Notes

Lifting The Corporate Veil, Piercing the corporate veil

Lifting The Corporate Veil – A company is an artificial person’ which is born by an act of law, functions as per the provisions of law and is terminated by an act of law. Its identity is totally different from that of its members. The company is in no way affected by the death, insolvency or lunacy of its members; nor is it affected by the members leaving the company or others joining it. An increase in the number of members likewise has no effect on the company. All affairs of the company are managed by its Board of Directors, who are the nominees of its shareholders. The company is liable for all actions of the Board of Directors which are done under the common seal of the company; but all actions of the Board which are beyond the declared objectives of the company, or which infringe the limits of law are void. Although the company is an association of members who have an interest in its assets, the moment it is incorporated, it assumes a separate identity than that of its members.

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’

Exceptions of Principle

Lifting the corporate veil is an act of the court, and the court might do it to safeguard justice and society’s interest, or to add to the government’s revenue by ensuring that the company discharges its obligation by paying what it legally owes to the government.

The situations under which the Lifting The Corporate Veil fall broadly under the following two heads:

  • Under Statutory Provisions
  • Under Judicial Interpretations

Under Statutory Provisions

The Indian Companies Act defines the express conditions under which the corporate veil may be lifted from a company. These conditions are as under:

(1) 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 realisation of such debts. It is important to note that, while the company continues to be liable for its debts, with the lifting of the corporate veil, its members too become individually and severally liable for the company’s debts even if their liability is limited.

(2) 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

  • (i) a copy of the balance sheet of the subsidiary,
  • (ii) a copy of its Profit and Loss Account,
  • (iii) a copy of the report of its Board of Directors, and
  • (iv) a copy of the report of its auditors

(3) 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 an other related company or companies under the same management or group. The ‘corporate veil’ or legal facade may be lifted to ascertain which company or companies are being managed by the holding company.  -Section 219   ( Lifting The Corporate Veil )

(4) 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 legal corporate veil of the company and hold the persons responsible for the fraudulent activities personally liable for the debts and liabilities of the company.

(5) Non-disclosure of company’s name: If the name of the company and the address of its registered office has not been properly and clearly written or affixed contract, on any document or 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 a company’s functionary signs a promissory note on behalf of the company without clearly affixing the company’s name on it, he shall be held personally responsible for the promissory note. -Section 12 

(6) Investigating company’s ownership: The Central Government may appoint one or more inspectors to investigate who are the persons who actually control or materially influence the policy of the company.  -Section 216

(7) Non-return of application money: 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.  -Section 39 ( Lifting The Corporate Veil )

(8) Mis-statement in prospectus: 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.  -Section 35

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Under Judicial Interpretations

Although there are numerous situations where the Tribunal is empowered by law to lift the corporate veil of a company, such situations are limited by the provisions of law and cannot be stretched too far. Some judicial interpretations of law are as under 

(1) 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. In this connection, the case of Re Sir Dinshaw Maneckjee Petit is an important illustration. Sir Dinshaw was a very rich man who had a huge income from dividends and interest. He floated four private companies and transferred his investments in part to each of the four companies in exchange of their shares. As a result, the income from dividends and interest went to the companies; and the companies, in turn, handed back the amount to him as ‘loans’. This way Sir Dinshaw divided his income in four parts to reduce his taxliability. It was held by the court that the companies were “formed purely and simply as a means of avoiding tax.”I other words, the court held that the companies and Sir Dinshaw were one and the same entity. ( Lifting The Corporate Veil )

(2) Prevention of Fraud and Improper Conduct: If a company conducts its affairs in a fraudulent and improper manner, the Tribunal is empowered to ignore the separate entity of he company,and may treat the company and its members as one entity. In the case of Jones vs. Lipman, Lipman had contracted to sell his land to Jones, but later changed his mind. To evade the contract, he formed a company and sold his land to it. The court held the seller of land and the company were one and the same entity, and made him sell his land to Jones with whom he had made the commitment in the first place.

(3) 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’

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