CASES WHEN CORPORATE VEIL MAY BE LIFTED

For the protection of revenue. – Sir

Dinshaw Maneckjee Petit
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It was held that the company was formed by the Sir Dinshaw purely and simply
as a means of avoiding tax and company was nothing more than he himself.

It did no business, but was created simply as a legal entity to ostensibly receive
the dividends and interest and to hand them over to Sir Dinshaw as pretended
loan.
Prevention of fraud– Jones v
Lipman
L agreed to sell a certain land to J. he
subsequently changed his mind and to avoid the
specific performance of the contract, he sold it
to a company which was formed specially for the
purpose. The company had L and a clerk of his
solicitors as the only members. J brought an
action for the specific performance against L
and the company.
The court looked to the reality of the
situation, ignored the transfer and
ordered that the company should
convey the land to J.
Prevention of improper conduct– Gilford motors v horne
f
o
r
m
e
d

Co.
Where the company is a sham – Gilford Motors Co. Ltd. v Horne
–
H a former employee of a company was subject to a covenant
not to solicit its customers.

He formed a company to carry on a business which if he had

done so would have been a breach of contract.

An injunction was granted both against him and the company

to restraint them from carrying on the business.

The company was described in this judgement as device a

stratagem and as a mere cloak or sham for the purpose of
enabling the defendant to commit a breach of his covenant
against solicitation
Determination of character of a company whether it is enemy – Daimler
Co. Ltd v Continental Tyre & Rubber Co. Ltd.

A co. was incorporated in England for the purpose of selling in England

Tyres made in Germany by 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.

During the First World War the English company commenced an action for
recovery of trade debt.

It was held that the company was alien company and payment of the
debt to it would amount to trading with the enemy and therefore the
company was not allowed to proceed with the action
UNDER STATUTORY PROVISION

 Mis-statement in the prospectus [s 34 and 35]

 Failure to return application money [s 39]
 Misdescription of Name [s 12]
 For facilitating the task of an inspector appointed under section 210 or 212 or 213
 Fraudulent Conduct [339]
 Liability under other Statutes.
FORMATION OF A COMPANY
The formation of a company involves 3 main
stages

1. Promotion of a Company

2. Incorporation by Registration and

3. Commencement of Business
PROMOTION OF A COMPANY
Before a company is formed there must be some
persons who have an intention to form it and take
necessary steps to bring it into existence.

The person who initiates the process of formation of

a company are called as PROMOTERS.
The first person who control a company’s affairs are its
promoters.

It is they who conceive the idea of forming the company,

with reference a given object and then to set it going.

It is they who take the necessary steps to incorporate the

company – provide it with share and loan capital and
acquire the business or property which it is to manage.

When these things have been done they handover the

control of the company to its directors who are often the
promoters themselves under a different names.
The promoter of a company decides its name and ascertains
that it will be accepted by the registrar of the companies.

He settles the details of the company’s Memorandum and

Articles, the nomination of directors, solicitors, bankers, auditors
and secretary and registered office of the company.

He arranges for the printing of the Memorandum and Articles,

the registration of the company, the issue of prospectus.

He is in fact responsible for bringing the company into existence

for the object which he has in view.
PRE-INCORPORATION
CONTRACT
Pre-Incorporation Contracts are those which
are purported to be made on behalf of a
company before its incorporation

The question therefore arises whether

company can be held liable for such
contracts.
 The true legal position in respect of pre-incorporation contracts
may be discussed under following two heads:

1. Position before 1963

2. Position after 1963

Position before 1963

A Pre-incorporation contract never binds a company as a

person cannot contract before his or its existence and a
company before incorporation has no legal existence.
Even where there is a request purported to
enforce such a contract, the company cannot
be bound because ratification is not possible as
the ostensible principal did not exist at the time
the contract was made
The company is also not entitled to sue on a pre-
incorporation contract
Position after 1963
Specific Relief Act 1963
Section 15 provides that where the
promoters of a company have made a
contract before its incorporation for the
purpose of the company, the company
may enforce it.

Section 19 also allows the other party to

enforce the contract against the
company.
REGISTRATION OF COMPANY
Registration of a company is obtained by filing an
application with the registrar of companies.

The application should be accompanied by the following

by the following documents :

1. Memorandum of Association
2. Articles of Association
3. A copy of the agreement, if any, which the company
proposes to enter into with any individual
4. A declaration that all the requirements of the Act have
been complied with.
MEMORANDUM OF ASSOCIATION
The first step in the formation is to
prepare a document called the
memorandum of association.

This contains the constitution of the

company.
OBJECTS, POWERS AND ULTRA
VIRES.
 The objects clause has a two – fold operation.

 It determines affirmatively the field of industry within which the

corporate activities are to be confined and

 It determines negatively that nothing shall be done beyond that

field.
The company was held not liable.

Their Lordships were of the opinion that general terms like

“general contractors” must be taken in reference to the
main objects of the company, because otherwise the
memorandum would authorise every kind of activity and
would be meaningless.
 The doctrine of ultra vires has been upheld in a large number
Lakshmanaswami Mudaliar v
of Indian cases also.

LIC
 It is significant to note that the doctrine of ultra vires confines
corporate action within fixed limits.

 Which resulted in long list syndrome.

 In case of Cotman v Brougham, the House of Lords ruled that
such an act will defeat the very purpose of object clause and
therefore, the courts should adopt the ‘main object rule’ of
construction while applying the ultra vires doctrine.
CAPITAL CLAUSE

 Amount of authorised capital with the company gets

registered
ALTERATION OF MEMORANDUM

 Alteration is allowed only when it is necessary for any of the

following purposes:
1. To enable the company to carry on its business more
economically or more efficiently.
2. To enable the company to attain its objects by new and
improved means.
3. to amalgamate with any other company or body or person.
The articles of association of a company and its
bye laws are the regulations which govern the
management of its internal affairs and the conduct
of its business.

They define the duties rights powers and authority

of the share holders and the directors in their
respective capacities and of the company

The mode and form in which the business of the

company is to be carried out.
The Articles of association of a company have a
contractual force between company and its
members as also between the members inter se
in relation to their rights as such members.

They are subordinate to and are controlled by

memorandum of association.
Articles of association can not supersede
the objects as set out in memorandum of
association.

The memorandum lays down the objects

scope and powers of the company,
where as the articles governs the ways in
which the objects of the company are to
be carried out.
ALTERATION OF ARTICLES

Subject to the provisions of the Act and to the

conditions contained in its memorandum, a
company may, by special resolution alter or add
to its articles.
 The alteration must not exceed the powers given by the
memorandum or conflict with other provisions of the
memorandum

 The alternation must not be inconsistent with any provision of the

Companies Act or any other statute.

 The altered articles must not include anything which is illegal, or

opposed to public policy or unlawful

 The alteration must be bonafide for the benefit of the company as

a whole.
 The memorandum and articles, when registered become
public documents and then they can be inspected by anyone
on payment of a nominal fee.

 Every person dealing with the company is presumed to have

read these documents and understood them in their true
perspective. This is known as Doctrine of Constructive Notice.
 Indoor management restricts the operation of “constructive
notice” to the public documents of the company.

 Accordingly a person dealing with the company is bound to

read only the public documents of the company.
 If his contract is consistent with them, the company is bound.

 He will not be affected by any irregularity in the internal

management of the company.
 The directors of the company borrowed a sum of money from
the plaintiff. The company’s regulations provided that the
directors might borrow on bonds such sums as may from time
to time be authorized by shareholders’ resolutions. The
shareholders contended that there had been no such
resolution authorizing the loan.
 The company was held liable once it was found that the
directors could borrow subject to a resolution, the plaintiff had
the right to assume that the necessary resolution must have
been passed
 The rule is based on the reason –
The internal procedure is not a matter of public knowledge.
An outsider is presumed to know the constitution of a
company, but not what may or may or have taken place
within the doors that are closed to him.
 The rule is applied to protect persons contracting with
companies from all kinds of internal irregularities.
 The rule is, however to certain limitations:
1. Knowledge of the irregularity
 Howard v. patent Ivory Co.
 The articles of the company empowered the directors to
borrow up to £1,000. They could exceed the limit of £ 1,000
with the consent of the company in general meeting. Without
such consent, they borrowed £ 3,500 from themselves and
took debentures. The company refused to the amount.
2. NO KNOWELDGE OF ARTICLES
 Rama Corporation v Proved Tin & General Investment

 T was a director in the investment company. He purporting to act

on behalf of the company, entered in to a contract with the
Rama Corporation and took a cheque from the latter. The articles
of the company did provide that the Directors could delegate
their powers to one of them. But Rama Corporation never read the
articles. Later, it was found that the directors of the company did
not delegate their powers to T. Plaintiffs relied on the rule of Indoor
Management.
 It was held that they could not, because they did not know the
existence of the power to delegate.
3. Void or illegal Transaction – the rule does not apply to
transactions which are void or illegal ab initio. E.g., forgery.
4. Negligence - If an officer of a company does something
which would not ordinarily be within his powers, the person
dealing with him must make proper inquiries and satisfy
himself as to the officer’s authority. If he fails to make inquiry,
he cannot rely on the rule.
PROSPECTUS

 A Public company may issue securities-

 To public through prospectus

 Through private placement
 A private company may issue securities –

 Through private placement

 Prospectus is a document described or issued as prospectus or any
notice, circular, advertisement or other document inviting offers from
the public for the subscription or purchase of any securities of a body
corporate.

 Prospectus must be in writing. An oral invitation to the public to

subscribe in or debentures of a company is not a prospectus.

 Likewise advertisements in television or film is not treated to be

prospectus.
 A document is not a prospectus unless it is an invitation to the public to subscribe
for shares in, or debentures of, a company.
 But if the document satisfies the condition of invitation to the public (Nash v Lynde)
 An advertisement which stated that “some shares are still available for sale
according to the terms of the company which may be obtained on application” was
held to be a prospectus as it invited the public to purchase shares (Pramatha Nath v
Kali kumar Dutt).
 If the invitation is made to a small circle of friends of the directors or the existing
shareholders it is not an offer to the general public.
 Prospectus is the window through which an investor can look into the
soundness of a company’s venture. The investor must therefore be given a
complete picture of a company’s intended activities and its position.

 This is done through prospectus which must secure the fullest disclosure
of all material and essential particulars and lay the same in full view of all
intending purchasers of shares.
 In order to finance its activities a company needs capital which is raised by
a public company by issue of a prospectus inviting offers for shares and
debentures from the public.

 A private company is prohibited from making any invitation to the public to

subscribe for any shares in or debentures of the company. Hence it need not
issue a prospectus.
 The central theme of a prospectus from the money raising point of view is
that it sets out the prospects of the company and the purpose for which the
capital is required.

 The prospectus is the basis on which the prospective investors form their
opinion and take decisions as to the worth and prospects of the company.
Misstatements in prospectus and their consequences

 If there is any misstatement of a material fact in a prospectus there may

arise –

 Civil liability

 Criminal liability
CIVIL LIABILTY

 A person who has been induced to subscribe for shares (or debentures) on
the faith of a misleading prospectus has remedies against the company, and
the directors, promoters and experts.
 Remedies against company –
 If there is a misstatement or withholding of a material information in a
prospectus, and if it has induced any shareholder to purchase shares he can
-
1. Rescind the contract
2. Claim damages from the company whether the statement is fraudulent or an
innocent one – (Damages for deceit) Derry v Peek
 The Statement must be untrue (Rex v Lord Kylsant)–
 A prospectus was issued by a company stating that the company had paid a
dividend every year between 1921 and 1927 (years of depression) and thus
giving the impression of a financially stable company. However the
company had in each of those year incurred considerable trading losses.
This fact was suppressed. It was held that the prospectus was ‘false in
material particular’ in that it conveyed a false impression.
 Remedies against the directors, promoters and experts –
 The persons who are liable to pay compensation for any loss or damage to
subscribers for any shares or debentures on the faith of a prospectus
containing misleading statements are:
 Director of the company at the time of the issue of the prospectus;
 Person who have authorised themselves to be named as directors in the
prospectus;
 Promoters;
 Persons who have authorised the issue of the prospectus;
 Expert
Criminal liability

 Where a prospectus contains any untrue statement, every person who

authorised the issue of the prospectus is punishable with imprisonment or
with fine or with both.