“LIFTING OF THE CORPORATE VEIL”

From the juristic point of view, a company is a legal person distinct from its
members [Salomon v. Salomon and Co. Ltd. (1897) A.C 22]. This principle may
be referred to as the ‘Veil of incorporation’. The courts in general consider
themselves bound by this principle. The effect of this Principle is that there is a
fictional veil between the company and its members. That is, the company has a
corporate personality which is distinct from its members. But, in a number of
circumstances, the Court will pierce the corporate veil or will ignore the corporate
veil to reach the person behind the veil or to reveal the true form and character of
the concerned company. The rationale behind this is probably that the law will not
allow the corporate form to be misused or abused. In those circumstances in which
the Court feels that the corporate form is being misused it will rip through the
corporate veil and expose its true character and nature disregarding the Salomon
principal as laid down by the House of Lords. Broadly there are two types of
provisions for the lifting of the Corporate Veil-

 Judicial Provisions and

 Statutory Provisions.

Judicial Provisions include Fraud, Character of Company, Protection of revenue,

Single Economic Entity etc. while Statutory Provisions include Reduction in
membership, Misdescription of name, fraudulent conduct of business, Failure to
refund application money, etc. This article at first introduces to the readers the
concept of “Veil of incorporation”, then it explains the meaning of the
term-‘Lifting of the Corporate Veil’, it then points out the Judicial as well as the
statutory provisions for Lifting of The Corporate Veil with the help of various
case-laws.

Introduction-

Incorporation of a company by registration was introduced in 1844 and the

doctrine of limited liability of a company followed in 1855. Subsequently in 1897
in Salomon v. Salomon & Company, the House of Lords effected these enactments
and cemented into English law the twin concepts of corporate entity and limited
liability. In that case the apex Court laid down the principle that a company is a
distinct legal person entirely different from the members of that company. This
principle is referred to as the ‘veil of incorporation’.
The chief advantage of incorporation from which all others follow is the separate
entity of the company. In reality, however, the business of the legal person is
always carried on by, and for the benefit of, some individuals. In the ultimate
analysis, some human beings are the real beneficiaries of the corporate advantages,
“for while, by fiction of law, a corporation is a distinct entity, yet in reality it is an
association of persons who are in fact the beneficial owners of all the corporate
property.”  And what the Salomon case decides is that ‘in questions of property
and capacity, of acts done and rights acquired or, liabilities assumed thereby…the
personalities of the natural persons who are the companies corporators is to be
ignored”. 

This theory of corporate entity is indeed the basic principle on which the whole
law of corporations is based. Instances are not few in which the Courts have
successfully resisted the temptation to break through the corporate veil.

But the theory cannot be pushed to unnatural limits. “There are situations where
the Court will lift the veil of incorporation in order to examine the ‘realities’ which
lay behind. Sometimes this is expressly authorized by statute…and sometimes the
Court will lift its own volition”. 

Meaning Of Lifting Or Piercing Of The Corporate Veil-

The human ingenuity however started using the veil of corporate personality
blatantly as a cloak for fraud or improper conduct. Thus it became necessary for
the Courts to break through or lift the corporate veil and look at the persons behind
the company who are the real beneficiaries of the corporate fiction.Lifting of the
corporate veil means disregarding the corporate personality and looking behind the
real person who are in the control of the company. In other words, where a
fraudulent and dishonest use is made of the legal entity, the individuals concerned
will not be allowed to take shelter behind the corporate personality. In this regards
the court will break through the corporate shell and apply the principle of what is
known as “lifting or piercing through the corporate veil.” And while by fiction of
law a corporation is a distinct entity, yet in reality it is an association of persons
who are in fact the beneficial owners of all the corporate property

Judicial Provisions Or Grounds For Lifting The Veil-

 FRAUD OR IMPROPER CONDUCT- The Courts have been more that
prepared to pierce the corporate veil when it fells that fraud is or could be
perpetrated behind the veil. The Courts will not allow the Salomon principal
 to be used as an engine of fraud. The two classic cases of the fraud exception
are Gilford Motor Company Ltd v. Horne and Jones v. Lipman . In the first
case, Mr. Horne was an ex-employee of The Gilford motor company and his
employment contract provided that he could not solicit the customers of the
company. In order to defeat this, he incorporated a limited company in his
wife's name and solicited the customers of the company. The company
brought an action against him. The Court of appeal was of the view that "the
company was formed as a device, a stratagem, in order to mask the effective
carrying on of business of Mr. Horne" in this case it was clear that the main
purpose of incorporating the new company was to perpetrate fraud. Thus the
Court of appeal regarded it as a mere sham to cloak his wrongdoings.

In the second case of Jones v. Lipman, a man contracted to sell his land and
thereafter changed his mind in order to avoid an order of specific performance he
transferred his property to a company. Russel judge specifically referred to the
judgments in Gilford v. Horne and held that the company here was "a mask which
(Mr. Lipman) holds before his face in an attempt to avoid recognition by the eye of
equity" .Therefore he awarded specific performance both against Mr.Lipman and
the company.

 FOR BENEFIT OF REVENUE-“The Court has the power to disregard

corporate entity if it is used for tax evasion or to circumvent tax obligations .
A clear illustration is Dinshaw Maneckjee Petit, Re 

The assesse was a wealthy man enjoying huge dividend and interest income. He
formed four private companies and agreed with each to hold a block of investment
as an agent for it. Income received was credited in the accounts of the company but
the company handed back the amount to him as a pretended loan. This way he
divided his income into four parts in a bid to reduce his tax liability.

But it was held that, “the company was formed by the assessee purely and simply
as a means of avoiding super tax and the company was nothing more than the
assessee himself. It did no business, but was created simply as a legal entity to
ostensibly receive the dividends and interests and to hand them over to the assessee
as pretended loans”.

 ENEMY CHARACTER-A company may assume an enemy character

when persons in de facto control of its affairs are residents in an enemy
country. In such a case, the Court may examine the character of persons in
real control of the company, and declare the company to be an enemy
 company. In Daimler Co.Ltd V. Continental Tyre And Rubber Co.Ltd , A
company was incorporated in England for the purpose of selling in England,
tyres made in Germany by a German company which held the bulk of shares
in the English company. The holders of the remaining shares, except one,
and all the directors were Germans, residing in Germany. During the First
World War, the English company commenced action for recovery of a trade
debt. Held, the company was an alien company and the payment of debt to it
would amount to trading with the enemy, and therefore, the company was
not allowed to proceed with the action.
 WHERE THE COMPANY IS A SHAM- The Courts also lift the veil
where a company is a mere cloak or sham (hoax) .
 COMPANY AVOIDING LEGAL OBLIGATIONS- Where the use of an
incorporated company is being made to avoid legal obligations, the Court
may disregard the legal personality of the company and proceed on the
assumption as if no company existed.
 SINGLE ECONOMIC ENTITY- Sometimes in the case of group of
enterprises the Salomon principal may not be adhered to and the Court may
lift the veil in order to look at the economic realities of the group itself. In
the case of D.H.N.food products Ltd. V. Tower Hamlets  , it has been said
that the Courts may disregard Salomon's case whenever it is just and
equitable to do so. In the above-mentioned case the Court of appeal thought
that the present case was one which was suitable for lifting the corporate
veil. Here the three subsidiary companies were treated as a part of the same
 AGENCY OR TRUST- Where a company is acting as agent for its
shareholder, the shareholders will be liable for the acts of the company. It is
a question of fact in each case whether the company is acting as an agent for
its shareholders. There may be an Express agreement to this effect or an
agreement may be implied from the circumstances of each particular case. In
the case of F.G.Films ltd , An American company financed the production of
a film in India in the name of a British company. The president of the
American company held 90 per cent of the capital of the British company.
The Board of trade of Great Britain refused to register the film as a British
film. Held, the decision was valid in view of the fact that British company
acted merely as he nominee of the American Company.
 AVOIDANCE OF WELFARE LEGISLATION- Avoidance of welfare
legislation is as common as avoidance of taxation and the approach of the
Courts in considering problems arising out of such avoidance is generally
the same as avoidance of taxation. It is the duty of the Courts in every case
 where ingenuity is expended to avoid welfare legislation to get behind the
smokescreen and discover the true state of affairs .
 PUBLIC INTEREST- The Courts may lift the veil to protect public policy
and prevent transactions contrary to public policy. The Courts will rely on
this ground when lifting the veil is the most ‘just’ result, but there are no
specific grounds for lifting the veil. Thus, where there is a conflict with
public policy, the Courts ignore the form and take into account the
substance.

Statutory Provisions For Lifting The Veil-

REDUCTION OF NUMBER OF MEMBERS- Under Section 45 of The Indian
Companies Act, 1956, if a company carries on business for more than six months
after the number of its members has been reduced to seven in case of a public
company and two in case of a private company, every person who knows this fact
and is a member during the time that the company so carries on business after the
six months, becomes liable jointly and severally with the company for the payment
of debts contracted after six months. It is only that member who remains after six
months who can be sued.

FRAUDULENT TRADING- Under Section 542 of The Indian Companies Act,

1956, if any business of a company is carried on with the intent to defraud
creditors of the company or creditors of any other person or for any fraudulent
purpose, who was knowingly a party to the carrying on of the business in that
manner is liable to imprisonment or fine or both. This applies whether or not the
company has been or is in the course of being wound up. This was upheld in Delhi
Development Authority v. Skipper Constructions Co. Ltd. (1997). 

MISDESCRIPTION OF THE COMPANY- Section 147 (4) of The Indian

Companies Act, 1956, provides that if any officer of the company or other person
acting on its behalf

signs or authorizes to be signed on behalf of the company any bill of exchange,

promissory note, endorsement, cheque or order for money or goods in which the
companies name is not mentioned in legible letters, he is liable to fine and he is
personally liable to the holder of the instrument unless the company has already
paid the amount .

PREMATURE TRADING- Another example of personal liability is mentioned in

Section 117 (8) of The English Companies Act. Under this section a public limited
company newly incorporated as such must not "do business or exercise any
borrowing power" until it has obtained from the registrar of companies a certificate
that has complied with the provisions of the act relating to the raising of the
prescribed share capital or until it has re-registered as a private company. If it
enters into any transaction contrary to this provision not only are the company and
it's officers in default , liable to pay fines but if the company fails to comply with
its obligations in that connection within 21 days of being called upon to do so, the
directors of the company are jointly and severally liable to indemnify the other
party in respect of any loss or damage suffered by reason of the company's failure.

FAILURE TO REFUND APPLICATION MONEY-According to Section 69(5)

of The Indian Companies Act, 1956, the directors of a company are jointly and
severally liable to repay the application money with interest if the company fails to
refund the money within 130 days of the date of issue of prospectus.

HOLDING AND SUBSIDIARY COMPANIES- In the eyes of law, the holding

company and its subsidiaries are separate legal entities. 

But in the following two cases the subsidiary may lose its separate entity-

Where at the end of its financial year, the company has subsidiaries, it must lay
before its members in general meeting not only its own accounts, but also attach
therewith annual accounts of each of its subsidiaries along with copy of the board’s
and auditor’s report and a statement of the holding company’s interest in the
subsidiary. 

Conclusion-
Thus it is abundantly clear that incorporation does not cut off personal liability at
all times and in all circumstances.  “Honest enterprise, by means of companies is
allowed; but the public are protected against kitting and humbuggery”.  The
sanctity of a separate entity is upheld only in so far as the entity is consonant with
the underlying policies which give it life. 

Thus those who enjoy the benefits of the machinery of incorporation have to assure
a capital structure adequate to the size of the enterprise. They must not withdraw
the corporate assets or mingle their own individual accounts with those of the
corporation. The Courts have at times seized upon these facts as evidence to justify
the imposition of liability upon the shareholders.
The act of piercing the corporate veil until now remains one of the most
controversial subjects in corporate law. There are categories such as fraud, agency,
sham or facade, unfairness and group enterprises, which are believed to be the
most peculiar basis under which the Law Courts would pierce the corporate veil.
But these categories are just guidelines and by no means far from being exhaustive.