Lifting Of Corporate Veil

The doctrine of corporate veil is one of those basic concepts that form the core of company law. In other words, it means that a company has a legal separation from its shareholders, directors, or officers. It is this separation that gives companies an independent legal identity so that any liabilities or obligations incurred by the company are completely separated from the personal property of its shareholders and directors. It encourages investment because the liability of participants will be limited, thus fostering economic development.

However, there are cases where this separation can be disregarded, and the Courts can hold liable those behind the corporation. This practice has become known as "lifting" or "piercing" the corporate veil.

Overview Of Lifting The Corporate Veil

What is Corporate Veil?

The corporate veil refers to the legal distinction between a corporation and its shareholders or owners. It treats the company as a separate legal entity, protecting the personal assets of the shareholders from the company's debts and liabilities. This separation allows the corporation to operate independently, make contracts, own property, and be sued, without directly involving the owners in legal obligations.

However, in certain cases, courts may "lift" or "pierce" the corporate veil, holding shareholders personally liable if the company is used for fraudulent or improper purposes.

What is Lifting the Corporate Veil?

Lifting the corporate veil is a legal principle where courts disregard the separate legal identity of a company to make shareholders or directors personally liable for the company’s actions or debts. This principle is applied when the corporate entity is misused, or its legal distinction is exploited to facilitate illegal activities. By lifting the corporate veil, courts remove the usual legal protections for shareholders, making them individually accountable for the company's wrongful conduct.

Common Grounds For Lifting Of The Corporate Veil

The Courts have found certain grounds on which the corporate veil could be lifted. Common situations where this occurs include:

Fraud or dishonesty

Where a company is utilized to deceive or defraud the creditors or any other person, Courts will lift this corporate veil. For instance, if the shareholders utilise the corporate structure to hide the assets with the intent of evading liabilities, the Courts may step in. In case the people running the corporation commit fraud and then take shelter behind the identity of that corporation, the Courts lift the veil and make them personally liable. The Courts will refuse to uphold the separate existence of the company where it is formed to defeat or circumvent law, to defraud creditors or to avoid legal obligations.

Evasion of legal obligations

The piercing of the corporate veil can be done where the company has been set up to evade any kind of legal obligation or to avoid some prescribed legal or regulatory requirements. That means it comprises entities that have established a shell firm either for tax evasion or for other unlawful purposes.

Determination of character

Occasionally it becomes necessary to determine the character of a company, for example, to see whether it is an "enemy". In such a case, the Courts may in their discretion examine the character of persons in real control of the corporate affairs.

Preventing Tax Evasion

 Sometimes, companies use their separate legal identity to avoid paying taxes they owe. If this be the case, then the Courts can lift the corporate veil of a company to check if it is trying to defraud taxes. In the case of Juggi Lal Kamlapat vs. Commissioner of Income-Tax, U.P. (1968) the Court held that "the Court has the power to disregard a corporate entity if it is used for tax evasion or to circumvent tax obligation."

Transactions' real character

The company's legal entity can be used to mask certain questionable transactions. In order to discover such transactions' real character and to make those people who are, in reality, in control, the Courts can lift the corporate veil.

In public policy

The Courts can also lift the corporate veil if it is in the interest of the public, especially when the separate legal entity of the company is used only to evade the laws.

Creation of subsidiaries to perform the role of an agent

In the case of Smith, Stone and Knight vs. Birmingham Corpn (1939), the following criteria were laid down for determining whether the business of the subsidiary company is the business of the parent company:

• Were the profits treated as the profits of the parent company?
• Were the persons conducting the business appointed by the parent company?
• Was the parent company the head and brain of the trading venture?
• Did the parent company govern the adventure, decide what should be done and what capital should be embarked on the venture?
• Did the parent company make the profits by its skill and direction?
• Was the parent company ineffectual and constant control?

Contempt of Court

In the case of Jyoti Limited v. Kanwaljit Kaur Bhasin (1987), a dispute arose from the default in an agreement of sale of property between Jyoti Limited and two ladies, Kanwaljit Kaur Bhasin and Kamleen Bhasin. The plaintiff filed a suit against the said ladies for not carrying out the agreement and thereby obtained an injunction against the ladies for not selling the property. However, the ladies later on sold the suit property through a company owned by them, namely Tower Height Builders Pvt. Ltd. The plaintiff thereafter, filed contempt of Court proceedings against the ladies on the grounds that they had wilfully neglected the stay order by using the company as a smoke screen. Finally, the Court ruled in favour of Jyoti Limited and pierced the corporate veil, holding the ladies guilty of contempt of Court, and sentencing them to 15 days in civil prison.

Key Legal Provisions Under The Companies Act, 2013

There exists a number of related provisions within the ambit of the Companies Act 2013 (hereinafter referred to as “the Act”). Following are some of the relevant provisions:

• Section 7(7): This Section holds the promoters and persons in charge responsible for the fraud if the company has been formed with fraudulent intentions.
• Section 34: This Section deals with criminal liability for misstatements in prospectus. It provides that any person who authorises the issue of a prospectus containing false or misleading information shall be liable under Section 447.

People Also Read : What is Prospectus in Company Law?

• Section 35: Section 35 forms the civil liability arising out of misstatements in the prospectus. It provides that the company and officers responsible for the issue of prospectus, such as directors, promoters, and experts will be liable to compensate for losses sustained as a consequence of a misleading prospectus to people buying the securities.
• Section 39: It provides under Section 39 that no allotment shall be made unless minimum subscription is received and the minimum payment on application is made. Where the minimum subscription is not received or the payments received are not paid within the time so allowed, such money received shall be repaid. It also compels a company to file, with the Registrar, a return of allotment. There are penalties prescribed for non-compliances of these requirements.
• Section 273(3)&(4): This provision is applicable when the Tribunal has concluded that a company should be wound up on the ground of not filing financial statements and or holding annual general meetings for such period as is required and,
  • The directors in that case are to present audited financial statements up to the date of the winding-up order to the liquidator so appointed within 30 days.
  • Failure to observe this may result in the liability of a penalty to be imposed on the director, whose amount is not mentioned herein.
• Section 336: When any company goes into liquidation, and it is found that any offence has been committed in relation to the liquidation by any officer of the company, Section 336 shall apply. This Section should, among other things, enumerate the particular offences and penalties thereof, which may comprise one or more of a fine, imprisonment, or both.
• Section 337: This Section speaks about fraud on the part of officers when the company is being wound up. It means that on conviction of any guilty officer, he shall be punished.
• Section 338: One of the major responsibilities of any officer of a company is to ensure that books and accounts are maintained properly. As per Section 338, where a company does not maintain accurate accounts, an officer is in a position to be held liable, especially in those cases which give the appearance of the business being conducted with fraudulent intention or for a fraudulent purpose.
• Section 339: This Section is similar to Section 338 but offers liability for the directors, managers, or officers in case the company winds up and it has been found that the business of the company was conducted with an intent to defraud creditors or for a fraudulent purpose.
  • The Tribunal may declare those officers liable to the debt and liabilities of the company.
• Section 340: Like the preceding Sections, this Section also provides for the fraudulent administration or misfeasance of company funds by directors, managers, liquidators and officers during winding-up.
  • It grants power to the Tribunal to investigate such matters and impose liability to such persons for damages, as may be estimated.
• Section 341: This Section provides that the liabilities incurred under Sections 339 and 340 extend to partners and directors in firms or companies which were involved in committing the offence. That is, no person can escape liability by claiming protection behind a mask of partnership or corporate entity.

These provisions are applied by the Courts in order to prevent companies from being used as mere shells for the purpose of carrying on illegal activities.

Notable Case Laws Related To Lifting Of Corporate Veil

Salomon v Salomon and Co. Ltd. (1897)

This case laid down the principle of separate legal entities. It protects the shareholders from personal liability arising in regard to the debts and liabilities of the company beyond their capital contribution. This principle is not considered to be an absolute one. There have been instances where Courts have provided exceptions to this rule by looking behind the veil of corporate structure and making them liable for the actions of the company. This is more popularly known as “piercing” or “lifting” the corporate veil.

The grounds on which the piercing of the corporate veil may be directed include fraud, sham or façade, agency, group enterprise, and injustice or unfairness, among others. These were conferred upon their creation under common law and have been considered equitable remedies, meaning these are available to ensure a just outcome in given cases.

Tata Engineering & Locomotive Co. Ltd vs State of Bihar & Others (1964)

In the instant case, the Supreme Court refused to lift the corporate veil. The Court held that a company being a juristic person, cannot claim the privileges available to citizens under Article 19 of the Constitution of India.

The Court took into consideration the fact that while the general principle is that a company is a separate legal entity, there are other exceptions to this rule in respect of which the Courts have lifted the veil to prevent fraud or to defeat trading with the enemy. However, in this case, the Court had no reason to lift the corporate veil. The petitioners contended that the Court should ignore the separate legal entity of the corporations and give recognition to the shareholders' rights, as they were citizens of India.

However, the Court rejected this argument. The Court held that if corporations were to enjoy the benefit of Article 19, then the legislature would have to broaden the definition of “citizen”. Since they had not done so, the Court held that it could not lift the veil and permit the corporations indirectly to claim the rights of citizens through their shareholders.

It concluded that the companies could not indirectly achieve what they could not achieve directly and as separate legal entities by way of lifting the corporate veil. Hence, the Court found the petitions incompetent under Article 32 of the Constitution and accordingly dismissed the same.

Life Insurance Corporation of India vs Escorts Ltd. & Ors (1985)

The Supreme Court, in this case, held that lifting the corporate veil was possible only in narrowly defined situations. Recognizing first the well-settled rule that a corporation has a legal entity separate from its stockholders, the Court acknowledged that there is an exception to this general rule. The Court established that lifting of the corporate veil may be allowed upon the following instances:

• When a statute so provides;
• When fraud or illegality is to be unmasked;
• There is an attempt to avoid a taxing statute or a beneficent statute;
• The companies concerned are so related that the associated company is in reality only one entity.

However, the Court indicated that it is not needed nor is it desirable to try to list all the circumstances when lifting the veil has been permitted. Again, this would depend on the facts of the particular case, and relevant law involved.

Delhi Development Authority vs. Skipper Construction Company(P) Ltd. & Anr. (1996)

The Supreme Court pierced the corporate veil so that Tejwant Singh and his wife, Surinder Kaur, did not leave scathe-free with the fraudulent gains made through impugned transactions by using a company controlled by them, Tej Properties Private Limited. It was done to protect the rights of creditors, including plaintiffs who purchased space in the building that was not built. The Court recognized that, no doubt, a corporation is a legal entity distinct from its shareholders, but this concept cannot be utilised to perpetrate fraud.

The Court referred to various precedents, including Salomon v. Salomon and Tata Engineering v. State of Bihar, wherein the Court had lifted the corporate veil so as not to allow the misapplication of the concept of a company. Tejwant Singh, along with his wife, executed a fraud transaction by transferring the prime property to Tej Properties for sheltering the property from creditors.

The Court exercised its powers under Articles 129 and 142 of the Constitution and treated Tej Properties as an alter ego of the directors to meet the ends of justice. The Court ordered the attachment of property belonging to Tej Properties. The Court also directed the couple to deposit ten crores as compensation to the defrauded buyers.

Consequence Of Lifting The Corporate Veil

On the occasion when the Courts lift the corporate veil, there are serious consequences awaiting the directors and the shareholders of such a company. They become deprived of the protection of limited liability that the corporate structures normally provide. This places them in a position where they can also be held personally liable for any kind of debts, obligations, or wrongful acts committed by the company.

This also has bigger implications for corporate governance. The risk of potential personal liability enables transparency and accountability, as it pushes directors into the service of the best interests of the company and its stakeholders. It serves as a warning against wrongdoing, enabling no companies to become instruments of fraud or even a way of avoiding the law.

Examples And Practical Applications

In practice, lifting the veil may be done, for example, when fraud or any other abusive conduct comes into play. For example, a corporation may be incorporated only to act as a front for loans or credits when the substantive business is conducted through another company or person behind that front. If that front declares bankruptcy without paying the creditors, then the Court may lift the veil and hold the individuals liable.

The other common area of application involves family businesses where companies are utilised in an attempt to make personal assets unreachable by creditors or tax authorities. Where such arrangements are held to be fraudulent or shams, the Courts can pierce the veil and make the members of a family responsible for the liabilities of the company.

Issues And Criticisms

While lifting the corporate veil is a strong tool, it also has its critics and challenges. Critics say that this goes against the principle of limited liability, one of the most important features of corporate law and one of the reasons why people invest in companies. Others believe that Courts should show restraint when piercing the veil, as over-intervention will hurt business growth and discourage entrepreneurship.

Besides that, there is also debate on the propriety and consistency of Court decisions in that area. Given that lifting the veil is discretionarily offered to a judge, sometimes the results may be unpredictable and can question the whole aspect of legal certainty.

Conclusion

The lifting of this veil is a basic policy within the jurisprudence, to protect shareholders from any individual liability arising, in an attempt to stimulate economic progress. To this end, whenever the corporate entity is abused for fraudulent or other despicable purposes, Courts are in a position to pierce this veil and expose the entities to liability. Such a piercing of the veil serves as an important avenue through which accountability is imposed on corporations and realised as well as how the legal regime keeps its integrity intact. It reminds the business world that, while limited liability is indeed a privilege, it entails responsibilities regarding proper and lawful use of the laws of corporate structure. This is achieved by increasing transparency, protection for creditors, and rule of law in corporate practices.