From a legal standpoint, a company is considered a separate legal entity different from its shareholders; a concept often termed the ‘Veil of Incorporation,’ established in the landmark case, Salomon v. Salomon and Co. Ltd. (1897) A.C. 22. Courts typically uphold this principle, acknowledging the company’s separate legal personality. The concept of “lifting the corporate veil” involves disregarding the corporate entity and examining the true individual who controls the company. Essentially, when the legal entity is used fraudulently or dishonestly, individuals cannot hide behind the corporate structure. In such cases, the court may penetrate the corporate facade and apply the principle known as “lifting or piercing through the corporate veil.” In the case of Woolfson v. Strathclyde Regional Council 1978 S.C. 2 (H.L.) 90, on page 96, it is said that “the corporate veil should only be lifted when specific circumstances suggest that it’s merely a facade hiding the truth.”.
Statutory lifting of the corporate veil
Person in default – If a company violates any provision of the Companies Act of 2013, the individual responsible for the company will face punishment, which may include a penalty, fine, or imprisonment as determined by the court or specified in the provision. The responsible person varies depending on the circumstances of each case. In such instances, the court will uncover the true offenders by lifting the corporate veil.
Irregularities in the prospectus – Sections 34 and 35 of the Companies Act 2013 outline the liability for misstatements. Section 34 addresses criminal liability, while section 35 deals with civil liability. The company must issue the prospectus as per the conditions of section 26 of the Companies Act 2013, ensuring all information provided is accurate. Failure to comply with this section may result in criminal or civil liability, as applicable.
Illegal acceptance of deposits from the public – If a company solicits, accepts, or permits others to provide it with funds in violation of the regulations outlined in sections 73 and 76 and fails to return the money within the specified timeframe, the court may lift the corporate veil to hold the individuals responsible for the company accountable. Those found guilty may face imprisonment for up to seven years and a fine ranging from a minimum of twenty-five lakh rupees to a maximum of two crore rupees.
Fraudulently seeking investment – If an individual makes false statements, promises, or forecasts about a company to entice others to invest in it, this action will be subject to prosecution under section 447 of the Companies Act. Section 447 specifies penalties for fraud, with offenders facing imprisonment ranging from six months to ten years, along with a fine.
Fraudulent conduct of businesses – During the winding-up process of a company, if the official liquidator, company liquidator, creditor, or contributor suspects that the company conducted its business to defraud creditors for fraudulent purposes, section 339 of the Companies Act allows the court to lift the corporate veil. This enables punishment for those responsible for the company’s actions. In such instances, the business owners will be held personally liable without any limitations.
Furnishing False evidence – If a company provides evidence which is false under any provision of the Companies Act of 2013, the court may order the lifting of the corporate veil to hold accountable those who are using the company as a shield. Individuals found guilty of providing false evidence through oaths, affirmations, affidavits, or depositions may face imprisonment for 3 to 7years and a fine of up to ten lakh rupees.
Grounds For Lifting of Corporate Veil
When individuals exploit the legal system for fraudulent gain, they can’t rely on the corporate veil for protection anymore. The authorities will uncover the true individuals behind the company and hold them responsible for any wrongdoing. This action, known as the “Lifting of Corporate Veil,” is stipulated in the Companies Act of 2013.
Judicial Grounds for Lifting of Corporate Veil
Alongside the statutory provisions, In certain cases, Indian courts have the authority to pierce the Corporate Veil at their discretion. Here are some examples:
1. Sham Company Fraud: It is not possible for a company to engage in fraudulent activities by itself. To commit such offences, there must be a human element involved with them. Consequently, measures can be adopted to prevent fraudulent activities in the future. The courts have the power to lift or pierce the veil if they determine that certain businesses are fraudulent or deceptive. These companies serve as mere disguises, and their characteristics may be disregarded to reveal the true culprit.
In Santanu Ray v. UOI 1988(18) ECC51 According to the Supreme Court, the veil can be lifted to investigate which director was responsible for allowing deliberate concealment or suppression of crucial information, as well as fraudulent evasion of excise duty.
2. Invocation of the Principal of the Agency: The Corporate Veil may be lifted if required to identify the principal and agent involved in a wrongful activity carried out by the agency.
In Smith Stone and Knight v. Birmingham Corporation 1939, The subsidiary working for the parent company’s benefit justified the parent company claiming on behalf of the subsidiary. Even though they recognized the subsidiary as having its own legal identity, the parent company was considered the principal using the agency principle, and the subsidiary was seen as acting on its behalf.
3. Against Public Policy: When a company’s actions go against public interest or policy, the courts have the power to lift the veil and directly hold the responsible parties accountable for their actions.
In Jyoti Limited v. Kanwaljit Kaur Bhasin 1987 CRILJ1282, The Supreme Court applied this doctrine to examine the company’s involvement in a commercial transaction, discovering that the corporation was in contempt of court. Eventually, the members were held responsible.
4. Determining the Original Character of the Company: When the objective of setting up a business is simply to make gains, a company will not try to do good for society. It might, however, cause harm instead.
In Workmen Employed in Associated Rubber Industries Ltd., v. The Associated Rubber Industries Ltd., Bhavnagar AIR 1986 SC 1, The Supreme Court affirmed that any steps taken by a company to circumvent welfare laws provide sufficient grounds for the courts to lift the veil.
5. Tax Evasion: Every earning person is responsible for paying the taxes. Taking the law into account, a company is not distinct from an individual. Any person who attempts to evade this responsibility illegitimately is regarded as an offender in the eyes of the law.
In Bacha F. Guzdar v. Commissioner of Income-tax AIR 1953 BOM 1, The Supreme Court differed from the plaintiff’s stance, asserting that while the company’s earnings contained agricultural elements, they couldn’t be labelled as such when disbursed to shareholders as dividends.
AUTHOR:
Eshwar S, 5th year B.A, LL. B(Hons.), Veltech School of Law, Chennai.