Lifting of the “Corporate Veil”

The basic principle, that the company is a distinct legal entity from its members, is regarded as a curtain or a veil between the company and its members. This 'corporate veil' protects the members from the liability of the company. When we look at the economic reality of the situation, the 'corporate veil' is said to have been lifted in certain circumstances.

As a matter of rule, the corporate veil cannot be lifted to see the identity of the persons behind it except in a few exceptional circumstances/situations, which have developed over a period of time through judicial pronouncements. These are:—

(i)   to determine whether, it is an enemy company;

(ii)   if it is used for evasion or to circumvent tax obligation;

(iii)  when it is formed to defeat or circumvent law or defraud creditors or to avoid legal obligations;

(iv) where the companies are in relationship of holding and subsidiary companies;

(v) the laws relating to foreign exchange control have been violated;

(vi) a shareholder has lost the privilege of limited liability;

  (vii) where the sole responsible person is the dependent himself;

(viii)   by implying in certain cases that the company is an agent or the trustee of its members;

(ix) where a particular director could be proceeded against in pursuance of the impugned show cause notice or where he is liable for the payment of all duties charged and to all penalties;

(x)   where the corporate entity is used for a fraudulent purpose;

(xi)   where the corporate shield was blatantly used to disobey the orders of the Court willfully.

The court will lift the corporate veil where the company is a sham formed for some fraudulent purpose or so that the proprietors of the company can exploit rules of law in an improper manner.  

The corporate veil may be lifted where a statute itself contemplates lifting the veil, or fraud or improper conduct is intended to be prevented, or a taxing statute or a beneficent statute is sought to be evaded or where associated companies are inextricably connected as to be, in reality, part of one concern. [Life Insurance Corpn. of India v Escorts Ltd. (1986) 59 Comp Cas 548 (SC)]

In Salomon vs. Salomon & Co. Ltd. [1897] A.C. 2 the House of Lords laid down that a company is a person distinct and separate from its members. In this case one Salomon incorporated a company named “Salomon & Co. Ltd.”, with seven subscribers consisting of himself, his wife, four sons and one daughter. This company took over the personal business assets of Salomon for £ 38,782 and in turn, Salomon took 20,000 shares of £ 1 each, debentures worth £ 10,000 of the company with charge on the company’s assets and the balance in cash. His wife, daughter and four sons took up one £ 1 share each. Subsequently, the company went into liquidation due to general trade depression. The unsecured creditors contended that Salomon could not be treated as a secured creditor of the company, in respect of the debentures held by him, as he was the managing director of one-man company, which was not different from Salomon and the cloak of the company was a mere sham and fraud. It was held by Lord MacNaghten : “The Company is at law a different person altogether from the subscribers to the memorandum, and though it may be that after incorporation the business is precisely the same as it was before and the same persons are managers, and the same hands receive the profits the company is not in law the agent of the subscribers or trustees for them. Nor are the subscribers, as members, liable, in any shape or form, except to the extent and in the manner provided by the Act.”

Thus, 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 corporation is in fact based on this theory of corporate entity. Now, the question may arise whether this Veil of Corporate Personality can even be lifted or rend (i.e., torn).

Before going into this question, you should first try to understand the meaning of the phrase “lifting the veil”. It means looking behind the company as a legal person, i.e., disregarding the corporate entity and paying regard, instead, to the realities behind the legal facade. Where the Courts ignore the company and concern themselves directly with the members or managers, the corporate veil may be said to have been lifted. Only in appropriate circumstances, are the Courts willing to lift the corporate veil and that too, when questions of control are involved rather than merely a question of ownership.

The following are the cases where company law disregards the principle of corporate personality or the principle that the company is a legal entity distinct and separate from its shareholders or members:

(1)   In the law relating to trading with the enemy where the test of control is adopted. The leading case in point is Daimler Co. Ltd. vs. Continental Tyres & Rubber Co., if the public interest is not likely to be in jeopardy, the Court may not be willing to crack the corporate shell. But it may rend the veil for ascertaining whether a company is an enemy company. It is true that, unlike a natural person, a company hasn’t mind or conscience; therefore, it cannot be a friend or foe. It may, however, be characterised as an enemy company, if its affairs are under the control of people of an enemy country. For the purpose, the Court may examine the character of the persons who are really at the helm of affairs of the company.

(2)   In certain matters concerning the law of taxes, death duties and stamps particularly where question of the controlling interest is in issue. [S. Berendsen Ltd. Vs.Commissioner of Inland Revenue. Where corporate entity is used to evade or circumvent tax, the Court can disregard the corporate entity [Juggilal vs.Commissioner of Income Tax]. Where it was found that the sole purpose for the formation of the company was to use it as a device to reduce the amount to be paid by way of bonus to workmen, the Supreme Court uphold the piercing of the veil to look at the real transaction (The Workmen Employed in Associated Rubber Industries Limited, Bhavnagar vs. The Associated Rubber Industries Ltd., Bhavnagar and another, AIR 1986 SC1).

(3)   Where companies form other companies as their subsidiaries to act as their agent. The application of the doctrine may operate in favour of such companies depending upon the acts of a particular case. Suppose, a company acquires a partnership concern and registers it as a company, which becomes subsidiary of the acquiring company. In an action for compulsory acquisition of the business premises of the subsidiary, it was held that the parent company (which through itself and nominees held all the shares) was entitled to compensation, maintain action for the same [Smith, Stone and Knight Ltd. vs. Lord Mayor, etc., of Birmingham]

(4)   Where the benefit of limited liability of shareholders is destroyed and each shareholder’s liability has become unlimited. This happens (under Section 45) when the number of members of a public company or a private company or a private company falls below 7 or 2 respectively, and business is carried on for more than six months. In such a situation, every person who is a member and is cognisant of the fact shall be severally liable for the payment of the whole debts of the company incurred during that time.

(5)    Under the law relating to exchange control.

(6)    Where the device of incorporation is adopted for some illegal or improper purpose, e.g., to defeat or circumvent law, to defraud creditors or to avoid legal obligations.