Open Access Research Article
Understanding The Lifting Of Corporate Veil And Its Intricacies (By-Kayomard Irani & Tanaya Kulkarni)
Abstract
Understanding
The Lifting Of Corporate Veil And Its Intricacies
Authored By-1. Kayomard Irani
2.Tanaya
Kulkarni
Abstract
From the decades-long decision of the House of
Lords in the case of Salomon v. A
Salomon & Co. Ltd, [1896] UKHL 1, it was established that the company
is a separate entity from its owners and members. The doctrine of the lifting
of the corporate veil or piercing the veil safeguards and protects the
principle of corporate personality which serves as one of the fundamental
principles of Company Law. The Authors in the present article have mentioned
the various key concepts which may help in a clear understanding leading to the
doctrine. The landmark cases of Salomon v. A Salomon & Co. Ltd, [1896]
UKHL 1 and Lee v. Lee’s Air Farming Ltd (1961) AC 12 have been cited in brief to provide a
better insight into the principle of corporate personality. The need for the
doctrine of the lifting of the corporate veil which is further classified into
the statutory and judicial provisions has been mentioned towards the
penultimate stages of the paper. The article then concludes with a brief
analysis of the case of Vodafone International Holdings B.V. v. Union of
India, (2012) 6 SCC 613 along with the personal views of the author on the
doctrine of the lifting of the corporate veil.
Keywords: Company, Corporate personality,
Incorporation of company, Corporate entity, Lifting of the Corporate Veil.
Introduction
The introductory aspect of the paper
gives a brief overview of the principle of the company as a separate entity and
the doctrine of the lifting of the corporate veil.
The years 1844 and 1855 are of immense
significance in the field of Company Law. The concept of incorporation of a
company by registration (1844) and the doctrine of limited liability (1855)
have established themselves as the fundamental principles of Company Law. It was due to these enactments that the House
of Lords applied these principles in the case of Salomon v. Salomon which
created the roots for the doctrine of the lifting of the corporate veil.
Corporate personality has been
described as one of the fundamental principles of Company Law in almost all the
countries around the globe. The principle establishes a company as a separate
entity from the shareholders. Once a company is incorporated it serves as a
distinct entity in the eyes of law and no promoter, director or shareholder of
the company shall be personally liable for any done on behalf of the company.
The company has the legal capacity to purchase any property and sell the
property in its own name. The Company can sue and can be sued in its own name.
However, with the passing of time
situations arose when the doctrine of corporate personality was being misused
by the members of the company through wrongful acts. In such cases, it was laid
down that the members of the company who committed the wrongful acts can be
personally held liable for the same. Therefore, in order to prevent the misuse
and safeguard the principle of a company as a separate legal entity, it led to
the establishment of a doctrine called the ‘Lifting of Corporate Veil’. The
doctrine enables the smooth functioning of the business and holds the persons
accountable for the wrongful acts done on behalf of the company.
Lifting Of
The Corporate Veil: An Explanation Of The Concepts Leading To The Doctrine:
The Authors in the present paper have
provided a general explanation of the concepts related to the lifting of the
corporate veil. The concepts are explained in brief and conclusively lead to
the doctrine.
•
Company:[1] Originated from the French word ‘compainie’,
the English word ‘company’ has been derived. A company means an establishment
incorporated under the Companies Act, 2013, or under any previous laws. A
company may be formed under a certain structure, such as partnership,
proprietorship or corporation. This structure also denotes the ownership of the
company. It can either be a private or a public company. In common law, Company
is a legal person or a legal entity separate from its members, that is capable
of surviving by itself. Companies are generally established with the aim to
earn profit. Black’s Law Dictionary provides a general definition of the term
corporation which can be used along the same lines as that of a company.
According to the dictionary, “ a corporation is an entity having authority
under law to act as a single person distinct from the shareholders who owe it
and having rights to issue stock and exist independently, a group of succession
of persons established in accordance with legal rules into a legal or juristic
person that has legal personality distinct from the natural persons who make it
up, exist independently apart from them and has the legal powers that its
constitution gives it”. Therefore, the definition sets up the meaning for a
company as a separate entity which is a universally accepted principle and is
explained in detail below[2]
•
Incorporation
of a company:
Incorporation refers to the legal process of formulating a company or a
corporate entity. It becomes a legal entity which has separate assets and
income from that to have its owners, shareholders and investors. This is also
known as a limited liability over the shareholders. Incorporation results in
protecting the owner’s assets against the company's liability. It also allows
transferring of ownership. The incorporation of a company eventually results in
protecting all the shareholders from the company’s liability, often referred to as a
corporate veil.
•
The
Doctrine of Corporate personality: A company at the time of its incorporation gets marked as
a separate entity in the eyes of the law. It establishes its own legal identity
and enjoys its own independent status. However, in reality, a corporation or a
company is a group of persons who are the beneficial owners of the body
corporate.[3]This doctrine mainly states that a
company has a different legal identity from its members. This doctrine is
recognised under Indian and English law. This again refers to the limited
liability principle over the shareholders. The creditors can demand recoveries
from the company only and not its members. This also means that the company has
no right over the member’s individual debts and assets. Being a corporate
personality, the company enjoys its rights over rights and assets in its name.
A.
The
theory of Corporate personality is the basic and pivotal principle which sets
the foundation for the law of corporation and there lay several instances where
the courts have managed to lift the corporate veil[4].
B.
The
doctrine of the lifting of the corporate veil has its roots embedded in the
principle of corporate personality and without the principle, the doctrine will
be left incomplete. Therefore, the authors have mentioned two leading cases on
the principle of the company as a separate entity which creates the foundation
for the doctrine of the lifting of corporate veil. Salomon v Salomon[5] stands its ground as one of the landmark judgments of
Company law and is applied even today in courts all around the globe. There was
a businessman called Aron Salomon, who was involved in the business of leather
and shoe manufacturing. He made a company called Salomon and co ltd. and sold
his business to the company at 38,000 pounds. The company had 7 subscribers
comprising of Salomon, his wife, daughter and 4 sons. The total share capital
of the company was 40,000 shares and the value of the share was 1 pound each.
Salomon himself had 20,001 shares and debentures worth 10,000 pounds. Due to
unforeseen circumstances, the company goes into a state of liquidation after a
year. On assessment, it is found that the company had 6,000 pounds worth of
assets and 17,000 pounds worth of liabilities. The main issue at hand was as
the company was being administered by Salomon and his family whether it fails
to have any legal identity of its own and therefore Salomon can be exposed to
unlimited personal liability. The Court of Appeal declared the company to be a
myth and hence held Salomon personally liable for the debt incurred. However,
the House of Lords on Appeal reversed the above decision and held that the
company was not a sham and Salomon shall not be
liable towards the debts of the
company as the company at the time of incorporation establishes itself as a
separate entity, therefore, becoming an independent person possessing its own
rights and liabilities. The principle of the company as a separate entity
adopted in the Salomon v Salomon case was further affirmed in another
leading case of Lee v Lee’s Air Farming Ltd[6]. There existed a company called Lee
Air Farming co ltd. whose total share capital was 300 shares from which Lee had
2999 shares. Lee was the managing director and a pilot for the company which
made him a salaried employee as well. However, he lost his life in an air crash
and his wife sought compensation under the Workmen’s compensation act. The case
at hand demonstrates the relationship between master and servant in the
company. The court held that the widow has the right to seek compensation as
the principle of the company as a separate legal entity is invoked which
creates a master-servant relationship at the same time[7].
•
The
doctrine of Corporate Veil: Becoming a corporate personality, a company has its own
name and company seal under which it is recognised apart from its owners and
members. It becomes a juristic person. The corporate veil becomes an important
aspect of such companies, as after becoming a separate legal entity, the veil
protects the members from the actions of a company. In other words, the
doctrine safeguards against those individuals who misuse and take shelter
behind the principle of corporate personality. If any violations occur or if
any liability is imposed on the company, the veil protects its members from
suffering as they will not be held liable due to the limited liability
principle[8]. Therefore, piercing the corporate
veil is the judicial act of imposing liability on the otherwise immune members
for the company's wrongful acts.
Need For The
Doctrine Of The Lifting Of Corporate Veil:
In layman’s terms, though a company
and its members are separated through a curtain, a company is dependent on its
members for smooth functioning. At times, it is found that the members use the
term corporate personality to their own benefit through fraud, illegal
activities, and improper conduct in order to safeguard themselves from the
wrongs committed. For instance, in a case, it was held by the Supreme Court
that the courts can look beyond the corporate character of the company if the
company is being used for the purpose of committing fraud[9]. The doctrine of the lifting of the
corporate veil is one of the most utilised doctrines by the courts. However,
the courts do not follow any precise strategy for its invoking. The authors in
the present paper have mentioned the circumstances under which the court may
pierce the corporate veil in order to safeguard the principle of corporate
personality:
1.
Fraud
or Improper Conduct:
There are numerous cases which have prepared the Courts to pierce the corporate
veil if it is realised that there has been some fraudulent activity, or where
the shareholders of the company have been indulged in a fraudulent act. By
virtue of such cases, it is understood that the corporate veil can be lifted in
case of a criminal act
and any misrepresentation. The Courts will refuse to uphold the separate legal
existence of the company where it is formed to defeat or circumvent the law,
defraud creditors and avoid legal obligations. For instance, in the case of Gilford
motor company ltd v. Horne[12], Mr Horne was an ex-employee of the
Gilford motor company. As per the terms of his employment contract, he could
not solicit the customers of the company. However, Mr Horne failed to abide by
the terms of the contract as he incorporated a company in his wife’s name
through which he solicited the customers of the company. The Court of Appeal
held that in the present case the company was formed as a device to mask the
effective carrying on business and it was clear that the main purpose of
incorporating the new company was to perpetrate fraud. Thus the court pierced
the corporate veil and held it as a mere sham to hide the wrongdoings.
Fraudulent conduct was witnessed in another leading case of Jones v. Lipman[13] whereby Lipman enters into a contract with Jones to sell
properties. However with the passing of time, Mr Lipman changes his views and
in order to safeguard the performance of the contract, he transfers the
properties to his company. Russell Judge relies on the judgment of Gilford
v. Horne and held that Mr Lipman used the company as a mask which is
thereby an illegitimate use and an attempt to avoid recognition. He, therefore,
awarded specific performance against Mr Lipman and the company.
2.
Tax Evasion: Court has the power to lift the
corporate veil if members of the company are using the name of the company for
illegal gains by evasion of taxation or circumventing tax obligations. In the
case of Sir Dinshaw Maneckjee Petit Re[14], the assessee was a wealthy man
enjoying huge dividends and interest on his income. He formed four private
companies and credited all the income received in the account of the companies.
This amount was then handed back to the assessee in the form of a loan from the
company. This way he divided his income and reduced his tax liability. In this
scenario, Court had lifted the Corporate veil in order to rule the case.
3.
Company
as an Agent:
Vicarious Liability can be imposed when the agent is acting on behalf of the
shareholders. The court determines the liability on the fact whether the Agent
was acting for the shareholders or not. In such cases, it becomes necessary to
determine the character of a company in order to ascertain if the company is an
enemy or not. Court will pierce the Corporate veil in order to understand the
true character of the Company.
4.
Determination
of enemy character (war): The
provision is applicable when a country goes into a war with any other country,
those citizens ipso facto acquire the position of alien enemies and hence the
normal law will fail to be applicable. In the case of Daimler Company Ltd v.
Continental Tyre & Rubber Co[15], a German company incorporated a
company called Daimler Company Ltd in London for the purpose of selling
tyres and expanding their business. The company incorporated in London composed
of a majority of German shareholders. Daimler Ltd was involved in a
series of transactions with Continental Tyre and Rubber Co. A war was
declared between Germany and England, and Daimler demanded the payment
from Continental Tyre. The claim of Continental Tyres was that any
transaction with Daimler will result in a transaction with an alien
enemy though the company was incorporated in England. The court held that
despite the fact that Daimler was incorporated in London is composed of
a majority of German shareholders who controlled the company. The trade was
dismissed on the ground that any transaction between the two companies would
account for business with an enemy company.
5.
The
company as a cloak:
The courts will pierce the corporate veil if it is of the opinion that the
company is incorporated for the purpose of restraining the performance of a
contract or is a bogus company or has any fraudulent motive. The
afore-mentioned case of Gilford motor company ltd v. Horne[16] provides a detailed
understanding of the provision.
1.
Officers in Default: Section 5 of the Companies Act, 2013[18] provides a list of officers including
a managing director or a whole-time director who shall be liable for punishment
or penalty on account of any default in the company. [19]
2.
Failure
to comply with the requirements necessary for incorporation: Section 464[20] of the Companies Act, 2013 comes into
effect when the conditions necessary for incorporation are not maintained.
3.
Minimisation
of members below the Lawful Limit: According to the Companies Act, 2013, seven and two are
the lawful limit of the members of the company in Public Company and Private
Company respectively, but if in any case, the company fails to have the
prescribed number of members and still decides to continue with its business
for more than six months then it's a well-settled principle of law that the
members who concealed this fact from the competent authorities will be
responsible for all the debts of the company incurred during the period where
the company had fewer members. The members will be forced to take personal
responsibility for the debts of the company.
4.
Misrepresentation
in Prospectus:
If there is any kind of falsification in the Company’s prospectus then every
person who approved such misleading prospectus including directors, promoters
etc will be liable to pay compensation to the investors who fell prey to such
prevarication in the prospectus[21].
5.
Inquiry
relating to Proprietorship of Company( Section 216): When one person gains profits
regardless of the Company incurring profit or loss, then it becomes essential
to find out such person for smooth functioning of the Company, in such cases,
the Central Government has the power to appoint one or more than one
investigating officers to inquire about the real owner of the company who takes
decisions which are further implemented in the Company policy[22].
6.
Misdescription
of Company’s Name ( Section 12): As the name suggests if there is any misdescription of the
Company’s name in any contract, agreement etc then the person who has wrongly
used the company name will be personally responsible for such wrongful use of
the Company’s name as it is an obligation on Companies to use the Company name
properly on contracts, letters, negotiable instruments etc. [23]
7.
Responsibility
for unscrupulous business conduct ( Section 339)[24]: While winding up of any Company, if it is discovered that
the Company was cheating the investors/creditors then in such cases the Court
has the discretion to hold people involved in such fraudulent business to be
liable for the damages caused by their conduct to the investors/creditors.
8.
Ultra
Vires Act: If
the director of any company decides to exercise his power beyond the Memorandum
of Association signed by him, then that director is held responsible for such
actions even if such acts were done on behalf of the company.
Amongst other laws, the case of Vodafone
v. Union of India serves as an important case towards the understanding of
the concept of piercing of corporate veil. The authors have given a brief
analysis of the case.
•
Brief
Facts:
In May 2007, Vodafone incorporated in
the Netherlands, acquired from Hong Kong-based Hutchinson Group, the entire
share capital of CGP Investments Limited (CGP), a Company incorporated in the
Cayman Islands, which controlled a 67% share of the Hutchinson-Essar Limited
(HEL), Hutchinson’s Indian mobile business. The Indian Income Tax Authorities
contended that capital gains were made by Hutchinson in India and that Vodafone
was, therefore, liable to pay tax, amounting to approximately INR 110 billion.
Vodafone challenged the tax demand in
the Bombay High Court, which ruled in favour of the income tax department,
holding that the essence of the transaction was a change in the controlling
interest in HEL, which was the source of income in India.
•
Appeal
in front of the Supreme Court:
After the Bombay High Court ruled
against Vodafone, an appeal was made in front of the Supreme Court, where the
SC overruled the High Court’s decision and held that the transaction fell
outside India’s territorial tax jurisdiction and was hence not taxable. This
judgement was important from the Principle of Lifting of Veil point of view, as
it states the circumstances where it may be lifted, also mentioning commercial
cross-border transactions and tax avoidance. The Hon’ble Court recognised the
fundamental principle of the corporate veil by taking a note that the approach
of corporate and tax laws, particularly in the matter of corporate taxation,
generally is founded on a separate entity principle, i.e. company is treated as
a separate entity. The Income Tax Act, 1961 in the matter of Corporate taxation
is founded on the principle of the independence of companies and other entities
subject to income tax.
The Supreme Court stated that as the
companies were in 2 different countries, section 9 of the Income Tax Act, which
states that it is mandatory to pay the tax in the territory where one earns, is
not applicable. If the case would have been where the assets were located in
India, and the income was also accrued in India, then taxes would have been
paid in India. But, firstly there was no direct transaction between Vodafone
International and HEL, and even though the assets were located in India, the
transaction and income were generated outside India. There was no transfer of
‘towers’.
•
Observations:
It was observed that in the context of parent/subsidiary
relationships, it is generally accepted that the parent company would guide the
subsidiary, but that by itself would not justify piercing the veil or imply
that the subsidiaries are to be deemed residents of the State in which the
parent company resides. A subsidiary and its parent are 2 different taxpayers.
Six factors which needed to be focused on to understand whether the transaction
was bogus in this case are:
1.
The
concept of participation in investment
2.
The
duration of time during which the Holding Structure exists
3.
The
Period of business operations in India
4.
The
generation of taxable revenues in India
5.
The
timing of exit
6.
The
continuity of business on such exit.
In finality, the Supreme Court decided
against the lifting of the corporate veil in Vodafone, as the tax authorities
failed to establish that the transaction was a bogus or a tax avoidance scheme.
Conclusion
We are on the brink of a revolution and with the advancements in the current world, there shall be a time where the doctrine will need to evolve as well. If one considers the time from Salomon v Salomon, we can see how far the subject of Company Law has evolved. From the recognition of the concepts of corporate personality to the piercing of the corporate veil, the subject keeps on evolving with the passing of time. The doctrine serves as a protector of the principle of corporate personality, however, soon there shall be multiple provisions and exceptions that will be needed in order to safeguard the principle. The Companies Act, 2013 which is the act governing Company Law in India may enact amendments that will be required to prevent misuse of the principle of corporate personality. However, for now, the doctrine of the lifting of the corporate veil remains to be an interesting subject of study and concluding the paper, one can safely term it as the protector of the principle of corporate personality.
Published Paper
Author Details
Author Name: Kayomard Irani & Tanaya Kulkarni
Title: Understanding The Lifting Of Corporate Veil And Its Intricacies
Email Id: Kayomard Irani-kayomard.irani529@gmail.com & Tanaya Kulkarni-tanaya.v.kulkarni@gmail.com
Article Information
Understanding The Lifting Of Corporate Veil And Its Intricacies (By-Kayomard Irani & Tanaya Kulkarni)
Authors: Author Name: Kayomard Irani, Tanaya KulkarniTitle: Understanding The Lifting Of Corporate Veil, Its Intricacies, Tanaya KulkarniEmail Id: Kayomard Irani-kayomard.irani529@gmail.com, Tanaya Kulkarni-tanaya.v.kulkarni@gmail.com
- Journal IJLRA
- ISSN 2582-6433
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International Journal for Legal Research and Analysis
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