This article is written by Madhuli Kango, a BLS LLB student from Pravin Gandhi College of Law, Mumbai. This is an exhaustive article which deals with the Concept of Corporate Veil and Reverse Piercing of the Corporate Veil.

Introduction and Origin

The history of corporate personhood is quite dated and begins not with the business but with religious institutions and churches who held properties separate from individuals or their legal heirs who were in control of these institutions. By the 16th century, this power was extended to other institutions such as hospitals, universities or colleges.

Furthermore, the 17th century brought an increase in trading and formation of trading corporations. With this, the number of companies increased drastically bringing in various legislations, statutes and judgements to expand and explain the position of these companies. Salomon v A Salomon and Co Ltd[1] was one judgement that clarified the concept of separate existence between the company and its shareholders.

Separate Legal Entities: Salomon v A Salomon and Co Ltd

No wonder when reading company law the first case any student becomes acquainted with is Salomon v A Salomon and Co Ltd [2] (Salomon). This case is not only frequently mentioned in textbooks and articles but has also found its presence in courtrooms and has received constant, well-deserved recognition throughout the years. It can be very well said that the case was well ahead of its times, the concepts are given then are still being used and applied and are what has made the company format lucrative for individuals and has aided in greater adaptation during the age of globalization. 

This case established the foundation of the existence of a company, its formation and functions, this case also brought in the concept of separate legal entities and became the benchmark and cornerstone of corporate jurisprudence. Though the concept of Separate Legal Entity has since then come across various exceptions and instances of veil lifting, the essence as given in this case is still upheld.

In the said case, Mr Aaron Salomon was a successful bootmaker carrying out a business as a sole trader. It was in 1892 when he decided to establish a company duly registered under the Companies act 1862 by the name of ‘A. Salomon & Co Ltd’. He made his two sons the directors and along with his wife and his five children, they all became the shareholders of this company. After the establishment and incorporation of the company, he sold his boot making business to the same company and in return got allotted 20,000 £1 shares and £10,000 in debentures in return of the £39,000 worth boot making business. He also received floating charges over the company’s stock-in-trade as security for the debentures.

Soon after the incorporation, the newly formed company went under, during the insolvency proceeding debt up to £7,773 was found pending towards the unsecured creditors, with an amount of only £1,055 available for repayment. Amidst this, Mr Solomon came forward claiming the amount since he was a secured creditor and thereby liable to get the first claim. If it stood successful, the other creditors would be left with nothing. 

Aggrieved by this situation Mr Bordip, the company’s liquidator asserted that Mr Solomon should be held responsible for the company’s debts just as he would have had he been the sole trader. Mr Bordip justified his stand by stating that the intent of formation was to defraud the creditors in furtherance of which the price paid towards acquiring the boot making business was excessive.

Mr Bordip filed a case in the first instance of which his claims were not accepted by Vaughan Williams J.[3] Instead the company was found to be the agent of Mr Solomon, with Solomon as the principle. The members of the company were held to be dummies and thereby Mr Solomon was asked to indemnify the creditors of the company, against this Mr Solomon appealed.

The High Court’s decision was upheld by the Court of Appeal, in this judgement given by Lindley LJ. acknowledged that the company formed had adhered to all the provisions of the acts but the judge went forward to hold that the company was formed for ‘illegitimate purposes’ and as a ‘device to defraud creditors’ and since due to the formation of company creditors could not reach to Solomon directly, he is now thereby liable to indemnify the company. 

Similar to Lopes’ judgement was the one given by Kay LJ.’s judgement which held that the sale of the business to the company was not valid and again set on Mr Salomon the task of indemnifying the company for the cost of sale and interests of debentures, along with the debts incurred.

Finally, it was the house of lords that rejected all the previous judgements talking of fraud ad agency and finally upheld Mr Salmons appeal. In this judgement, the lords decided that the company has been bought into a valid existence with strict adherence to laws and rules in accordance with the acts. Furthermore, upholding the fact that the company and Mr Solomon were separate legal entities and thereby not liable to indemnify for the losses. 

Two other important innovative principles were upheld by this case law, it visibly accepted and recognized that ‘one-man company’ was ahead of the legislature formally allowing it in 1992[4], this judgement also went forwards and held that on the basis of shareholding a relationship of agency or trust cannot be inferred.

The concept of Separate Legal Entity thus developed has had far-reaching implications and has become an uncompromising precedent around the world. This concept was widely favoured as it allowed individuals to take in economic opportunities without exposure to unnecessary risks and liabilities in a personal capacity, by giving the company and shareholders a distinct and separate existence. 

By virtue of this, the company and shareholder could independently open properties, execute contracts, and earn without one being liable, monetarily or legally to the other, where a company can survive the death of its shareholder. King v. Portus; ex parte Federated Clerks Union of Australia[5] which explicitly stated and ruled that “The company is a distinct person from its shareholders, who are neither liable to the creditors nor do they own any interest in the property of the company”. 

Decisions of courts in various previous cases across jurisdictions have upheld the ruling in Salomon, these judgements have fine-tuned the doctrine, coming up with various situations where this veil can be lifted.

Piercing of Corporate Veil

In extraordinary situations, a court can order to bind this veil of separation, this piercing of corporate veil is done in situations where the company is used by the owners to shield their mala fide intention and activities. [6] While some of these exceptions directly arise from various statues, the others have formed through precedents. 

The veil of separation between the company and shareholder often aids in committing frauds or illegal acts. Since a company as an artificial person cannot directly perform these actions, it is the owners that are obviously responsible for the same, in such situations the façade is lifted and the people behind the operation are held accountable.

This listing is done by means of statutory provisions or judicial interpretations, there are no specific hard and fast rules or situations where this veil is lifted but depends and varies from case to case. Supreme Court had put it best in the case of Life Insurance Corporation of India v. Escorts Ltd, “it is neither necessary nor desirable to enumerate the classes of cases where lifting the veil is permissible since that must necessarily depend on the relevant statutory or other provisions, the object sought to be achieved, the impugned conduct, the involvement of the element of public interest, the effect on parties who may be affected, etc.”

Reverse Piercing

While the doctrine of piercing the corporate veil is a textbook doctrine, “reverse piercing” of corporate veil is relatively unknown. While the traditional approach of the piercing of the corporate veil imposes liability on individuals or entities for debts of the corporation for misusing this facade [7] reverse piercing of corporate veil in a complete contrast shifts the sphere of liability and holds the corporation liable for the debts of the individual. [8] The essence of this doctrine of reverse piercing is well put forth by the United States Bankruptcy Code [9] and has explained it to be a mechanism used to obtain claims from defaulting debtors by the creditors.

Reverse piercing of corporate veil is of broadly two types, inside piercing and outside piercing, this largely depends upon the position of the parties seeking to pierce the veil. Well evident from the denoting words, inside piercing is done by the corporation owners or insiders to obtain a benefit or satisfying liability of the corporation, it exists for the benefits of the corporation.

Outside piercing is undertaken by third parties as the word indicates, ‘outsiders’ to satisfy their debts and is the more prevalent of the two and is where third party individuals seek redress against wrongdoings of the debtors by obtaining hold of the corporation’s assets.

One of the foremost usages of this theory can be seen in the case of W.G. Platts Inc. v Platts [10]; in this case of a marital property dispute, the court allowed the plaintiff to impose liability on her husband’s corporation for satisfying her debts in accordance with a divorce decree. This was done because the corporation was essentially an alter ego of the husband. 

An organization is said to be the alter ego of a shareholder if he or she holds a strong dominance on the corporation. The claim for alter ego is maintained by application of the test of “control” and extent of ownership, but it is essential to note that substantial ownership is a requirement, not complete ownership as established in the case of Trossman v. Philipsborn[11].

In addition, the case of State v. Easton[12] mentions that fraud is an essential character for the application of this theory and that the defaulting shareholder should have used his or her strong dominance on the corporation to evade a personal obligation or to perpetrate a fraud or crime. In the case of G. M. Leasing Corporation v. the US[13] the government held that the corporation was an alter ego of a taxpayer who was a fugitive from justice and had failed to file proper tax returns for two years and thereby the doctrine of the reverse piercing of the corporate veil was applied.

The Indian Courts have shown strong reluctance in accepting this idea that a corporation could be held liable and punished as the two essentials of possessing men’s rea and bearing imprisonment were not possible. This opinion changed in 2005 with the arrival of Standard Chartered Bank v. Directorate of Enforcement[14] in this case the Supreme Court applied the essence of this doctrine of reverse piercing by holding that the corporation can be prosecuted and punished for an offence with fines on behalf of its owners. 

Furthermore, it was in the case of Iridium India Telecom Ltd. v. Motorola Incorporation and Others[15] where courts held that the corporation would be imputed with the criminal intent of the people who are essentially the alter-ego of the corporation. This doctrine is still in a nascent stage in India while developing but at a slower pace. 

An active understanding of this doctrine is of more importance today than ever before due to the large increase of white-collar crimes and non-payment of dues. In the present market where bad loans and debt crises are becoming rampant and cases of the company’s closing are surging there needs to be an increase in acceptance and usage of doctrines such as these. According to a recent RTI top 20 borrowers in India, today have managed to get about Rs. 16 of every Rs. 100 loan amount of the Indian banking system, borrowers owed Rs 14 lakh crore exposure in the financial year 2019.[16] 

The doctrine of the piercing of the corporate veil is an exception brought about to achieve the ends of justice and fairness. Corporations were given the benefit of separate entities for their protection and development but have been misused for protection from deceptive practices. In these situations, the courts should adopt to reverse piercing of the veil for greater good and justice.

A statement from the case of Shamrock Oil & Gas v. Ethridge[17], puts down the essence of this doctrine in words by stating that, “the mere abstraction of the corporate entity should never be allowed to bar out and pervert the real and obvious truth.”

References

[1] Salomon v A Salomon and Co Ltd [1897] AC 22.

[2] Salomon v A Salomon and Co Ltd [1897] AC 22.

[3] Brodrip v Salomon [1893] B 4793.

[4] Companies (Single-member Private Limited Companies) Regulation 1992.

[5] The King v Portus; ex parte Federated Clerks Union of Australia (1949) 79 CLR 42.

[6] Woolfson v Strathclyde Regional Council [1978] SC 90 (HL) at 96. See also Adams v Cape Industries plc [1990] 1 Ch 433 (CA) at 539; and Official Assignee v 15 Insoll Avenue Ltd [2001] 2 NZLR 492 (HC) at [22].

[7] ROBERT R. PENNINGTON, PENNINGTON’S COMPANY LAW (8th ed., 2006).

[8] Nicholas B Allen, Reverse Piercing of the Corporate Veil: A Straightforward Path to Justice, 85 ST. JOHN’S L. REV. 1147 (2011); See also Kurtis A Kemper, Acceptance and Application of Reverse Veil Piercing, 2 A.L.R. 195 (2005).

[9] In re Evan Zhang, Debtor, 463 B.R. 66 (S.D. Ohio).

[10]W.G. Platts Inc. v Platts, 73 Wn.2d 434 (1968).

[11]Trossman v. Philipsborn, 373 Ill.App.3d 1020 (Ill.App.Ct. 2007).

[12]State v. Easton, 2018-Ohio-3995.

[13]G. M. Leasing Corp. v. The United States, 429 U.S. 338 (1977).

[14]Standard Chartered Bank v. Directorate of Enforcement, AIR 2005 SC 2622.

[15] iridium India Telecom Ltd. v. Motorola Incorporation and Others (2011) 1 SCC 74.

[16]Debt time bomb: Only 20 borrowers owed more than 16% of India’s total loan portfolio, India Today, Dipu Rai, November 28, 2019, 11:05 IST.

[17] Shamrock Oil & Gas v. Ethridge, 159 F. Supp. 693 (D. Colo. 1958).