Lifting The Corporate Veil

INTRODUCTION
Before dealing with the lifting of corporate veil it is pertinent to define what the
meaning of a company is. Strictly, a company has no particular definition but section
3(1) (i) of the Companies Act attempts to provide the meaning of the word in context
of the provisions and for the use of this act. It states: ‘a company means a company
formed and registered under this Act or an existing company as defined in section 3
(1) (ii).’ The company must be registered under the Companies Act for it to become
an incorporated association. If it is not registered it becomes an illegal association.
This paper would deal with the lifting of corporate veil and its aspects with the
judicial decisions. Let us first discuss the exact meaning of corporate veil and lifting
of corporate veil with limited liability concept.

Corporate veil:
A legal concept that separates the personality of a corporation from the
personalities of its shareholders, and protects them from being personally liable for
the company’s debts and other obligations.

Lifting of Corporate veil:

At times it may happen that the corporate personality of the company is used to
commit frauds and improper or illegal acts. Since an artificial person is not capable
of doing anything illegal or fraudulent, the façade of corporate personality might
have to be removed to identify the persons who are really guilty. This is known as
‘lifting of corporate veil’.

It refers to the situation where a shareholder is held liable for its corporation’s debts
despite the rule of limited liability and/of separate personality. The veil doctrine is
invoked when shareholders blur the distinction between the corporation and the
shareholders. A company or corporation can only act through human agents that
compose it. As a result, there are two main ways through which a company becomes
liable in company or corporate law: firstly through direct liability (for direct
infringement) and secondly through secondary liability (for acts of its human agents
acting in the course of their employment).

There are two existing theories for the lifting of the corporate veil. The first is the
“alter-ego” or other self theory, and the other is the “instrumentality” theory.

The alter-ego theory considers if there is in distinctive nature of the boundaries

between the corporation and its shareholders.
The instrumentality theory on the other hand examines the use of a corporation by its
owners in ways that benefit the owner rather than the corporation. It is up to the
court to decide on which theory to apply or make a combination of the two doctrines.

Concept of limited liability:

One of the main motives for forming a corporation or company is the limited liability
that it offers to its shareholders. By this doctrine, a shareholder can only lose what
he or she has contributed as shares to the corporate entity and nothing more. This
concept is in serious conflict with the doctrine of lifting the veil as both these do not
co-exist which is discussed by us in the paper in detail.

DEVELOPMENT OF THE CONCEPT

OF “LIFTING THE CORPORATE VEIL”
One of the main characteristic features of a company is that the company is a
separate legal entity distinct from its members. The most illustrative case in this
regard is the case decided by House of Lords- Salomon v. A Salomon & Co. Ltd[i]. In
this case Mr. Solomon had business of shoe and boots manufacture. ‘A Salomon &
Co. Ltd.’ was incorporated by Solomon with seven subscribers-Himself, his wife, a
daughter and four sons. All shareholders held shares of UK pound 1 each. The
company purchased business of Salomon for 39000 pounds, the purchase
consideration was paid in terms of 10000 pounds debentures conferring charge on
the company’s assets, 20000 pounds in fully paid 1 pound share each and the
balance in cash. The company in less than one year ran into difficulties and
liquidation proceedings commenced. The assets of the company were not even
sufficient to discharge the debentures (held entirely by Salomon itself) and nothing
was left to the insured creditors. The House of Lords unanimously held that the
company had been validly constituted, since the Act only required seven members
holding at least one share each and that Salomon is separate from Salomon & Co.
Ltd. The entity of the corporation is entirely separate from that of its shareholders; it
bears its own name and has a seal of its own; its assets are distinct and separate
from those of its members; it can sue and be sued exclusively for its purpose; liability
of the members are limited to the capital invested by them.[ii]Further in Lee v. Lee’s
Air Farming Ltd.[iii], it was held that there was a valid contract of service between Lee
and the Company, and Lee was a therefore a worker within the meaning of the Act. It
was a logical consequence of the decision in Salomon’s case that one person may
function in the dual capacity both as director and employee of the same company.

In The King v Portus; ex parte Federated Clerks Union of Australia[iv], where Latham
CJ while deciding whether or not employees of a company owned by the Federal
Government were not employed by the Federal Government ruled that the company
is a distinct person from its shareholders. The shareholders are not liable to
creditors for the debts of the company. The shareholders do not own the property of
the company.

In course of time, the doctrine that a company has a separate and legal entity of its
own has been subjected to certain exceptions by the application of the fiction that
the veil of corporation can be lifted and its face examined in substance.

Thus when “Tata Company” or “German Company” or “Government Company” is

referred to, we look behind the smoke-screen of the company and find the individual
who can be identified with the company. This phenomenon which is applied by the
courts and which is also provided now in many statutes is called “lifting of the
corporate veil”. As a consequence of the lifting of the corporate veil, the company as
a separate legal entity is disregarded and the people behind the act are identified
irrespective of the personality of the company. So, this principle is also
called “disregarding the corporate entity”.

LIFTING THE CORPORATE VEIL

Meaning of the doctrine:
Lifting the corporate refers to the possibility of looking behind the company’s
framework (or behind the company’s separate personality) to make the members
liable, as an exception to the rule that they are normally shielded by the corporate
shell (i.e. they are normally not liable to outsiders at all either as principles or as
agents or in any other guise, and are already normally liable to pay the company what
they agreed to pay by way of share purchase price or guarantee, nothing more).[v]

When the true legal position of a company and the circumstances under which its
entity as a corporate body will be ignored and the corporate veil is lifted, the
individual shareholder may be treated as liable for its acts.

The corporate veil may be lifted where the statute itself contemplates lifting the veil
or fraud or improper conduct is intended to be prevented.

“It is neither necessary nor desirable to enumerate the classes of cases where lifting
the veil is permissible, since that must necessarily depend on the relevant statutory
or other provisions, the object sought to be achieved, the impugned conduct, the
involvement of the element of public interest, the effect on parties who may be
affected, etc.”. This was iterated by the Supreme Court in Life Insurance Corporation
of India v. Escorts Ltd.[vi]
The circumstances under which corporate veil may be lifted can be categorized
broadly into two following heads:

1. Statutory Provisions
2. Judicial interpretation

STATUTORY PROVISIONS
Section 5 of the Companies Act defines the individual person committing a wrong or
an illegal act to be held liable in respect of offences as ‘officer who is in default’. This
section gives a list of officers who shall be liable to punishment or penalty under the
expression ‘officer who is in default’ which includes a managing director or a whole-
time director.

Section 45– Reduction of membership below statutory minimum: This section

provides that if the members of a company is reduced below seven in the case of a
public company and below two in the case of a private company (given in Section
12) and the company continues to carry on the business for more than six months,
while the number is so reduced, every person who knows this fact and is a member
of the company is severally liable for the debts of the company contracted during
that time. In the case of Madan lal v. Himatlal & Co.[vii] the respondent filed suit
against a private limited company and its directors for recovery of dues. The
directors resisted the suit on the ground that at no point of time the company did
carry on business with members below the legal minimum and therefore, the
directors could not be made severally liable for the debt in question. It was held that
it was for the respondent being dominus litus, to choose persons of his choice to be
sued.

Section 147- Misdescription of name: Under sub-section (4) of this section, an

officer of a company who signs any bill of exchange, hundi, promissory note, cheque
wherein the name of the company is not mentioned is the prescribed manner, such
officer can be held personally liable to the holder of the bill of exchange, hundi etc.
unless it is duly paid by the company. Such instance was observed in the case of
Hendon v. Adelman.[viii]

Section 239– Power of inspector to investigate affairs of another company in same

group or management: It provides that if it is necessary for the satisfactory
completion of the task of an inspector appointed to investigate the affairs of the
company for the alleged mismanagement, or oppressive policy towards its
members, he may investigate into the affairs of another related company in the same
management or group.

Section 275- Subject to the provisions of Section 278, this section provides that no
person can be a director of more than 15 companies at a time. Section 279 provides
for a punishment with fine which may extend to Rs. 50,000 in respect of each of
those companies after the first twenty.

Section 299- This Section gives effect to the following recommendation of the
Company Law Committee: “It is necessary to provide that the general notice which a
director is entitled to give to the company of his interest in a particular company or
firm under the proviso to sub-section (1) of section 91-A should be given at a
meeting of the directors or take reasonable steps to secure that it is brought up and
read at the next meeting of the Board after it is given.[ix] The section applies to all
public as well as private companies. Failure to comply with requirements of this
Section will cause vacation of the office of the Director and will also subject him to
penalty under sub-section (4).

Sections 307 and 308- Section 307 applies to every director and every deemed
director. Not only the name, description and amount of shareholding of each of the
persons mentioned but also the nature and extent of interest or right in or over any
shares or debentures of such person must be shown in the register of shareholders.

Section 314- The object of this section is to prohibit a director and anyone
connected with him, holding any employment carrying remuneration of as such sum
as prescribed or more under the company unless the company approves of it by a
special resolution.

Section 542- Fraudulent conduct: If in the course of the winding up of the company,
it appears that any business of the company has been carried on with intent to
defraud the creditors of the company or any other person or for any fraudulent
purpose, the persons who were knowingly parties to the carrying on of the business,
in the manner aforesaid, shall be personally responsible, without any limitation of
liability for all or any of the debts or other liabilities of the company, as the court may
direct. In Popular Bank Ltd., In re[x] it was held that section 542 appears to make the
directors liable in disregard of principles of limited liability. It leaves the Court with
discretion to make a declaration of liability, in relation to ‘all or any of the debts or
other liabilities of the company’. This [xi]section postulates a nexus between
fraudulent reading or purpose and liability of persons concerned.

JUDICIAL INTERPRETATIONS
By contrast with the limited and careful statutory directions to ‘lift the veil’ judicial
inroads into the principle of separate personality are more numerous. Besides
statutory provisions for lifting the corporate veil, courts also do lift the corporate veil
to see the real state of affairs. Some cases where the courts did lift the veil are as
follows:
 1. United States v. Milwaukee Refrigerator Transit Company[xii]– In this case the
U.S. Supreme Court held that “where the notion of legal entity is used to
defeat public convenience, justify wrong, protect fraud or defend crime, the
law will disregard the corporate entity and treat it as an association of
persons.”

Some of the earliest instances where the English and Indian Courts disregarded the
principle established in Salomon’s case are:

2. Daimler Co. Ltd. v. Continental Tyre and Rubber Co. (Great Britain) Ltd[xiii]–
This is an instance of determination of enemy character of a company. In this
case, there was a German company. It set up a subsidiary company in Britain
and entered into a contract with Continental Tyre and Rubber Co. (Great
Britain) Ltd. for supply of tyres. During the time of war the British company
refused to pay as trading with an alien company is prohibited during that time.
To find out whether the company was a German or a British company, the
Court lifted the veil and found out that since the decision making bodies, the
board of directors and the general body of share holders were controlled by
Germans, the company was a German company and not a British company
and hence it was an enemy company.

3. Gilford Motor Co. v. Horne[xiv]– This is an instance for prevention of façade or

sham. In this case an employee entered into an agreement that after his
employment is terminated he shall not enter into a competing business or he
should not solicit their customers by setting up his own business. After the
defendant’s service was terminated, he set up a company of the same
business. His wife and another employee were the main share holders and the
directors of the company. Although it was in their name, he was the main
controller of the business and the business solicited customers of the
previous company. The Court held that the formation of the new company
was a mere cloak or sham to enable him to enable him to breach the
agreement with the plaintiff.

4. Re, FG (Films) Ltd[xv]– In this case the court refused to compel the board of
film censors to register a film as an English film, which was in fact produced
by a powerful American film company in the name of a company registered in
England in order to avoid certain technical difficulties. The English company
was created with a nominal capital of 100 pounds only, consisting of 100
shares of which 90 were held by the American president of the company. The
Court held that the real producer was the American company and that it would
be a sham to hold that the American company and American president were
merely agents of the English company for producing the film.
 5. Jones v. Lipman[xvi]– In this case, seller of a piece of land sought to evade
specific performance of a contract for the sale of the land by conveying the
land to a company which he formed for the purpose and thus he attempted to
avoid completing the sale of his house to the plaintiff. Russel J. describing the
company as a “devise and a sham, a mask which he holds before his face and
attempt to avoid recognition by the eye of equity” and ordered both the
defendant and his company specifically to perform the contract with the
plaintiff.

6. Tata Engineering and Locomotive Co. Ltd. State of Bihar[xvii] – In this case it
was stated that a company is also not allowed to lay claim on fundamental
rights on the basis of its being an aggregation of citizens. Once a company is
formed, its business is the business of an incorporated body thus formed and
not of the citizens and the rights of such body must be judged on that footing
and cannot be judged on the assumption that they are the rights attributable
to the business of the individual citizens.

7. N.B. Finance Ltd. v. Shital Prasad Jain[xviii]– In this case the Delhi High Court
granted to the plaintiff company an order of interim injunction restraining
defendant companies from alienating the properties of their ownership on the
ground that the defendant companies were merely nominees of the defendant
who had fraudulently used the money borrowed from the plaintiff company
and bought properties in the name of defendant companies. The court did not
in this case grant protection under the doctrine of corporate veil.

8. Shri Ambica Mills Ltd. v. State of Gujarat[xix]– It was held that the petitioners
were as good as parties to the proceedings, though their names were not
expressly mentioned as persons filing the petitions on behalf of the company.
The managing directors in their individual capacities may not be parties to
such proceedings but in the official capacity as managing directors and as
officers of the company, they could certainly be said to represent the
company in such proceedings. Also as they were required to so act as seen
from the various provisions of the Act and the Rules they could not be said to
be total strangers to the company petition.

COMPANIES BILL 2011

India being one of the top three emerging economies, has been longing for strong
and cogent corporate laws that will enable the country’s international trade to
conduct its affairs on a par with the western industrialized nations. The proposals in
the Bill are expected to act as a catalyst to fostering growth of the economy. One of
the main highlights of this Bill is that it proposes a mechanism for vigilance that will
reward whistle blowers. This measure will allow companies to follow transparency at
every move they initiate. The authors have mentioned a few provisions which bring in
responsibilities and liabilities upon a director.

Section 127- A director of a company is punishable with imprisonment or fine if a

dividend which is declared has not been paid or a warrant which in respect thereof
has not been posted within 30 days of the date of declaration.

Section 159 r/w 156- It is the duty of every existing director to intimate his Director
Identification Number to the company or all companies wherein he is a director
within one month of the receipt of the same from the Central Government. If any
director of a company contravenes, such director shall be punishable with
imprisonment or with fine under Section 159.

Section 166- Under this section various duties of a director are enumerated such as
the duty of good faith, of due and reasonable care, to act in accordance with the
articles of association etc. Any director in violation of these duties will be punishable
with a fine of not less that Rs 1 lakh and not more than Rs 5 lakhs.

Section 184- This section imposes a duty upon a director of a company to disclose
his concern or interest, including shareholding, in any company or companies, or
bodies corporate, companies, firms, or other associations of individuals or if he is a
party to any contract or agreement with a body corporate in which such director
holds more than 2% shareholding or otherwise as mentioned or any firm in which
such director is a partner or owner etc. Sub-section (4) is the penalty clause.

Section 194- This section puts a prohibition in forward dealings of securities of the
company, its subsidiaries or in its holding or associate company by a director of
such company. In any contravention to this effect, the director will be punishable
with imprisonment or/and fine as prescribed.

APPROACH OF THE INDIAN COURTS

IN THE 21ST CENTURY
1. Subhra Mukherjee v. Bharat Coking Coal Ltd.[xx]– Sham or façade- In this case
a private coal company sold its immovable property to the wives of directors
prior to nationalization of the company. In fact, documents were ante-dated to
show the transaction was prior to nationalization of the company). Where
such transaction is alleged to be sham and collusive, the Court was justified in
piercing the veil of incorporation to ascertain the true nature of the transaction
as to know who were the real parties to the sale and whether it was genuine
and bona fide or whether it was between the husbands and wives behind the
façade of the separate entity of the company.
2. Bajrang Prasad Jalan v. Mahabir Prasad Jalan[xxi]– Subsidiary-holding
company- The court, for the purpose of considering a complaint of oppression
held that the corporate veil can be lifted in the cases of not merely of a
holding company, but also its subsidiary when both are family companies.

3. Singer India v. Chander Mohan Chadha[xxii]– The concept of corporate entity

was evolved to encourage and promote trade and commerce but not to
commit illegalities or to defraud the people. Where therefore the corporate
charter is employed for the purpose of committing illegality or for defrauding
others, the court would ignore the corporate character and will look at the
reality behind the corporate veil so as to enable it to pass appropriate orders
to do justice between the parties concerned.

4. Saurabh Exports v. Blaze Finance & Credits (P.) Ltd. [xxiii]– Defendant no. 1
was a private limited company. Defendant no. 2 and 3 were the directors of
that company. Defendant no. 4 was the husband of D-3 and the brother of D-2.
Allegedly on representation of D-4 that D-1 company was inviting short term
deposits at good interest rates, plaintiff made a deposit of Rs. 15 lakhs in the
company for a period of 6 months. When the company failed to pay the
amount, the plaintiff sued it for the said amount along with interest. D-2 and 3
denied their liability in the ground that there was no personal liability of the
directors as the deposit was received in the name of the company. D-4 denied
the liability on the ground that it had nothing to do with the transaction in
question as he was neither a director nor a shareholder of the company so it
was held that he had no locus in the company and hence not liable. It was
held that D-3 being a house wife had little role to play and therefore could not
be made liable. The plaintiff was sought to be defrauded under the cloak of a
corporate entity of D-1 and, therefore, corporate veil was lifted taking into
consideration that D-1 was only a family arrangement of the remaining
defendants. D-2 was running the business in the name of the company. So D-1
and D-2 were both personally liable.

5. Universal Pollution Control India (P.) Ltd. v. Regional Provident Fund

Commissioner[xxiv]– This is a case of ‘default in payment of employee’s
provident fund’- Certain amount was due and payable to provident fund office
by the sister concern of the petitioner-company, a demand was raised on the
petitioner company only on the ground that two directors of these two
companies were common. It was held that the contention raised by the
respondent that the Court should lift the corporate veil and fasten the liability
on the petitioner was without any merits and was baseless. Both the
companies were separate legal entities under the provisions of the
Companies Act and there was no provision under the Provident Fund Act that
a liability of one company can be fastened on the other company even by
lifting the corporate veil.
 6. The Decision of Karnataka High Court. Decided On 24.03.2011 – Richter
Holding Ltd. v. The Assistant Director of Income Tax[xxv]– Richter Holdings
Ltd., a Cypriot company and West Globe Limited, a Mauritian company
purchased all shares of Finsider International Co. Ltd. (FICL), a U.K. company
from Early Guard Ltd. another U.K. company. FICL held 51% shares of Sesa
Goa Ltd. (SGL), an Indian company. The Tax department issued a show cause
notice to Petitioner alleging that the Petitioner had indirectly acquired 51% in
Sesa Goa Ltd and was therefore, liable to deduct tax at source before making
payment to Early Guard Limited. The Income Tax Department contended that
as per section 195 of the Act, the Petitioner is liable to deduct tax at source in
respect of payment made for purchase of capital asset. The High Court of
Karnataka held that the Petitioner should reply to show-cause notice issued
by the Tax department and urge all their contentions before it. The High Court
also emphasized that the fact finding authority (Tax Department) may lift the
corporate veil to look into the real nature of the transaction to ascertain the
vital facts.

The aspect that deserves greater attention is that the Karnataka High Court
demonstrates a keen interest in lifting the corporate veil. This has a number of
implications. First, the Richter Holding Case extends even further the scope of the
principles laid down in the Vodafone Case. For example, in Vodafone the Bombay
High Court did not consider lifting the corporate veil to impose taxation in case of
indirect transfers. Second, it is not clear from the judgment itself whether the tax
authorities advanced the argument regarding lifting the corporate veil. Third, the
Karnataka High Court appears to have readily permitted lifting the corporate veil
without at all alluding to the jurisprudence on the subject-matter. Generally, courts
defer to the sanctity of the corporate form as a separate legal personality and are
slow to lift the corporate veil, as evidenced by Adams v. Cape Industries[xxvi], unless
one of the established grounds exist.[xxvii]

CONCLUSION
It should be noted that the principle of Salomon v. A. Salomon & Co. Ltd.[xxviii] is still
the rule and the instances of piercing the veil are the exceptions to this rule. The
legislature and the courts have in many cases now allowed the corporate veil to be
lifted. The principle that a company has its own separate legal personality of its own
finds an important place in the Constitution of India as well. Article 21 of the
Constitution of India, says that: No person shall be deprived of his life and personal
liberty except according to procedure established by law. Under Article a company
also has the right to life and personal liberty as a person. This was laid down in the
case of Chiranjitlal Chaudhary v. Union of India[xxix] where the Supreme Court held
that fundamental rights guaranteed by the constitution are available not merely to
individual citizens but to corporate bodies as well except where the language of the
provision or the nature of right compels the inference that they are applicable only to
natural persons.

So, a corporation can own and sell properties, sue or be sued, or commit a criminal
offence because a corporation is made up of and run by people, acting as agents of
the company. It is under the ‘seal of the company’ that the members or shareholders
commit fraud or such acts and therefore the company should also be liable as it also
a person which is accorded fundamental rights under Article 21 of the Constitution
of India.

The other side of this coin can be that, as the company is privileged to have its own
right to life and personal liberty, how can its fundamental right be taken away by
disregarding its corporate entity for the wrongs committed by its members and not
the company itself.

As a result of incorporation, an incorporated company wears a ‘corporate veil’ and

thus acquires the ‘corporate personality’, behind which there are shareholders who
have formed the company. Although in law the company has an independent
personality, it is an artificial person and hence, behind the corporate
curtain, there are natural persons, i.e. shareholders who have associated themselves
into a company. So if this corporate personality is uncovered or unveiled, the
shareholders or the directors mostly are found to be behind the veil.

Edited by Kanchi Kaushik

[i] [1897] AC 22 (House of Lords)

[ii] Guide to Companies Act, 17th edn 2010, part 1, A. Ramaiya, Pg 582

[iii] [1961] A.C. 12

[iv] (1949) 79 CLR 42

[v] See Sealy’s Cases and Materials in Company Law,9 th edn., Len Sealy, Sarah
Worthington;Oxford,Pg 53

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

[vii] [2009] 99 Comp. Cas. 266 (M.P)

[viii] [1973] New Delhi LR 637

[ix] Guide to Companies Act, 17th edn 2010, part 2, A. Ramaiya, Pg 3781

[x] [1969] 39 Comp. Cas. 685(Ker.)

[xi] http://www.business-standard.com/india/news/industry-welcomes-companies-
bill/458638/, visited on 28.09.2012 at 12:30 a.m.

[xii] (1905) 142 F, edn. 247

[xiii] [1916]2 AC 307

[xiv] [1933] 1 CH 935

[xv] [1953] 1 All ER 615 (Ch D)

[xvi] [1962] 1 All ER 442

[xvii] [1964] 34 Comp. Cas. 458(SC), AIR 1965 SC 40

[xviii] [1983] 54 Comp. Cas. 66 (Del)

[xix] [1986] 59 Comp. Cas. 368 (Guj)

[xx] [2000] 101 Comp. Cas. 257 (SC), [2000] 3 SCC 312

[xxi] [2000] 6 Comp LJ 377

[xxii] [2004] 122 Comp. Cas. 468 (SC)

[xxiii] [2006] 133 Comp. Cas. 495

[xxiv] [2007] 137 Comp. Cas. 319 (Bom.)

[xxv][ 2011]199 TAXMAN 70(Kar.)

[xxvi] Supra note 21.

[xxvii] ‘Lifting the corporate veil for tax purposes’ by V. Umakanth

[xxviii] Supra note 1

[xxix] [1951] 21 Comp. Cas. 33