It is a known fact that a Company is a ‘separate legal entity’, which is distinct from its shareholders and other members. However, it cannot be ignored that a company is basically run by its members who are human beings. Thereby, it becomes necessary to balance the two concepts, one being the limited liability of members and the other being the distinct legal personality of a company. In this article, we will discuss in detail how the veil is lifted and then what happens to the limited liability concept.
A veil is an imaginary yet an essential legal concept in protecting the personality of the corporation from that of its members. The acts of members are considered as acts of Company. However, when the members engage in illegal or fraudulent activities, it becomes difficult to impose the liability. In this situation, who can be blamed for? The company or the members who were engaged in such fraudulent acts. Here is where the lifting of the corporate veil comes into picture. The veil is lifted and the members will be held independently liable from that of the company. But to what extent, the members can be held liable, as the limited liability principle says that the members are liable only to the extent of the shares he contributed. This is in direct conflict with the concept of ‘lifting of veil’. So, to understand this better, let’s summarize the lifting of veil.
There are two principles which constitute the ‘lifting the veil’ concept; “alter- ego” and the “instrumentality theory”. As per the “alter- ego” theory, the boundaries between the shareholders and the company is examined. And as per the “instrumentality theory”, the use of the company by the shareholders for their benefit is analyzed.
Thus, we can deduce from the above analysis that a Company is a separate legal entity as explained in the Solomon v. A. Solomon & Co Ltd., and the lifting of the veil is an exception.
Development of the “Lifting of Corporate Veil” principle
The case of United States v. Milwaukee Refrigerator Transit Company, is one of the earliest instances where Supreme Court departed from the Solomon case and observed that “where the company is used to defeat the public convenience, contrary to the morals and law, justify wrong, do fraudulent activities, then the corporate personality of the company will be ignored and it will considered just as an association of persons.”
Grounds where the veil is lifted
Some of the grounds for lifting the corporate veil are as follows-
- When the company is a sham- In the case of Gilford Motor Company v. Horne, it was held that the company was incorporated to evade Mr. Horne’s contractual obligations. The company was used to conceal his fraudulent acts and thereby the veil was lifted and injunction was granted against Horne (Former Managing Director).
- Principle of agency- In the case of RG Films Ltd, An American Company financed for the production of a film in India but was refused permission by the board for its distribution in the name of a British company as it was just an agency and had nothing to do with the film. Here the veil was lifted and the decision of the board was upheld.
- Public Policy- When the Company is formed to do acts which is against the public policy the veil can be lifted. (Connors Bros v. Connors).
- Enemy Character- In Daimler Co. LTD. v. Continental Tyre and Rubber Co. (Great Britain) Ltd., the issue was whether the Company incorporated was a German Company or British Company, i.e., to determine its enemy character. The court lifted the veil and found out that, the company was in fact a German Company, thereby an enemy.
- Tax evasion- CIT v. Meenakshi Mills Ltd. is a case wherein it was held that the Income Tax Authorities have the right to lift the veil, if the company was merely formed for the purposes of evading tax.
Statutory provisions under Companies Act, 2013
- Section 5- This section categorizes the officials liable for punishment or penalty under the head ‘official who is in default’.
- Section 45- This section says that, if the number of members required to carry on the business is less than what is required by law, i.e., less than 7 in case of public and 2 in case of private organization, then each existing member aware of the fact will be liable.
- Section 147- As per this section, clause 4, the member of the company who is executing any promissory notes, hundi or bills of exchange without mentioning the organization’s name in it, can be held liable on a personal level to the holder.
- Section 239- According to this section the inspector empowered to examine the wrong- doings of a particular organization has the power to examine other companies of similar nature.
- Section 275- It says that no person can be director for more than 15 companies at a single time, and penalty can be imposed as per section 279.
- Section 299- It stipulates the need for every public or private organization’s director to serve the notice of his interest at a gathering. Inability to act in accordance to this section can terminate the director from his position.
- Section 307 and 308- It says that, a registry should be maintained not only consisting the names of the directors, but also their shares, description of shareholding , nature and extent of the right to shareholder over the debentures or shares.
- Section 542- If it is found out that, over the span of winding up of the company, it moves with the direction of defrauding the creditors, and the members were aware of it, they will be personally liable.
In the case of Chiranjitlal Chaudhary v. Union of India, the Supreme Court held that the fundamental rights are not only guaranteed to the individual citizens but also to the corporate bodies. The rule laid down in Solomon case is an accepted principle but lifting of the corporate veil is an exception as stated earlier. It is necessary to protect the company from its members who engage in fraudulent or illegal activities. As the basic feature of the Company is the members may come and go but the Company continues. Thereby, it is necessary to lift the veil and impose liability on those who are actually liable. No one should be excused in the name of the Company.