stores Ltd V. Inland Revenue Commrs, it was observed that:
“\The regulation set down in Salomon v. Salomon and Salomon Co.Ltd must deliberately be observed. It has frequently should cast a veil over the personality of a limited liability organization through which the Courts can’t see. In any case, that is not valid. The Courts can and generally it does draw aside the veil. They can and often do, pull off the cover. They hope to perceive what truly lies behind”.
Separate Legal Entity
Section 9 of the Companies Act, 2013 provides that a company enjoys a separate identity from its shareholders. A firm’s corporate legal existence requires it to function like a legal individual. It specifies that it is independent from the identity of owners, directors, promoters, etc. In simpler terms, the definition of a separate legal entity means that the responsibility of a member is limited to the liability sustained by the company’s actions. This is also known as the principle of limited liability or the limited liability doctrine. In addition, under normal circumstances, the responsibility of a shareholder is limited to its outstanding shares and cannot be held liable for the company’s actions. The Doctrine of lifting of corporate veil is an exception to the principle of limited liability or separate legal entity.
History
The doctrine of lifting of corporate veil was established in the case of Salomon V. Salomon in 1897. It has been pursued since then, but the way the Doctrine of Corporate Veil is implemented has taken various approaches over the years.
In this case , Mr. Solomon was involved in the shoe and boot manufacturing industry. ‘The Salomon & Co. Ltd. ‘was incorporated by Solomon with seven subscribers, including himself, his wife, his daughter, and four sons. All of the shareholders owned shares of UK Pound 1 each. The company acquired the business of Salomon for 39000 pounds, the purchase consideration was charged in respect of 10000 pounds of debits conferring a fee on the assets of the company, 20,000 pounds in a completely paid share of 1 pound each and the balance in cash. The company had experienced problems in less than one year and liquidation proceedings had begun. The assets of the company were not even sufficient to discharge the debts (entirely held by Salomon) and nothing was left to the insured creditors. The House of Lords unanimously held that the company had been validly constituted, because the Act allowed only seven members to hold at least one share each and that Solomon was distinct from Solomon & Co. Ltd.
Doctrine of lifting of corporate veil has been pursued since then, but the way the Doctrine of Corporate Veil is implemented has taken various approaches over the years. It was called the era of early experimentation from 1897 to 1966, in which the courts experimented with various approaches to the doctrine. The various approaches were attempted to bear in mind the decision of the House of Lords in the case of Salomon. From 1966 to 1989, in Salomon’s case, the laws of the House of Lords were updated and the raising of the veil was encouraged. In Littlewoods Mailstores v IRC, Lord Denning stated that the principle laid down in the case of Salomon must be watched very carefully. It was also meant to throw a curtain over a limited company’s identity through which the courts would not see, but that is not valid. The courts can, and sometimes do, take the mask off. From 1989 to the present day, the Doctrine of the Lift of the Corporate Veil began to be disliked by the courts. The classic case that began the trend of disapproving the doctrine is Woolfsan v. Strathclyde Regional Council, in which Lord Keith argued that the only condition where a corporate veil could be lifted was when exceptional circumstances exist suggesting that the company is only a disguise to cover the true facts.
Judicial provisions or grounds for lifting The Corporate Veil
Fraud Or Improper Conduct
The Courts have been more than arranged to pierce the corporate veil when it feels that fraud is or could be executed behind the veil. The Courts won’t enable the Salomon standard to be utilized as an engine of fraud. The two great instances of the fraud exception are Gilford Motor Company Ltd v. Horne and Jones v. Lipman. In the main case, Mr. Horne was an ex-worker of The Gilford engine organization and his business contract gave that he couldn’t solicit the clients of the organization. With a specific end goal to crush this, he incorporated a limited organization in his better half’s name and solicited the clients of the organization. The organization brought an action against him. The Court of appeal was of the view that “the organization was shaped as a gadget, a stratagem, keeping in mind the end goal to veil the viable carrying on of the business of Mr. Horne” for this situation obviously the primary reason for incorporating the new organization was to execute fraud. Along these lines, the Court of appeal viewed it as a negligible sham to shroud his wrongdoings.
In the second instance of Jones v. Lipman, a man contracted to offer his territory and after that point altered his opinion with a specific end goal to keep away from an order of specific performance, he transferred his property to an organization. The court, in this case, held that the organization here was “a veil which (Mr. Lipman) holds before his face trying to maintain a strategic distance from acknowledgment by the eye of equity” Therefore the court ordered for specific performance both against Mr.Lipman and the organization.
For Benefit Of Revenue
“The Court has the ability to ignore corporate substance in the event that it is utilized for tax evasion or to dodge tax commitments. A reasonable outline is Dinshaw Maneckjee Petit, Re;
The assessee was a rich man enjoying gigantic profit and interest income. He formed four privately owned businesses and concurred with each to hold a piece of speculation as an operator for it. Income received was credited in the accounts of the organization however the organization gave back the sum to him as a pretended loan. Along these lines, he separated his income into four sections in an offer to lessen his tax liability.
It was held that “the organization was formed by the assessee absolutely and basically as a method for maintaining a strategic distance from super tax and the organization was just the assessee himself. It did no business, yet was made basically as a legitimate entity to apparently get the profits and interests and to hand them over to the assessee as pretended loans”.
Enemy Character
An organization may expect a foe character when people in true control of its affairs are occupants in an enemy nation. In such a case, the Court may analyze the character of people in genuine control of the organization, and announce the organization to be an adversary organization. In Daimler Co.Ltd V. Mainland Tire And Rubber Co.Ltd, An organization was incorporated in England with the end goal of selling in England, tires made in Germany by a German organization which held the majority of shares in the English organization. The holders of the rest of the shares, aside from one, and every one of the chiefs was Germans, living in Germany. Amid the First World War, the English organization commenced an action for the recuperation of a trade debt. Held, the organization was an outsider organization and the payment of debt to it would add up to trading with the foe, and in this manner, the organization was not permitted to continue with the activity.
Where The Company Is A Sham
The Courts additionally lift the veil where an organization is a minor cloak or sham (lie).
Company Avoiding Legal Obligations
Where the utilization of an incorporated organization is being made to maintain a strategic distance from legitimate commitments, the Court may dismiss the lawful personality of the organization and continue on the presumption as though no organization existed.
Single Economic Entity
Now and again on account of the meeting of endeavors, the Salomon principle may not be clung to and the Court may lift the veil to take a gander at the financial realities of the group itself. On account of D.H.N.food items Ltd. V. Tower Hamlets, it has been said that the Courts may neglect Salomon’s case at whatever point it is just and impartial to do so. In the previously mentioned case, the Court of claim suspected that the present case was one which was appropriate for lifting the corporate veil. Here the three auxiliary organizations were dealt with as a part of the same financial entity or group and were qualified to pay compensation.
Agency Or Trust
Where an organization is going about as agent for its investor, the investors will be obligated for the acts of the organization. It is an issue of facts for each situation whether the organization is going about as an agent for its investors. There might be an Express consent to this impact or an agreement might be suggested from the conditions of every specific case. In the case of F.G.Films ltd, An American organization financed the creation of a film in India in the name of a British organization. The leader of the American organization held 90% of the capital of the British organization. The Board of exchange of Great Britain declined to register the film as a British film. Held, the decision was substantial in perspective of the way that British organization acted only as the nominee of the American Company.
Avoidance Of Welfare Legislation
Avoidance of welfare enactment is as normal as avoidance of tax collection and the approach of the Courts in considering issues emerging out of such evasion is, for the most part, the same as avoidance of tax assessment. It is the obligation of the Courts for each situation where ingenuity is used to maintain a strategic distance from welfare enactment to get behind the smoke screen and find the genuine state of affairs.
Public Interest
The Courts may lift the veil to ensure open strategy and prevent exchanges in opposition to public policy. The Courts will depend on this ground while lifting the veil is the most “just” result, however, there is no particular justification for lifting the veil. Consequently, where there is a contention with public policy, the Courts disregard the form and consider the substance.
Tax Evasion
The Court has the right to ignore a corporate body if it is used for tax evasion or the avoidance of tax obligations. If the company was founded by the assesse solely and simply as a means of escaping a super-tax and the company was nothing more than the assesse himself. It did not do business, but was merely created as a legal entity to obviously collect dividends and interest and hand them over to the assesse as planned loans.
Statutory Provisions For Lifting The Corporate Veil
Reduction Of Number Of Members
Under Section 45 of The Indian Companies Act, 1956, if an organization carries on business for over a half year after the number of its members has been diminished to seven if there should arise an occurrence of a public company and two in the event of a privately owned business, each individual who knows this fact and is a member during the time that the organization so carries on business after the half year, becomes liable severally and jointly with the organization for the payment of debts contracted following a half year. It is just that part who stays after a half year who can be sued.
Fraudulent Trading
Under Section 542 of The Indian Companies Act, 1956, if any business of an organization is gone ahead with the aim to defraud creditors of the organization or creditors of some other individual or for any deceitful reason, who was intentionally a party to the carrying on of the business in that way is subject to imprisonment or fine or both. This applies regardless of whether the organization has been or is in course of being twisted up. This was upheld in Delhi Development Authority v. Captain Constructions Co. Ltd. (1997).
Misdescription Of The Company
Section 147(4) of The Indian Companies Act, 1956, gives that if any officer of the organization or other individual acting on its benefit signs or approves/authorized to be signed by the organization any promissory note, bill of exchange, order or cheque for money or goods, endorsement in which the organization’s name is not specified in readable letters, he is obligated to fine and he is personally liable to the holder of the instrument unless the organization has effectively paid the sum.
Failure To Refund Application Money
As indicated by Section 69(5) of The Indian Companies Act, 1956, the executives of an organization are mutually and severally at risk to reimburse the application cash with premium if the organization neglects to refund the cash within 130 days of the date of issue of the prospectus.
Holding and Subsidiary Companies
In the eyes of law, the holding organization and its subsidiaries are separate legitimate entities.
However, in the accompanying two cases, the subsidiary may lose its different entity-
- Where toward the end of its monetary year, the organization has subsidiaries, it must lay before its members in meeting not only its own particular accounts but also append therewith yearly accounts of each of its auxiliaries along with copy of the board’s and examiner’s report and a statement of the holding organization’s interest in the subsidiary.
- The Court may, on the facts of a case, regard a subsidiary as simply a branch or division of one expensive endeavor claimed by the holding organization.
Furnishing false statements
Under Section 448 of the Act, if, in any return, report, certificate, financial declaration, prospectus, statement or other document necessary, any person makes false or wrong statements or conceals any relevant or material evidence, that person is liable under Section 447 of the Act.
Repeated Offence
Pursuant to Section 449 of the Act, if a company or an officer of a company commits an offense punishable by a fine or imprisonment and that offense is committed again within a period of three years, the company and the officer shall pay twice the penalty for that offence, in addition to any imprisonment for that offence.
Recent Developments
In India with the recent development of the Companies Act 2013, the Ministry of Corporate Affairs has amended the Companies (Significant Beneficial Owners) Rules, 2018 for companies. The Companies (Significant Beneficial Owners) Amendments Rules, 2019 are introduced in February 8th, 2019 in order to create a more reformed and unmistakable regulatory structure, making it easier for corporations to have their headquarters outside the country. The rules are simple, specific and “all forms of control” that may be exercised in the affairs of a corporation are recorded.
In addition to clearly categorizing whether an individual or an organization has substantial beneficial ownership, the revised rules also make it necessary for businesses to provide the Ministry with more comprehensive descriptions and information on the entity.
In addition, the amendment will be beneficial in eliminating the principle of proportional calculation and seeking to remove the corporate veil. Changes are put in place to identify and eradicate illicit fund flows on behalf of corporate entities and to identify and have the authority to govern entities controlled from somewhere else by either companies or individuals who are not on the radar. Lately, the Ministry has deregistered companies for not operating the business for a significant period of time.
Conclusion
The doctrine of piercing the corporate veil is not subject to any specific rule; it is usually based on the facts and circumstances of each matter. All matters are decided by taking into account the gravity of the issues involved in the matter.
In this manner, it is bounteously certain that incorporation does not cut off individual liability consistently and in all conditions. “Honest enterprise, by methods for organizations, is permitted; however people, in general, are ensured against kitting and humbuggery”. The holiness of a different entity is maintained just in so far as the entity is consonant with the fundamental approaches which give it life.
Along these lines, the individuals who enjoy the advantages of the machinery of incorporation need to guarantee a capital structure satisfactory to the size of the enterprise. They should not pull back the corporate assets or blend their own individual accounts with those of the corporation. The Courts have now and again seized upon these realities as evidence to legitimize the burden of liability upon the investors.
The demonstration of piercing the corporate veil up to this point says a standout amongst the most disputable subjects in corporate law. There are categories, for example, agency, fraud, facade or sham, group enterprises, and unfairness, which are accepted to be the most curious premise under which the Law Courts would pierce the corporate veil. However, these categories are simple rules and in no way, means far from exhaustive.
References
Lawteacher.net. (n.d.). Lifting Of The Corporate Veil | Law Teacher. [online] Available at: https://www.lawteacher.net/free-law-essays/business-law/article-on-lifting-of-the-law-essays.php [Accessed 3 Aug. 2017].
Majithia, V. and Rajora, Y. (2015). Lifting Of Corporate Veil – Academike (ISSN: 2349-9796). [online] Academike (ISSN: 2349-9796). Available at: https://www.lawctopus.com/academike/corporate-veil-2/ [Accessed 3 Aug. 2017].
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