LIFTING THE CORPORATE VEIL

INTRODUCTION
The general rule is that a company is a legal person and is distinct from its members. The principle is regarded as a curtain, a veil, or a shield between the company and its members, thus protecting the latter from the liability of the former. The veil is impassable as an iron curtain. But when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud or defend crime the law will regard the company as an association of persons. In these cases the law disregards the corporate entity and pays regards to the economic realities behind the legal faade. The court may look behind the artificial person- the company and take account of the personalities of natural persons- the cooperators. A company is in law regarded as an entity separate from its members. In other works, it has an independent corporate existence. Any of its members can enter into contracts with it in the same manner as any other individual can. A member cannot be held liable for the acts of the company even if he holds virtually the entire share capital. The leading case in which the legal personality of a company was respected is as follows: Solomon v. Salomon & Co. Ltd., (1897) Salomon sold his shoe making business to a new company for 30,000. His six family members were given one share of 1 each. He got himself allotted shares and debentures in the new company as part of purchase consideration. Subsequently when the company was wound up, its assets were found to be worth 6,000 and its liabilities amounted to 17,000 of which 10,000 were due to Salomon and 7,000 were due to unsecured creditors. The unsecured creditors claimed that Salomon and the company were one and the same person and, therefore, they should be paid in preference to Salomon. Held, the company was a separate person independent from Salomon and was not is agent. Salomon, though the promoter and virtually the holder of all the shares, was also a secured creditor. He was entitled to repayment in priority to unsecured creditors.

The company is at law a different person altogether from the subscribers to the Memorandum and, although it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or the trustee for them. Nor are subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act. -Lord McNaughtenSoloman v. Soloman and Co.,(1897) A.C 22 (H.L)

From the legal point of view, a company is a legal person distinct from its members. This principle is referred to as 'veil of incorporation'. The Courts in general consider themselves bound by the principle of the corporate veil. There is a fictional veil between the company and its members, i.e.,the company has a corporate personality which is distinct from its members. When the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud or defend crime, the law will regard the company as an association of persons. In other words, the separate existence of the company shall be disregarded. The Companies Act, 1956 itself contains some provisions (Sections 45, 147, 212, 247, and 542) which lift corporate veil to reach the real forces of action. Corporate veil can be lifted for following circumstance:

1. JUDICIAL INTERPRETATIONS

2. STATUTORY EXCEPTIONS

1) JUDICIAL INTERPRETATIONS : It is very difficult to enumerate all the cases in which court has lifted or might lift the veil. The corporate veil has been lifted by courts in following cases a) PREVENTION OF FRAUD OR IMPROPER CONDUCT: The Court shall not uphold the separate existence of the company if it is formed to defraud creditors, avoid legal obligations. Case Law: Gilford Motor Co. Ltd. v. Horne (1933) Ch. 935 CA. Horne was appointed as a managing director on the condition that he shall not at any time solicit or entice away the customers of the company. He formed a company to carry on a business which, if he had done so personally, would have been a breach of the condition. Held, the defendant company was a mere channel used by the defendant Horne for the purpose of enabling him, for his own benefit, to obtain the advantages of the customers of the plaintiff company and that the defendant company ought to be restrained as well as the defendant Horne. b) DETERMINATION OF CHARACTER

In times of war, the court will lift the veil to see whether a company is controlled by the enemy aliens. Case Law: Daimler Co Ltd vs. Continental Tyre & Rubber Co. Ltd (1916) A company was incorporated in England with a capital of 25,000 in 1 shares 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 resident in Germany. The one share was registered in the name of the secretary, who was born in Germany, but resided in England and had become a naturalized British subject. After the outbreak of the war between England and Germany, an action was commenced in the

name of the English company on the instructions of the secretary, for a payment of trade debt. One of the defenses was that the company was an alien company and that payment of the debt would be trading with the enemy. In his judgment, Lord Parker stated: My Lords, the truth is that considerations which govern civil liability and rights of property in time of peace differ radically from those which govern enemy character in time of war. The law on the subject may be summarized in the following propositions: (I) A company incorporated in the UK is a legal entity, a creation of law with the status and capacity which the law confers. It is not a natural person with mind or conscience. (II) Such a company can only act through agents properly authorized and as long as it is carrying on business in this country through agents so authorized and residing in this country, it is prima facie to be regarded as a friend.

(III) Such a company may, however, assume an enemy character. This will be the case if its agents or the persons in defacto control of its affairs are resident in an enemy country or taking instructions from or acting under the control of enemies. (IV) The character of individual shareholders cannot itself affect the character of the company in times of peace. The enemy character of individual shareholders and their conduct may however, be very material on the question of whether the companys agents in defacto control of its affairs are infact adhering to, taking instructions from or acting under the control of enemies. This will vary with the number of shareholders who are enemies and the value of their holdings. Given in the case the fact that the secretary held one share only out of 25,000 shares and was the only shareholder who was not an enemy might well suggest that he was acting under the control of, taking his instructions from, or adhering to the enemies.

c)

COMPANY IS A SHAM

The court will lift the veil where the device of incorporation is used for some illegal or improper purpose. The courts have intervened on numerous occasions and lifted the veil inorder to circumvent a fraudulent or improper design by a bunch of scheming promoters or shareholders. Case Law: Jones vs. Lipman Lipman agreed to sell freehold land with registered title to the plaintiff (Jones) for 5,250. Pending completion he sold and transferred the land to the defendant company (having a capital 100, which he acquired and of which he and a clerk were sole shareholders and directors), for 3000 of which 1,564 was borrowed by the defendant company from a bank and the rest owing to him. In an action by the plaintiff for specific performance, it was held that, the defendant company was a cloak for Lipman. The Lord Lawrence in his judgment stated that the defendant company is the creature of Lipman, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity. The proper order to make is an order on both the defendants specifically to perform the agreement between the plaintiffs and Lipman.

d)

COMPANY IS ACTING AS THE AGENT OF THE SHAREHOLDERS

One of the ratio decided in Salomans case was that the company is not in law an agent of the subscribers. Under the ordinary rules of law, a parent company and a subsidiary company even 100% subsidiary company are distinct legal entities, and in the absence of an agency contract between the two companies, one cannot be said to be the agent of the other. If a court held that a company acted in particular instance as an agent of its holding company the veil of incorporation would have been lifted.

Case Law: Firestone Tyre & Rubber vs. Llewellin An American company formed a wholly-owned subsidiary company in England to manufacture and sell its brand of tyres in Europe. The distributors sent their orders to the subsidiary direct and the orders were met without any consultation with the American company. The subsidiary received the money for the tyres sold to the distributors and after deducting its manufacturing expenses pus 5 percent, it forwarded the balance of the money to the American company. All the directors resided in England except one who was the president of American company and they managed the subsidiaries affairs free from day-to-day control by the American company. It was held that the American company was carrying on business in England through its English subsidiary acting as its agent and it was consequently liable to pay UK tax.

e)

PROTECTION OF REVENUE

The courts may disregard the corporate entity of a company where it is used for tax evasion or to circumvent tax obligation. Further, where it is desired to establish for tax purposes in what country a company is resident the court will lift the veil and find out where the control management is and that determines the residential status.

Case Law: Dinshaw Maneckjee Petit 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.

f) AVOIDANCE OF WELFARE LEGISLATIONAvoidance 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. Case Law: Workmen of associated rubber industry v. Asssociated rubber co. A subsidiary was formed to split the profits of the company so that the incidence of bonus in the hand of parent company will be reduced. The court disregarded the existence of aseparate company for the purpose of working out bonus for its employees.

g) PUBLIC INTERESTThe 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 .

2) STATUTORY EXCEPTIONS
If lifting the veil is regarded as removing the advantages which incorporation gives to the corporate , then there are a number of important instances where statutory provisions also bring about this effect. The term, corporate, is here being used widely to include both shareholders and directors. In most of the cases below, the statutory provision is imposing liability on directors or other officers, whose general duties and liabilities are considered but these provisions are usefully considered here, both because in the small companies to which the provisions usually apply there is an identity between the directors and the shareholders and, also, because, in respect of fraudulent and wrongful trading, it is important to bear in mind that, in certain circumstances, companies cannot be formed or run to the economic detriment of third parties. a) 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. b) 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.

c) 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 reregistered 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. d) 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. e) HOLDING AND SUBSIDIARY COMPANIES. In the eyes of the law, the holding company and its subsidiaries are separate legal entities. Even a 100 per cent subsidiary is a separate legal entity and its creator and controller (i.e., the holding company) is not liable for its breaches of contracts and torts. Nor can the holding company sue to enforce right which belong to its subsidiary. Case Law : Free Wheel (India) Ltd. V. Ved Mitra, A.I.R. (1969) Delhi 258. A holding company requested the court for restraining its subsidiary from issuing further capital as it would depreciate the value of its shares. The injunction prayed for was refused on the ground that the subsidiary company had not lost its identity as a separate legal entity. But in the following two cases, a subsidiary company may lose its separate identity to certain extent:-

 Where at the end of its financial year, a company has subsidiaries, it must lay before its members in general meeting not only its own accounts, but also a set of group accounts showing the profit or loss earned or suffered by the holding company and its subsidiaries collectively, and their collective state of affairs at the end of the year. The court may, on the facts of the case, treat a subsidiary company as merely a branch or department of one large undertaking owned by the holding company

f)

GROUP ACCOUNTS (SECTION 150)

Section 150 requires a company which has subsidiaries to lay before the company in a general meeting accounts or statements dealing with the state of affairs and profit and loss account of the company and the subsidiaries at the time when the companys own balance sheet and profit and loss account are laid before the companys general meeting. This is regarded in a loose sense as a case of lifting the veil because a holding company is obliged to incorporate into its balance sheet the assets and liabilities of the subsidiary company as if they were its own assets and liabilities. This is a modification of the general principle that a companys assets and liabilities are not a members assets and liabilities and would not therefore be incorporated into the members own balance sheet.

g)

INVESTIGATION OF COMPANYS AFFAIRS

Section 167 gives an inspector appointed by the court to investigate companys affairs the power to investigate the affairs of a companys subsidiary or holding company, if the inspector thinks it necessary to do so for the purpose of his investigation. An investigation instituted pursuant to this power would be regarded in a loose sense, as an instance of lifting the veil because the order to investigate a company sufficed to investigate the companys member as if they were one entity.

h)

MISDESCRIPTION OF COMPANYS NAME (SEC 147(4)):-

Where an officer or agent of a company does any act or enters into a contract without fully or properly mentioning the companys name and the address of its registered office, he shall be personally liable. Thus where a bill of exchange, or promissory note is signed by an officer of a company or any other person on its behalf, without mentioning this fact that he is signing on behalf of the company, he is personally liable to the holder of the instrument unless the company has already paid the amount. Hendon v. Alderman, (1973), 117 S.J. 631. The directors of L & R Agencies Ltd. signed a cheque in the name of the company stating the companys name as L. R. Agencies Ltd. (omitting the word & from the name). Held, they were personally liable.