PIERCING THE CORPORATE FAÇADE— A JURISPRUDENTIAL EXPLORATION OF VEIL LIFTING

 

 

AUTHOR - HIR PATEL

Unitedworld School of Law, Karnavati University

 

 

 

ABSTRACT:

This research paper explores the doctrine of piercing the corporate veil, a lawful principle where courts disregard the legal distinction between a corporation and its shareholders or directors, holding them personally responsible for the company's actions. The paper examines the conditions under which courts lift the corporate veil, analyzing laws, judicial interpretations, and case precedents from countries like the United States, the United Kingdom, and India.

 

Beginning with an introduction, the paper sets the stage by highlighting the  paradox of the doctrine and its exceptions to the principle of corporate personality, as established in the landmark case of Solomon v. Solomon. It outlines the scope and limitations of the study, focusing on the legal doctrines, case studies, and comparative analysis across jurisdictions.

 

The paper then delves into the doctrine of lifting the corporate veil, explaining the concept and its importance in corporate law. It discusses the primary advantages of incorporation, such as limited liability, while also recognizing the potential for misuse of the corporate structure. It presents Frederick J. Powell's classic test for piercing the corporate veil, which involves a unity of interest, wrongful actions, and unjust costs to creditors.

 

Next, the paper explores the statutory provisions governing the lifting of the corporate veil under the Companies Act, 2013, in India. It discusses specific sections that hold directors or members personally liable for certain actions, such as misrepresentation in prospectuses, failure to return application money, and fraudulent conduct during winding-up proceedings.

 

Moving on, the paper analyses judicial standards for disregarding the corporate veil through case law examples. It covers instances where courts have lifted the veil to prevent fraud, protect revenue, determine technical competence, and punish contempt of court. The paper concludes by summarizing the objectives of lifting the corporate veil and the importance of this doctrine in ensuring transparency, accountability, and justice in corporate governance.

 

KEYWORDS: Piercing of corporate veil, Objectives, Meaning, Statutory Provisions, Judicial Standards, Separate Entity, Limited Liability.

 

INTRODUCTION

In the realm of company law, the doctrine of piercing the corporate veil emerges as a fascinating paradox and stands as an exception to the entrenched principle of corporate personality. This jurisprudential exploration delves into the circumstances under which courts can disregard the corporate entity and hold the individuals behind it accountable for the entity's obligations. The concept of a corporation as a separate legal entity, enshrined in the landmark case of Salomon v. Salomon, has been the bedrock of corporate jurisprudence. However, this principle is not absolute. The veil that shields the members and directors of a corporation from liability can be lifted, revealing the faces of those who operate the corporate machinery. This research paper aims to dissect the legal anatomy of veil lifting, scrutinizing the statutory provisions and judicial interpretations that have shaped this doctrine. It will examine the various grounds such as fraud, sham, agency, and public interest on which courts have justified piercing the corporate veil. The paper will also explore the jurisprudential underpinnings of this doctrine, analyzing how it balances the competing interests of corporate autonomy against the need for accountability and justice. Ultimately, this paper seeks to offer a nuanced view of the doctrine of piercing the corporate veil.

 

SCOPE: The paper will centre on exploring the legal doctrines surrounding piercing the corporate veil across different jurisdictions such as the United States, the United Kingdom, and India. It will delve into statutory laws, precedents, and regulatory frameworks that delineate the parameters of this doctrine. Through a comparative lens, it aims to uncover both commonalities and disparities in the application of piercing the corporate veil across these regions. Furthermore, it will incorporate case studies of notable court decisions where this doctrine has been invoked, offering tangible illustrations of its practical application and implications.

 

LIMITATION: The paper will address various jurisdictions but acknowledges the impossibility of encompassing all global perspectives in corporate law. It will be bounded temporally, focusing on developments up to a certain point and excluding the latest legal changes or cases beyond a specified period. While corporate governance is a vast field, the paper will maintain a narrow focus solely on piercing the corporate veil, omitting broader discussions. Given the nature of the topic, the paper will lean towards qualitative analysis over quantitative empirical data in its examination.

 

RESEARCH QUESTIONS

1. Under what legal and philosophical justifications can the corporate veil be pierced in different jurisdictions?
2. How do competing jurisprudential theories influence the application of veil piercing doctrines?
3. To what extent does veil piercing promote fairness and accountability in corporate structures?
4. Are there potential limitations or unintended consequences associated with veil piercing doctrines?

 

RESEARCH OBJECTIVES

• To critically examine the theoretical underpinnings of veil piercing doctrines across various legal systems.
• To analyse the impact of different jurisprudential perspectives on the judicial application of veil piercing principles.
• To assess the effectiveness of veil piercing in achieving fairness and accountability within corporate structures.
• To identify potential limitations and unintended consequences associated with veil piercing.

 

RESEARCH METHODOLOGY

1. Conduct a comprehensive review of relevant legal literature, including scholarly articles, case law, and legal treatises, focusing on veil piercing principles and jurisprudence.
2. Analyze landmark court decisions on veil piercing from various jurisdictions to understand the development and application of the doctrine.
3. Employ comparative legal analysis to compare and contrast veil piercing doctrines across different legal systems.
4. Consider theoretical perspectives from legal philosophy and jurisprudence to critically examine the justifications for and against veil piercing.

 

THE DOCTRINE OF LIFTING OF CORPORATE VEIL

Piercing the corporate veil is one of the most commonly applied doctrines in corporate law to determine when shareholders may be held accountable for the corporation's obligations. It remains highly contested and frequently debated, making it one of the most litigated and discussed aspects of corporate law.

 

The term “corporate veil” symbolizes the concept of limited liability in a company, wherein, under normal circumstances, shareholders are protected from being personally liable for the debts and obligations of the company. As long as the company follows legal formalities, has sufficient initial financing, and isn't established to defraud creditors or other parties, the corporate structure is respected, and shareholders' liability is limited to their investment in the company. However, when courts lift or pierce the corporate veil, they disregard this separation and hold shareholders accountable for the company's actions as if they were personally responsible.

 

The main benefit of incorporation is establishing a distinct legal entity for the company. However, in practice, the activities of this artificial entity are carried out by and for the advantage of individuals. Ultimately, real people are the beneficiaries of corporate advantages, as stated in Gallaghar v. Germania Brewing Company[1]. Sometimes, this corporate entity is misused for fraud or illegal acts. Since a corporation cannot commit illegal or fraudulent acts itself, the concept of “lifting the corporate veil” is used to expose the individuals behind such acts.

 

Frederick J. Powell proposed the classic test for piercing the corporate veil, which suggests that courts should disregard the corporate entity and impose personal liability under certain conditions: Firstly, there should be a shared interest between the corporation and its owners. Secondly, the corporation's actions must be wrongful or fraudulent. Lastly, the creditors of the corporation must endure an unfair burden that warrants overlooking its corporate structure.

 

Courts generally uphold the principle of the separate legal entity, as established in Solomon’s case[2] and others, but may intervene in certain cases for the interest of the members or the public. In Cotton Corporation of India Ltd. v. G.C. Odusumathd[3], the Karnataka High Court stated that the corporate veil can only be lifted if there are clear statutory provisions or compelling reasons, such as preventing fraud or dealing with enemy companies.

 

The Apex Court's observations in Life Insurance Corporation of India v. Escorts Ltd.[4] highlight the situations where the corporate veil may be lifted, such as when fraud is intended to be prevented, when evading taxes or beneficial statutes, or when associated companies are closely connected.

 

In State of U.P. v. Renusagar Power Co.[5], the SC emphasized that the notion of lifting the corporate veil is evolving. It stated that the veil of corporate personality is becoming more transparent in modern jurisprudence, and the decision to lift it depends on the realities of the situation.

 

This concept of lifting the corporate veil helps to uncover the true economic realities behind the legal framework and prevents the misuse of corporate structure by individual members driven by personal economic interests.

 

The situations in which courts may lift the corporate veil can generally be categorized into two main groups:

1. When statutory provisions explicitly allow for it.
2. When courts interpret the law to justify piercing the corporate veil.

The objectives of lifting the corporate veil serve to uphold the integrity of corporate law and ensure justice in various scenarios. These objectives include:

1. Preventing Fraud and Wrongdoing: Lifting the corporate veil allows courts to identify individuals or groups misusing the corporate structure for fraudulent purposes, ensuring accountability and deterrence.
2. Protecting Creditors: When a company hides behind its corporate status to evade debts or obligations, lifting the corporate veil enables creditors to seek redress from the responsible parties, ensuring fair treatment and preventing unjust enrichment.
3. Ensuring Corporate Governance: Lifting the corporate veil helps maintain good corporate governance. It holds directors, officers, or shareholders accountable for their actions, ensuring they act in the best interests of the company and its stakeholders.
4. Promoting Transparency and Accountability: By revealing the true beneficiaries or controllers behind a corporate entity, lifting the corporate veil promotes transparency and accountability. This transparency is crucial for stakeholders, regulators, and the public to understand who is ultimately responsible for corporate decisions and actions.
5. Preventing Abuse of Legal Personality: Lifting the corporate veil prevents the abuse of the legal personality of the company. It ensures that the separate legal entity of the corporation is not exploited to shield individuals from liability for their actions or to perpetrate injustice.
6. Enforcing Legal Obligations: Lifting the corporate veil helps enforce legal obligations. It allows courts to hold individuals accountable for complying with laws and regulations, even if they attempt to hide behind the corporate structure.

 

PIERCING THE CORPORATE SHIELD THROUGH STATUTORY PROVISIONS

The concept of the separate legal entity and limited liability of a corporation may be disregarded or overridden in specific circumstances outlined in the law. The Companies Act, 2013 includes provisions where directors or members of a company can be held personally liable. In such cases, although the company's distinct legal status is maintained, the directors or members are held accountable individually alongside the company. These cases include:

 

1. SECTION 12 :– Mis-description of Name

According to Section 12, a company must ensure that its name is printed on documents such as hundies, promissory notes, bills of exchange, and other prescribed documents. If an officer of the company signs any contract or financial instrument on behalf of the company without correctly stating or excluding the company's name, that individual becomes personally liable to the holder. For instance, in the case of Hendon v. Adelman[6], where a cheque stated the company's name as ‘LR agencies limited’ instead of the correct name ‘L&R Agencies Ltd.’, the signing directors were held personally liable. Moreover, the company and the defaulting officer are subject to a penalty of one thousand rupees per day or one lakh rupees, whichever is less.

 

1. SECTION 34 & 35 :– Mis-Statements in Prospectus

In cases of misrepresentation in a prospectus, the company and all those involved in authorizing it are liable to compensate for any resulting loss or damage suffered by shareholders. They may face imprisonment for six months to ten years, along with fines ranging from the amount involved in the fraud to three times that amount. However, individuals can avoid conviction by proving that the statement was immaterial or that they genuinely believed it was true or necessary at the time of issuing the prospectus.

1. SECTION 39 :– Failure to Return Application Money

When a company issues shares to the public and fails to receive the minimum subscription stated in the prospectus within 30 days, or within a period specified by SEBI, the application money must be repaid within fifteen days from the close of the issue, as per Rule 11 of the Companies (Prospectus and Allotment of Securities) Rules, 2014. If the money is not repaid within this timeframe, the directors of the company accountable for the default are collectively and individually responsible for repaying the money with interest at a rate of fifteen percent per annum. In the event of such a default, both the company and the responsible officer are liable to a penalty of one thousand rupees per day or one lakh rupees, whichever is lower.

 

1. SECTION 76 A :– Punishment for Contravening Section 73 or 76

If a company violates rules regarding deposits under sections 73 or 76, it can face fines ranging from one crore to ten crore rupees. Officers responsible for the default may be imprisoned for up to seven years or fined between twenty-five lakh to two crore rupees, or both. If an officer knowingly breaches these rules to deceive the company, shareholders, depositors, creditors, or tax authorities, they may also face action under section 447.

 

1. SECTION 216 :– For Investigating Ownership of Company

Section 216 grants the Central Government the power to designate one or more inspectors to investigate and report on the membership of any company. This investigation aims to identify the real individuals who are financially involved in the company and control its policies or significantly influence them.

 

1. SECTION 219 :– Facilitating the task of Inspector appointed u/s 210, 212 or 213 for Investigation of Company Affairs

Section 219 specifies that if an inspector appointed under sections 210, 212, or 213 finds it necessary during an investigation into a company’s affairs to also investigate:

1. Any other corporate body that is or has been a subsidiary or holding company of the company, or a subsidiary of its holding company;
2. Any other corporate body managed by a person who is or was the company’s managing director or manager;
3. Any other corporate body whose board comprises nominees of the company or acts according to the company's directions;
4. Any person who is or has been the company’s managing director, manager, or employee,

The inspector may investigate and report on these entities or individuals, subject to the prior approval of the Central Government, if he deems their affairs relevant to the investigation of the company for which he was appointed.

 

1. SECTION 339 :– For Fraudulent Conduct

During the winding-up of a company, if it is discovered that any business of the company was carried out with the intention to defraud creditors or for any fraudulent purpose, individuals knowingly involved in such conduct may, at the Tribunal's discretion, be held personally liable without limitation for all or any debts or liabilities of the company. Liability under this section can only be imposed if it is proven that the company's business was conducted with the intent to defraud creditors[7].

 

1. Obligation for Ultra Vires Act:–

Directors and other officers of a company may face personal liability for actions carried out on behalf of the company if those actions surpass the company's legal authority. For example, in a case where directors of a railway company, having used up their borrowing powers, sought loans secured by debentures through an advertisement, and ‘W’ lent £500 based on this advertisement, receiving a debenture, the court ruled that the debenture was invalid. However, ‘W’ could sue the directors for breaching their warranty of authority, as they had advertised that they had borrowing power which they did not actually possess[8].

 

1. Liability under Other Statutes:–

Besides the Companies Act, directors and officers of a company may incur personal liability under other statutes. For example, under the Income-tax Act, if a private company is wound up and its tax arrears from any previous year cannot be recovered, every person who was a director during that year is jointly and severally liable for the payment of tax. Similarly, under the Foreign Exchange Management Act, 1999, directors and officers can be held individually or jointly responsible for breaches of the Act.

 

 

JUDICIAL STANDARDS FOR DISREGARDING THE CORPORATE VEIL

It's difficult to address every situation in which courts have lifted or could lift the corporate veil. However, examining some cases where the veil of incorporation was lifted through judicial decisions can provide insight into the circumstances under which the corporate structure is disregarded or the individuals behind the corporate entity are revealed and, if necessary, held accountable.

 

1. Protection of revenue

In the case of Sir Dinshaw Maneckjee Petit, Re[9], the assesse, a millionaire, earned substantial income through dividends and interest. He set up four private companies and transferred his investments to each of them in exchange for their shares. The companies then returned the dividends and interest income to Sir Dinshaw as if they were loans. The court found that these companies were formed solely to avoid taxes, and they essentially acted as conduits for transferring income back to Sir Dinshaw. These companies did not engage in any business activities; they were merely legal entities used to receive income and transfer it back to the assesse.

 

1. Prevention of improper conduct and fraud

When a company is used for fraudulent or improper activities, courts have disregarded its corporate status to investigate the actual circumstances. In Gilford Motor Company v. Horne[10], Horne was employed by the company with an agreement not to solicit its customers or engage in competition upon departure. After leaving, Horne formed a company with his wife and an employee as directors, which competed with the plaintiff. It was found that Horne controlled the company, and its formation was merely a disguise to breach his agreement. Therefore, an injunction was issued against him and his company, preventing them from soliciting the plaintiff’s clienteles.

 

1. Determination of the enemy character of the company

In the case of Merchandise Transport Limited v. British Transport Commission[11], a transport company needed licenses for its vehicles, but it was unable to obtain them if it applied in its own name. So, it created a subsidiary company and applied for licenses in the subsidiary's name. The plan was to transfer the vehicles to the subsidiary. The court ruled that the parent and subsidiary were essentially one commercial entity, and therefore the license application was rejected.

1. Forming subsidiaries acting as agent

In Merchandise Transport Limited v. British Transport Commission[12], a transport company sought licenses for its vehicles but couldn't do so in its own name. Thus, it created a subsidiary, through which it applied for the licenses. The court ruled that the parent and subsidiary were effectively one entity, and therefore rejected the license application.

 

1. Company acting as an agent for its shareholder

In Smith, Stone and Knight v. Birmingham Corp.[13], it was established that merely owning all shares in a company doesn't automatically make the company's business the shareholder's business or the company their agent. However, if there's an arrangement making the company the shareholders' agent for conducting the business, the shareholders can be held liable.

 

1. In cases of economic offences

In Santanu Ray v. Union of India[14], it was determined that in cases of economic offenses, courts can lift the corporate veil and examine the economic realities behind the legal structure. The case involved an alleged breach of section 11(a) of the Central Excises and Salt Act, 1944, where the court permitted adjudicating authorities to lift the corporate veil to identify which directors were engaged in evading excise duty through fraud, concealment, or violation of the law.

 

1. Company is used to avoid welfare legislation

The Supreme Court upheld the lifting of the corporate veil in case of Workmen of Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd.[15], when it was discovered that the sole intention behind forming a new company was to use it as a method to decrease the amount to be paid as bonuses to workers.

 

1. Company is used for improper or illegal causes

Courts have been willing to lift the corporate veil when incorporation is used for illegal purposes. In PNB Finance Limited v. Shital Prasad Jain[16], ‘S’, a financial advisor, obtained a loan from a public limited company under false pretences and diverted it to other companies for property purchase. The court restrained ‘S’, his son, and the companies from disposing of the properties purchased with the loan.

 

1. Punish for contempt of Court

In Jyoti Limited v. Kanwaljit Kaur Bhasin[17], a firm’s partners agreed to sell property but later cancelled the agreement due to litigation. Despite a court order restraining the firm from selling, the partners formed a private company, became its sole shareholders and directors, and transferred the property to it. The company then sold the property, leading to contempt proceedings. The court held that the partners, as the sole controllers of the company, were in fact disobeying the court order by selling the property through the company.

 

1. Determine technical competence of the company

In the case of New Horizons Ltd. v. Union of India[18], the Supreme Court ruled that the corporate veil should be lifted to consider the experience of the constituents of a joint venture company when assessing eligibility for a contract. Despite NHL lacking direct experience, the Court found that the combined experience of its joint venture partners should be taken into account. The Tender Evaluation Committee's refusal to consider NHL's tender and acceptance of another's was deemed arbitrary and irrational by the Court.

 

1. Company is a mere sham or cloak

In Delhi Development Authority v. Skipper Construction Company (P.) Ltd.[19], the Supreme Court stated that if it is found that a director and their family have established multiple corporate entities, the court may still consider them as a single entity controlled by the director and their family if these corporate bodies are found to be mere facades used to commit illegal acts or defraud people.

 

1. Fraudulent Scheme of arrangement or compromise

The corporate veil can be lifted when examining a structure of arrangement or compromise under section 391 of the Act if the Court determines that the proposed scheme is fraudulent and serves a different purpose than what is claimed[20].

 

 

1. Conversion of sole proprietorship into company

In Prem Lata Bhatia v. Union of India[21], if an individual leases premises and converts their sole proprietorship into a private limited company where they hold a controlling interest, they cannot be evicted from the premises on the grounds that they have transferred possession to someone else. This is because the same individual remains in possession, even though the business is now technically run by the company.

 

CONCLUSION

In conclusion, the doctrine of piercing the corporate veil represents a significant departure from the fundamental principle of corporate personality, allowing courts to hold individuals accountable for the actions of a corporation. Through an exploration of statutory provisions and judicial interpretations across different jurisdictions, including the United States, the United Kingdom, and India, this research paper has shed light on the situations under which the corporate veil may be elevated. The analysis has revealed a myriad of grounds on which courts justify piercing the corporate veil, ranging from preventing fraud and improper conduct to protecting the interests of stakeholders and upholding public policy.

 

The paper has highlighted that while the concept of a separate legal entity is vital for promoting business and economic activities, it should not be abused or exploited for wrongful purposes. Instances where companies are used as mere facades to commit fraud, evade legal obligations, or circumvent regulatory requirements underscore the necessity of piercing the corporate veil to reveal the true beneficiaries and hold them accountable. Moreover, the exploration of statutory provisions has demonstrated that lawmakers recognize the need to balance the benefits of corporate autonomy with the imperative of accountability.

 

Through detailed case studies and comparative analysis, this paper has underscored the importance of judicial scrutiny in ensuring the integrity of corporate structures and maintaining public trust. The doctrine of piercing the corporate veil serves as a powerful tool for promoting transparency, preventing abuse, and enforcing legal obligations. However, its application requires careful consideration of the facts and circumstances of each case to avoid unintended consequences or unjust outcomes.

 

In essence, the doctrine of piercing the corporate veil represents a crucial mechanism for maintaining the balance between corporate autonomy and accountability, thereby contributing to the fairness and efficiency of the corporate legal framework. As business practices continue to evolve, it is imperative for courts and lawmakers to adapt and refine this doctrine to meet the evolving needs of society and the economy.

 

BIBLIOGRAPHY

STATTUTE:

The Companies Act, 2013

BOOKS:

1. Dr G.K. Kapoor, Company Law and Practice, Taxmann 2019 (24th Edition)
2. Avtar Singh, Company Law, Eastern Book Company 2022 (17th Edition)

ONLINE SOURCES:

1. https://cbcl.nliu.ac.in/company-law/lifting-or-piercing-the-corporate-veil-clarifying-the-two-step-examination/
2. https://lawbhoomi.com/lifting-of-corporate-veil-of-the-companies-in-india/#What_is_corporate_veil
3. AN ANALYSIS ON THE DOCTRINE OF LIFTING OF CORPORATE VEIL (ijirl.com)
4. JETIR2206724.pdf
5. https://ssrn.com/abstract=1725433
6. https://ssrn.com/abstract=2951569
7. https://www.nascollege.org/e%20cotent%2010-4-20/dr%20ashok%20kumar/LIFTING%20OF%20CORPORATE%20VEIL-LL%20B%20IV%2026-4-1.pdf

 

 

 

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[1] [1893] 53 MINN. 214.

[2] Solomon v. Solomon & Co. Ltd. [1897] AC 22.

[3] [1999] 22 SCL 228 (Kar.).

[4] [1986] 59 Comp. Cas. 548.

[5] [1991] 70 Comp. Cas. 127.

[6] (1973) New Delhi LR 637.

[7] Re Augustus Barnett & Sons Ltd., [1986] B CLC 170 Ch. D.

[8] Weeks v. Propert, [1873] L. R. 8 C.P. 427.

[9] AIR 1927 Bom. 371.

[10] [1933] 1 CH 935.

[11] [1982] 2 QB 173.

[12] [1982] 2 QB 173.

[13] [1939] 4 All ER 116 (KB).

[14] [1989] 65 Comp. Cas. 196 (Delhi).

[15]  [1986] 59 Comp. Cas. 134.

[16] [1983] 54 Comp. Cas. 66 (Delhi).

[17] [1987] 62 Comp. Cas. 626 (Delhi).

[18] [1995] 1 Comp. LJ 100 (SC); [1997] 27 CLA 56 (SC).

[19] [1996] 4 SCALE 202.

[20] In Re, Bedrock Ltd., [1998] 17 SCL 385 (Bom.).

[21] [2006] 71 SCL 142 (Delhi).