Separate legal entity, lifting & piercing of the corporate veil

Name- Yamini Shekhawat

Institution- Mody University of Science and Technology

Course- B. Com LL. B

Branch- Law

Email I’d- yaminishekhawat2001@gmail.com

ABSTARCT

If we dig deep into the world of Corporate, one of its most crucial and controversial topics is “The Principle of Corporate Veil”.

The ‘Principle of Corporate Veil’ is based on the legal principle of ‘Separate Legal Entity’. According to the legal concept of Separate Legal Entity, the personality of corporate’s is different from the personality of its shareholders, members, directors etc.

But, in order to determine the liability of the persons hiding behind the veil, in the circumstances where the corporate is found guilty of any offence or fraudulent conduct, this legal principle of corporate veil can be lifted by the courts of competent jurisdiction. 

As corporates are considered as artificial persons, they are not capable enough to attract Mens Rea, to charge with the criminal liability. So, the question arises that whether they (corporates) can be held criminally liable or not? 

INTRODUCTION 

One of the most important concepts or we can say backbone of the company law is, the ‘Corporate Personality’ of the company. It is the corporate personality only which makes a company an entity and the result of which the company becomes an entirely distinct entity which has a separate legal entity from its members, shareholders, promoters, directors and many more. 

Therefore, as soon as a company comes into incorporation, an entity also gets created along with the incorporation of the company, which has separate entity from its members, employees, directors, shareholders, promoters etc. This has resulted into the birth of concept ‘Corporate Veil’. The main objective behind the establishment of this doctrine was to provide efficacy and convenience to the business. While using the doctrine of ‘Lifting the Corporate Veil’, the law goes beyond the veil of corporation in order to determine the real group of persons, behind the company. Even in the jurists have emphasised on the concept of lifting the corporate veil. According to the Gower’s Common Dictum, the courts have the power to lift the corporate veil when the company’s corporate personality is evidently being used as a tool to commit fraud, improper conduct or in case where the interest of the public is the main concern or where the only moto behind the formation of the company was to evade taxes. The corporation is rather deemed to be or considered as an association of persons, instead of as a legal entity, when it is used against the public interest or in order to commit fraud or any other sort of crime.

Earlier, courts were of view that the corporate being an artificial personality, is incapable of having mens rea, and therefore, criminal liability cannot be fixed.

But later, a totally different approach was adopted by the courts, where in the judicial pronouncements can be held against the corporates and they can be now criminally prosecuted.  

SEPARATE LEGAL PERSONALITY OF A COMPANY

The consequence of attributing a legal personality to a corporation is that it is distinct entity from its members and this “legal personality” is often described as an artificial person in contrast with a human being, a natural person. The corporation is subjected to certain right and duties which are completely not same as borne by its members, directors, shareholders, promoters, investors etc. The concept of ‘Separate Legal Personality’ of a company was established in the landmark case of Solomon v. Solomon & Co. Ltd.

This case was about a sole trader named, Solomon, who had a flourishing business as a leather merchant. Solomon sold his business of manufacturing to one another company named, Solomon & Co. Ltd. This company was also incorporated by Solomon. Solomon’s wife and his five children, being the other subscribers to the company, took up one share each. Solomon received debentures worth 10 thousand pounds. 

After sometimes, the business subsequently collapsed. A claim was made by Solomon, on the ground that the debentures were held as a secured creditor. On this claim made by Solomon, the liquidator argued that both the company and Mr. Solomon, were one and the same thing which means that the business was carried on the behalf of Solomon and thus, Mr. Solomon could not be ranked ahead of the other creditors of the company. 

The House of Lords after hearing from both the sides, finally held that the Solomon & Co. Ltd. was not fictitious, the debts of the corporation/company were not the debts of Mr. Solomon because the concept of ‘Separate Legal Entities’ applies here and thus, they were two separate legal entities. The house of Lords held that, “as soon as an artificial person is created, it must be treated like any other independent person, having its own rights and liabilities”.  

Solomon’s case has been the authority ever since in the decisions of the doctrine in Indian company cases.

In another case of Macura v. Northern Assurance Co. Ltd, it was pronounced by the House of Lords, that in the case of an insurance company, the insurer cannot be held liable for the insurance on property, that was insured by the Plaintiff, but being owned by the company, in which the Plaintiff held his all shares, which were fully paid.  

It was held by the House of Lords that in case of the said property, only the company is separate legal owner and not the plaintiff, who had the required insurable interest. The plaintiff, being a shareholder, did not have any legal or beneficial interest in that property merely because of his shareholding. 

EXCEPTIONS TO THE PRINCIPLE OF SEPARATE ENTITY 

     There can be two reasons behind classifying the exception into two segments: 

  • Firstly, though the corporation is considered as an ‘Separate Legal Entity’, it cannot be, in real sense, be treated as a natural person because the corporation is not capable to commit a crime or fraud or to deceive people, as they all require presence of guilty mind (mens rea), unless and until the court is court is capable to determine the intention and motive of the members, directors, shareholders, promoters etc.  
  • Secondly, in case if the principle is applied strictly, then it may result in unjust or misleading outcome, as the interested parties in the company, can camouflage themselves behind the veil of limited liability. 
  • It is even permitted by the Judiciary and Legislature, to disregard the legal principle of ‘Separate Legal Entity’, in cases where it’s applicability would result in injustice.

PIERCING OF CORPORATE VEIL 

In simple terms, ‘Lifting of Corporate Veil’, means disregarding the legal concept of Separate Legal Entity”, and peeping behind the veil to find out the real persons, having control over the company and thus indulging into dishonest and fraudulent acts in order to deceive the concerned public. The object behind lifting the corporate veil is to prevent such members of the company, to take shelter behind the veil of ‘Corporate Personality’. In such situations, the court has the power to break through or to pierce the corporate veil. 

“Piercing the Corporate Veil”, refers to a situation in which courts put aside limited liability and holds a corporation’s shareholders or directors personally liable for the corporation’s actions or debts. 

There are some situations and instances, where the courts have upheld this principle and have come up with this approach to break through the veil. But, when such corporation is mis-used by its members, directors, promoters etc., then the court also has the ultimate power to lift the veil of corporate personality and to peek into the realities behind the veil. In doing so, the court sub serves the important public interest, namely, to arrest misuse or abuse of benefit conferred by law. Thus, it is quite evident that ‘Piercing the veil’ law exists as a check on the principle that, in general, investor shareholders should not be held liable for the debts of their corporation beyond the value of their investment. 

APPROACHES ADOPTED BY THE COURTS TO LIFT THE VEIL 

The practice of lifting the corporate veil is accepted and adopted by the courts of competent jurisdiction, in different manners depending upon the circumstances and facts of the cases. There are four parameters which are taken into consideration by the court, while deciding the different cases. These are as follows –

  • Peeping Behind the Veil
  • Penetrating The Veil
  • Extending The Veil
  1. Peeping Behind the Veil:  The concept of Peeping behind the Veil, is used by the court to act with the information regarding shareholders of the company and their respective holding and shares, controllers of the company, inter-personal relationships etc. After collecting all this information, the veil is finally pulled down by the court and the company once again becomes a separate legal entity. 
  1. Penetrating The Veil:  In the concept of Penetrating the Veil, the courts approach the shareholders, controlling the company personally. The objective behind penetrating the veil, by the court, is to fix the roles and responsibilities of the shareholders, in relation to the acts of the company and for establishing their interest in the assets of company.

      Example-   Taxation, Tendency of War etc.

      Case – R v. London Country Council 

  1. Extending The Veil:  The concept of Extending the Veil, is adopted by the court for the purpose of extension to squeeze a bunch of companies. When a class or group of companies, comes together to carry out any common activity, then instead of referring to each and every company separately, one can count all of them as a single entity. This is known as ‘Extended Veil of Incorporation’.

     Case – DHN Food Distributors Ltd. v London Borough of Tower Hamlets

GROUNDS OF LIFTING THE CORPORATE VEIL 

There are various circumstances under which the Courts may lift the veil of corporation. The circumstances may broadly be grouped under the following two heads: 

  1. Under Statutory Provision –
  • Reduction of membership (Under section 45 of the Companies Act) 
  • Improper use of the name (Section 147(4)) 
  • In case of Fraudulent Conduct (Section 542) 
  • Failure of company to refund application money (Section 69(5)) 
  • Misrepresentation in prospectus (Section 62) 
  • Holding Subsidiary Companies (Section 212) 
  • Inspector to investigate the affairs of the company (Section 239) 
  • Investigation of Ownership 
  • Liability for ultra vires acts
  1. Under Judicial Interpretations –
  • Revenue Protection
  • Preventing fraud or improper conduct
  • Determination of enemy character of a company
  • When company acts as an agent for its shareholders
  • Economic offences
  • Where Company is a sham or cloak

CONCLUSION

Courts have been struggling since years to establish a balance between the legal concept of separate legal entity and interest of the public. The principle of ‘Lifting the Corporate Veil’, is thereby adopted and used by the courts to make sure that the justice is delivered. If this concept of lifting the veil of corporation is used in rigorous manner, then this will lead to an end of judicial discretion, which will automatically result in the defeat of the purpose of this principle. Till date, one of the most controversial and crucial subjects of the corporate law is ‘Piercing the Corporate Veil’. There are certain grounds which have been provided, where the corporate veil can be pierced such as in case of Fraud, Sham or façade, Unfairness, Deceiving People having interest in the company etc., but there is one thing that must be kept in mind that these grounds are not exhaustive, they are just guidelines and therefore it is inclusive in nature. Although, in certain cases, the corporate veil has been pierced by the courts to determine the identity of the real persons, responsible for the commission of offences such as frauds etc., the courts have also held through their judicial interpretation, that the corporates should not be treated differently from an individual and they must be kept on the same footing while fixing criminal liability and therefore even they can be criminally prosecuted.

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