QUESTION: What is corporate veil? When it can be lifted?
Answer:
CORPORATE VEIL:
The Corporate Veil is a shield that protects the members from the action of the company. In simple terms, if a company violates any law or incurs any liability, then the members cannot be held liable. Thus, shareholders enjoy protection from the acts of the company.
Case Law: Salomon vs. Salomon and Co Ltd. Fact of the case: In this case, Salomon incorporated a company named “Salomon & Co. Ltd.”, with seven subscribers consisting of himself, his wife, four sons and one daughter. Salomon was a shareholder as well as a secured creditor. There were other unsecured creditors as well. Later on, the company incurred losses and decides to wind up. At the time of winding up, the unsecured creditors claimed that they should be paid before Salomon (as a secured creditor) as it was his company.
Held: This case clearly established that company has its own existence and as a result, a shareholder cannot be held liable for the acts of the company even though he holds virtually the entire share capital. The whole law of a corporation is in fact based on the principle of the separate legal entity.
The separate legal entity of a company is a statutory privilege that must be used for legitimate purposes only but with advantages comes the disadvantages as well. Thus, the Doctrine of lifting up of or piercing of Corporate Veil was introduced to hold the members liable in case of fraudulent or dishonest use of the separate legal entity.
LIFTING UP OF THE CORPORATE VEIL
The company, being an artificial person, does not perform any function by itself-its functions are performed by its directors. If the directors of a company defraud the company or any third party, or do an act which goes against the Companies Act, the law permits, on the orders of the National Company Law Tribunal, to lift the corporate veil and make the directors or members guilty of misconduct and face the wrath of law. In situations when, under the provisions of law and recognising the separate entity of the company, the court directs the lifting of the corporate veil and hold the directors or functionaries of the company liable for their actions, it is called ‘piercing the corporate veil’.
According to Prof. Gover, “Where the law disregards the corporate entity and pays regard instead to the individual members behind the legal facade, it is known as lifting the veil of corporate personality.”
Cases where the court has ordered lifting up of veil-
- In case the Company commits a Fraud.
- Where the company do not have a physical presence, it is just on instruments.
- If the company has an enemy character because of its association with the enemy country.
- If the criminal activities are being hidden behind the company’s name.
Further, the lifting of the corporate veil can be Statutory Lifting or Judicial Lifting.
Statutory Lifting: If the company violates the Companies Act, 2013 and the act provides for the lifting of the veil for the same, then it is termed to be Statutory Lifting. The circumstances are as follows:
- Reduction of the number of members below statutory limits: If, at any time, the number of members in a public company is reduced to less than seven, or it is reduced to less than two in a private company, and the company carries on its business for more than six months, every individual member of the company who is aware of this fact shall be individually liable for the total debts of the company, and can be sued for the realization of such debts.
- Establishing the relationship of holding and subsidiary company: When the management of one company is controlled by another, the company controlling the management is called the ‘holding company’ and the one whose management is controlled is called the ‘subsidiary’. The subsidiary company retains its separate entity, and the holding company cannot be held liable for the actions of the subsidiary merely because it has originated the subsidiary and has control on its management. The subsidiary company cannot be deemed to be the inheritance or property of the holding company. The law provides that the corporate veil may be lifted to determine whether there exists a relationship of a holding and a subsidiary company between the two. Every holding company shall attach to its balance sheet:
- a copy of the balance sheet of the subsidiary,
- a copy of its Profit and Loss Account.
- a copy of the report of its Board of Directors, and
- copy of the report of its auditors
- Investigating the affairs of the company: If the management of the company is not satisfactory, or it is following fraudulent and oppressive policies towards some or all its members, the inspector appointed to investigate the affairs of the company is empowered by law to investigate the affairs of another related company or companies under the same management or group. As per section 219- the ‘corporate veil’ or legal facade may be lifted to ascertain which company or companies are being managed by the holding company.
- Investigating fraudulent trading: If, in the course of winding up a company, it is revealed that the company has been carrying on its business with the intent to defraud its creditors or any other persons, or for any fraudulent purpose, the Tribunal may set aside the leg corporate veil of the company and hold the persons responsible for the fraudulent activities personally liable for the debts and liabilities of the company.
- Non-disclosure of company’s name (Under Section 12): If the name of the company and the address of registered office has not been properly and clearly written or affixed on any document contract, the persons actually responsible for such act shall be personally liable for the consequences of such act even if the contract is in the name of the company. For example, if company’s functionary signs a promissory note on behalf of the company without dead affixing the company’s name on it, he shall be held personally responsible for the promissor note.
- Investigating company’s ownership (Under Section 216): The Central Government may appoint one or mor inspectors to investigate who are the persons who actually control or materially influence the policy of the company.
- Non-return of application money (Under Section 39): One liability of a company is that it must forthwith return all moneys received from the applicants of shares who are not allotted the shares they had applied for. If any such money is not repaid within 130 days of the issue of prospectus to applicants who have not been allotted any shares, the directors of the company shall be individually and severally held liable.
- Mis-statement in prospectus (Under Section 35): If there is a mis-statement in the prospectus of a company inviting the public to subscribe for shares or debentures, then every director, promoter or the person who has issued the prospectus is personally held liable.
Judicial Lifting: If the company violates the Companies Act, 2013 and the act does not provide for the lifting of the veil then the judges can order the lifting of the veil which is known as Judicial Lifting. The circumstances of judicial lifting are as follows:
- Protection of Revenue: If a company or companies are formed only for the purpose of evading the payment of tax-be it income tax, sales tax, wealth tax, death tax, etc.-the law empowers the Tribunal to pierce the veil of corporate entity. If it is revealed that the company was formed for the purpose of evading the payment of taxes, the court can pierce the corporate veil, and make the members liable for the responsibilities of the company.
- Prevention of Fraud and Improper Conduct: If a company conducts its affairs in fraudulent and improper manner, the Tribunal is empowered to ignore the separate entity of the company, and may treat the company and its members as one entity.
- Determination of Enemy Character of a Company: The Tribunal lifts the corporate veil to determine the enemy character of a company and examine the real promoters of the company. If the company’s management constitutes hostile aliens, or Indian nationals operating under the direction of hostile aliens, the Tribunal can lift the corporate veil and have a look at the company’s real ‘face’.
