Explained: Lifting of the Corporate Veil

The author has explained the meaning and of the concept of Lifting of the Corporate Veil in a generic manner.

Introduction

According to Section 2(20) of the Companies Act, 2013, a company is defined as a company that is incorporated under this Act or any other previous prevailing Companies Act.

A company can be formed in accordance with the provisions of Section 3 which provides for the incorporation of a company.

A company has the following features:

1. Incorporated association,
2. Independent legal entity,
3. Common seal,
4. Perpetual existence,
5. Limited liability, etc.

What is a Corporate Veil?

The separate or independent legal entity of a company is one of the most important and unique features of a company.

A separate legal entity means that the promoters and owners of a company have a separate identity from that of the company. Official documents are signed in the name of the company and not the promoters or owners. It shields the promoters and owners of a company from liability unlike in a sole proprietorship or a partnership wherein the owners have unlimited liability.

If the company incurs any debt or is involved in any contravention of the law, it the company which is liable and not the promoters or owners, hence they have limited liability.

The purpose of the doctrine of corporate veil is to ensure business efficacy and convenience as one of the attractive features of a company is limited liability. Limited liability means that the liability of each shareholder is to the extent of his or her ownership in the company.

So, basically, a corporate veil is something that separates the personality of a company from the personality of its shareholders and protects them from being personally liable for the company’s obligations.

One of the landmark cases in regard to the corporate veil is – Salomon v Salomon & Co. Ltd[i]

Here, Mr. Salomon incorporated the business of manufacturing shoes and boots by the name of “Salomon & Co. Ltd” and the company had seven shareholders, which were his family members.

He, his wife, his daughter, and his four sons were the shareholders of the company.

He sold his sole trader business to the company and retained 6 of the shares and received debentures worth 10 thousand pounds.

The business ran into some difficulties and was unable to pay the interest on debentures. Salomon made a claim on the basis that he was a secured creditor, and the company was defaulting on his payments.

It was held that the debts of the company were not the debts of Mr. Salomon because it was validly incorporated, and both are separate legal entities.

Understanding the Lifting of the Corporate Veil

There might be some instances wherein it is necessary to know who the people behind the corporate veil are and, in these instances, the corporate veil needs to be lifted and the real culprits need to be punished.

The courts usually lift the corporate veil where fraud has been committed, improper conduct wherein the public interest is at large, or where the sole purpose of incorporating the company is the evade taxes, etc.

Grounds for Lifting the Corporate Veil

The circumstances under which the corporate veil can be lifted can be divided into two types:

Statutory Provisions:

• Section 45 – Reduction of membership below the statutory limit: The minimum number of members or shareholders in a public company is seven and in a private company is two and if the membership is reduced below that then lifting of corporate veil is needed.

• Section 147 – Misdescription of name: If an officer of a company who signs any bill of exchange where the name of the company is not mentioned in the prescribed manners, such officer will be held liable and not the company.

• Section 239 – Power of inspector to investigate: This section provides for the power of the inspector to investigate the affairs of a company for allegations of mismanagement, oppression etc.

• Section 307 & 308 – These sections apply to every Director and deemed Director. It states that the nature of their shareholding must be mentioned in the shareholder’s register and non-compliance will result in the lifting of the corporate veil.

Judicial Interpretations:

Following are the instances where the judiciary can lift the corporate veil-

• Tax Evasion: Where it is evident that the company is trying to evade taxation, then the courts can lift the corporate veil and punish the people responsible.

• Fraud: In order to prevent fraudulent activities or improper conduct, the courts can lift the corporate veil. Since the fraudulent or improper conduct cannot be committed by the company, which is an artificial legal person, hence the people who manage it are responsible. In Gilford Motor Company Ltd. v Horne[ii]it was held that companies cannot be used as a cloak by members for their wrongdoings.

• Determination of enemy character: In certain situations, it becomes essential to lift the corporate veil and check the character of the individuals and to determine whether they are enemies of the country. In Daimler Co. Ltd. v Continental Tire and Rubber Co. Ltd[iii]– a company was set up in England for selling tires, the company was a German company and most of the control was held by German individuals. During the first world war, the company situated in England started a recovery process and it was eventually held that the company was an enemy character and hence the court chose to lift the corporate veil.

• Liability for ultra vires act: Every company is bound to perform only the acts which are mentioned in its Memorandum of Association, however if acts which are ultra vires the memorandum of association are done then lifting of corporate veil is required.

Conclusion

The principle is given in Salomon v Salomon Co & Ltd. is the rule and the above statutory and judicial provisions are an exception to the rule of the corporate veil.

The separate identity of a company is of utmost importance but there needs to be a balance and the corporate veil needs to be lifted whenever it is needed.

[i] Salomon v Salomon & Co. Ltd [1897] AC 22 (House of Lords)

[ii] Gilford Motor Company Ltd v. Horne  [1933] Ch. 935 (CA)

[iii] Daimler Co. Ltd. v Continental Tire and Rubber Co. Ltd 53 SLR 845