A company form of business gives a formal structure to the business organisation and makes it a secure option for undertaking business operations. People usually incorporate a company because of its several benefits, namely, legal status, a separate entity, limited liability, etc., helping them to minimise risks and maximise profits. When a company is incorporated, it is treated as a separate entity and distinct from the members forming it. It also has a separate legal and official status before the law. These features of a company give a sense of protection and assurance to the owners against any risk or unlawful proceedings.
But it also, at the same time, gives them a chance to engage in fraud or any illegal activities and take share under the companies identity and status. To avoid such circumstances, the government has enacted laws and provisions and made exceptions where the Court or the Tribunal has the power to ignore the company’s distinct status and proceed with a suit against the owners or the members for the acts or offences committed by the company.
What is a Company?
A company form of business is regulated by the Companies Act 2013 and is defined under Section 2(20) of the Act as ‘a company incorporated under this Act or any previous company law’.
A company is not a natural person like a human being but is taken as a person in the context of law. It is an artificial person created by law having its own legal identity and a separate status where the company and its owners are not considered as same entities but two distinct personalities. As such, the company is held responsible for its own actions and practices and the members are merely acting on behalf of the company.
What is the Meaning of Doctrines in Law?
A doctrine represents a set of beliefs and the term originates from the Latin word ‘doctrina’, meaning ‘teaching or learning’.
A legal doctrine consists of rules, principles, theories, or procedures that are utilized to render judgments in legal cases. It can also refer to a principle, position, or body of principles in a branch of knowledge or system of belief, similar to dogma.
A legal doctrine is not a part of rules and regulations. Legal doctrine is a primary and firmly established judicial model for deciding cases. Legal principles affect all members of society, not just legal fraternities. Legal experts, policymakers, and other people rely on legal principles. The principles of justice reflect the state’s respect for justice, equity and the rule of law. Examples include the doctrine of alter ego, the doctrine of indoor management, the doctrine of lifting the corporate veil, and many others.
What is the Doctrine of Lifting the Corporate Veil?
According to law, every corporate body is identified as a separate entity with a distinct legal status from its members. This provides an imaginary veil that protects the corporates and members and is known as ‘the corporate veil’ in the legal parlance. It is under the shield of this corporate veil that a company can sue and be sued, own a property and enter into contracts like any other natural person.
However, this veil does not give an absolute cover and there are conditions or exceptions to this doctrine where the general rule or principle of artificial person and separate status shall not hold true. The Court may disregard the legal status of the company in situations where the Court thinks that the corporate identity has been used as a facade to navigate the attention from their illegal or unlawful activities. This is known as ’lifting’ or ‘piercing’ the corporate veil. When the veil is lifted, the company loses its status, and the owners or members are exposed to personal liability for the company’s acts and deeds.
The concept of “piercing the corporate veil” would mean a significant tenet of company law, which basically permits courts or regulatory authorities to disregard the legal status of a corporation and hold its shareholders or directors liable for the company’s actions. Under normal conditions, it is treated that the company and the shareholders are two different legal entities, which had been ruled by the court of law in the landmark case Salomon v. Salomon & Co. Ltd. back in 1897. However, such legal separation is sometimes overlooked in certain circumstances to avoid malpractice of the corporate form.
Causes or Grounds for Lifting the Corporate Veil
Courts would normally pierce the corporate veil in specific circumstances where justice and equity demand that it be done. General circumstances within which the separate legal personality of the company is exploited or abused are usually those circumstances in which grounds for lifting the corporate veil exist. Some of the common grounds for lifting the corporate veil include:
1. Deceit and improper conduct of business
In those cases where a corporation is used to commit fraud or other illegal activities, courts can pierce the corporate veil. The more egregious the fraudulent or criminal nature of the activity, the better the argument to pierce the corporate veil. For example, where a corporation is being used as a sham to defraud creditors or to engage in criminal conduct, where people seek shelter behind the corporate structure to avoid personal liability then, there is one such case, namely that of Gilford Motor Co. This was so in the case of Gilford Motor Co Ltd v. Horne (1933) when the court pierced the veil to restrain a person from using a company to break a restrictive covenant. Mr. Horne had formed a company to escape his contracts with Gilford Motors, which the court held was nothing but a sham to avoid liability.
2. Avoiding legal obligations
The veil of incorporation will be lifted by the courts if a company is established as a ploy to avoid some other antecedent legal obligation. In effect, the corporate form of organisation should not be used as a charade to avoid responsibilities or as a ruse to deceive creditors by avoiding any legal obligations. As regards Jones v. Lipman, 1962, Mr. Lipman attempted to circumvent a contract to sell a property by transferring it to a company created. The court saw through the corporate veil and held that the company was an illusion created to avoid a contract.
3. Tax evasion or avoidance
Where the courts find that a company is being used to evade tax obligations, they lift the corporate veil. While a company has been formed with the primary motive of evading taxes, courts will ignore its separate legal personality and place the liability in the hands of individuals behind the company. For reference, in the Commissioner of Inland Revenue v. Sansom (1921), the court declared that a company was an amalgamation only for tax avoidance purposes and thus a sham and set aside its corporate veil.
4. Agency relationship
Sometimes, a company acts as an agent for its owners or other stakeholders. When such is the case, the protections of law given to the corporate entity can be lifted in order to hold the principals liable for the action of the corporate entity. The courts pierce the corporate veil when they decide that the corporation is not an independent entity but a front or an agent of dominant shareholders.
5. Group companies
In some instances concerning group companies, courts might pierce the corporate veil to treat a parent company and its subsidiaries as one unit, especially if the evidence of misuse of the structure of the corporate body to avoid liability is evident. This is very common when a parent company uses the legal independence of its subsidiaries as an umbrella to shield itself from liability.
Not only does judicial intervention exist, but provisions in statutes are also provided that give room for exceptions where the corporate veil can be lifted. Different statutes provide for different cases where directors, shareholders, or even other people in control of the corporation should be liable personally for actions carried out by the company.
6. Company law
The Indian Companies Act 2013 makes provisions that refer to the directors in cases of fraudulent and wrongful trading, imposing a personal liability. Under the Insolvency and Bankruptcy Law, a person is personally liable if he is found to have carried on the business of the company with intent to defraud creditors. Sections 339-341 deals with wrongful trading. This section states that the directors can be vicariously liable against the wrongful trading petition if they carry on the business despite knowing that the company is insolvent.
7. Laws relating to the environment, health and safety
There are rules of these laws that directly hold people accountable when there are violations of environmental law or health and safety. For example, individuals such as directors or company officials who consensually agree to, aid or abet in or negligently fail to prevent a crime committed by the company can be held personally liable under the Environmental Protection Act 1986.
8. Employment law
In certain circumstances, employment law is also able to pierce the corporate veil. Such circumstances arise where business organizations take on incorporation with the ostensible object of avoiding obligations toward employees such as wages, pension payments, and separation pay. In such cases, the courts relieve the corporate structure and decide to enforce employee rights against those operating the business.
In order to prevent the misuse of the corporate structure, the doctrine of lifting the corporate veil comes to the rescue as an important tool. Generally, the courts do not pierce the corporate veil straightaway unless and until there is sharply defined and unambiguous evidence of abuse. Not only businesses but also the economy needs the basic corporate features of distinct personality and limited liability. It would go to the end of the rainbow to support these crucial doctrines.
Courts apply the doctrine of lifting the corporate veil on rare occasions and only on the ground and benefit of justice and is based only on the discretion of the Court according to the severity of the offence and conduct.
The courts have, therefore, in recent years adopted a more pragmatic approach towards cases of corporate abuse. Indeed, there has been an increasing tendency to consider the substance rather than the form of the cases, especially where multinational corporations or group enterprises are involved and cross-border transactions are involved. However, the courts have also impressed on the need to exercise caution in order not to invalidate the principle of separate corporate personality unless absolutely necessary.
Important Case Studies
Several landmark cases in India have applied the doctrine of piercing the corporate veil. These cases explain the situations in which Indian courts refused to respect the framework of a corporation and held individuals liable for any act committed under the name of the company. They depict various scenarios of when the doctrine has been applied primarily in fraud, tax evasion, or wrongdoing-related matters. However, this doctrine can be applied only in exceptional circumstances if it becomes a means to further justice.
1. State of U.P. v. Renusagar Power Co. (1988)
- Facts and issue – The State of Uttar Pradesh taxed electricity duty on Renusagar Power Co., which was a wholly owned subsidiary of Hindalco. Pleading from the premise that Renusagar was not an independent company but an organ or an instrument of Hindalco, it contended that Hindalco was liable to pay the electricity duty.
- Judgement order – In this case, the Supreme Court did not Pierce the Veil as it held that Renusagar was a bonafide independent legal entity and not merely an agent or a corporate sham of Hindalco. The court found that Renusagar was established for valid business purposes and, therefore, had a legal existence.
- Consequences – This case demonstrated that it is important for the instance of fraud or improper conduct to be sufficiently evident to lift the corporate veil.
2. Vodafone International Holdings BV v. Union of India (2012)
- Facts and issue – This was a tax dispute where the situation revolved around the attempt made by the Indian tax authorities to raise taxes on Vodafone for the purchase of shares of a company based in the Cayman Islands who itself is an owner of shares of an Indian company. Indian authorities contended that the transfer involved Indian assets and was thus taxable by Indian tax authorities.
- Judgement order – The court ruled that the corporate veil was not pierced and determined that the transaction involved two foreign entities, making Indian law not directly applicable to taxation. The court also established that the corporate structure was commercially viable under these arrangements.
- Consequences – This case made it clear that courts would not lift the corporate veil when the corporate structure was valid and had been established for genuinely valid purposes of business, rather than as a device for tax evasion.
3. Tata Engineering and Locomotive Co. Ltd. v. State of Bihar (1964)
- Facts and issue – Bihar State had levied sales tax on sales of products manufactured by Tata Engineering and Locomotive Company Limited (TELCO). TELCO contended that it was not liable to pay the tax since the sales were made by the distributor instead of the company itself.
- Judgment order – The Supreme Court upheld its ruling against TELCO and pierced its corporate veil to discover the actual relationship between the company and its distributor. In consequence, the court ruled that the distributor was not an independent body but only an agent for TELCO.
- Consequences – This case means that corporate structures are open to courts to look beyond them and decide on the real nature of business transactions, especially if it deals with tax evasion cases.
4. Life Insurance Corporation of India v. Escorts Ltd (1986)
- Facts and issue – In this case, the Indian company Escorts Ltd. issued shares to foreign investors despite the failure of the company to get its decision approved by the RBI. LIC argued that foreign investors were attempting to take control of the company through its corporate structure.
- Judgement order – The Supreme Court has ruled that LIC cannot challenge the foreign investment strictly on its grounds of shareholder status as the company was lawfully issuing shares. The court also refused to set aside the corporate form because the plaintiff had no intent to commit fraud or improper action.
- Consequences – This case established that structures of company forms should be disregarded only in the clear evidence of fraud and, therefore, brought to the limelight the independence of companies in matters of internal management.
5. National Textile Workers’ Union v. P.R. Ramakrishnan (1983)
- Facts and issue – The case was one of applying to represent the workers’ interest before the process of winding-up could take place in a company. Here, the court had to determine whether, in the light of the status given to such a company as a legal entity distinct from its owners, on their own being stakeholders, the workers had a right to participate in the process.
- Judgement order – On these facts, the Supreme Court held that the corporate veil could be pierced to allow workers to appear before the court in winding-up proceedings while placing emphasis upon the need for justice to listen to employees who were critical stakeholders to the matter as the court observed.
- Consequences – This case further expanded the application of the doctrine and brought it forward to protect the rights of employees during insolvency or winding-up proceedings by lifting the corporate veil.
Conclusion
This doctrine of lifting the corporate veil is an essential tool of law for the protection of companies. The courts can use this provision to prohibit the shareholder and directors’ wrong use of the structure of a company for profit or doing anything wrong against the public at large. Generally, company law holds that the shareholders and directors are distinct entities different from the companies themselves. However, the veil can be pierced in certain circumstances like fraud, sham incorporation, tax evasion, or breach of legal duties.
Moreover, it still continues to evolve, and courts apply it with reservation, always keeping in mind the conflicting interests between the maintenance of limited liability and the obligation to prevent injustice. In the complex corporate world today, the lifting of the veil of incorporation has the effect of preventing citizens from hiding behind the facade of incorporation to avoid accountability as companies operate across multiple jurisdictions with more sophisticated structures. Its application is, however, likely to be exceptional enough to preserve the underlying principle of corporate personality in most cases.
