The company is a separate legal entity, different from its members. It has independent legal existence. Its assets are not the assets of the members, nor is its liability or the debts to be discharged by the members. It has been noted in Salomon v. Salomon & Co., that even if one person and his family members contribute to the whole of the capital and have control over the business, yet the members and the company are different persons, separated by corporate veil.
The character of a body corporate was explained by the Supreme Court in Tata Engineering & Locomotive Co. Ltd. V. State of Bihar, as follows:
“The corporation in law is equal to a natural person and has a legal entity of its own. 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 separate and distinct from those of its members; it can sue and be sued exclusively for its own purpose; its creditors cannot obtain satisfaction from the assets of its members; the liability of the members or shareholders is limited to the capital invested by them; similarly, the creditors or the members have no right to the assets of the corporation.”
Lifting the Corporate Veil
In some exceptional cases the corporate veil may be lifted and corporate personality of the company may be ignored and the principle of piercing the corporate veil may be applied in the interest of justice. The courts may look at the things as if the company did not have separate corporate existence.
When a Statute contemplates the lifting of the corporate veil, or when corporate personality of a company is being misused to do something unlawful or improper, e.g., to avoid tax, to commit fraud, etc, the fundamental principle of corporate personality may be disregarded, and the courts may look beyond the veil in the interest of justice. Various Situations, when the lifting of corporate veil has been considered to be justified, are being discussed below :
1. When corporate personality used as an instrument of fraud
When the corporate entity is being used as an instrument of fraud, the principle of corporate personality may be disregarded and the doctrine of piercing the corporate veil may be applied in the interest of justice. This may be illustrated by the Delhi High Court decision in PNB Finance Ltd. V. Shital Prasad Jain.
In this case, the defendant No. 1, Shital Prasad Jain, who was financial adviser of the plaintiff company (PNB Finance Ltd.) took loan from the plaintiff company to the extent of Rs. 15 lakh representing that the loan was needed for the purpose of purchasing i….novable property in Delhi. The loan was sanctioned to S.P. Jain on the condition that he would deposit the title-deeds of the property with the plaintiff company, as security. S.P. Jain did not repay anything towards the principal and interest, but diverted the amount to three public limited companies floated by him and his son, Mukul Jain. The funds diverted to these three public companies were utilised by them in purchasing immovable properties in Delhi. The plaintiff brought an action against defendant No. 1 his son and the three companies to whom the funds had been diverted. It was contended that the defendant No. 1 had committed the fraud by not purchasing property in his own name and diverting the same to the three companies, and the three companies were sought to be made liable for repayment of loans on the ground that the properties were held by them for the benefit of the plaintiff. It was held that it was a fit case for the grant of an interim relief to the plaintiff by restraining the three defendant companies from in any manner alienating, transferring or disposing of or encumbering the properties in question, i.e., the properties purchased by them with the funds diverted by the dependent No. 1 to these companies.
2. The company is used as a mere cloak or sham
When the corporate personality of a company is being used as a “cloak or sham” for doing an unlawful act, the courts will look behind the corporate veil to know the reality.
In Subhra Mukherjee v. Bharat Cooking Coal Ltd.,¹ there was nationalisation of coal mines by passing of the Coal Mines (Nationalisation) Act, 1973, which came into force w.e.f. May 1, 1973, whereby the right, title and interest in certain coal mines vested in the Central Government, through Bharat Coking Ltd. (BCCL).
Nichitpur Coal Company Pvt. Ltd. Executed sale deed on March 20, 1972 making sale of the company’s immovable property in favour of the appellants, who were the wives of the two directors.
Lifting veil
The appellants did not hand over the possession of the suit property to BCCL. Being faced with the eviction proceedings, the appellants filed suit against BCCL for declaration of their title to the property.
It was held that the transaction of sale in favour of the appellants was a sham. In fact, the property alleged to be sold in favour of directors’ wives of a private company remained the property of the company and thus the said property vested in BCCL on nationalisation of coal business, the decision of the Patna High Court to the above effect was upheld by the Supreme Court, and appeal against the decision of the High Court was dismissed.
3. When the cloak of corporate personality is used for circumventing tax obligations or to evade tax or avoiding welfare legislation
Although from the juristic point of view the company is a legal personality entirely distinct from its members, but “in certain exceptional cases, the court is entitled to lift the veil of corporate entity and to pay regard to the economic realities behind the legal façade. For example, the court has power to disregard the corporate entity if it is used for tax evasion or to circumvent tax obligations.Lifting the corporate veil has also to be there when the device of corporate personality is used to avoid some welfare legislation.”
In State of U.P. v. Renusagar Power Co., Hindalco, an aluminium factory in U.P. established a subsidiary company, named Renusagar Power Co. The former held 100% shares in the subsidiary company. The subsidiary company had been established only for the purpose of generating power and supplying the same to the holding company only. The question which had arisen in the case was, whether Renusagar would be Hindalco’s “own source of generation” within the meaning of Sections 3(1)© and of the Electricity (Duty) Act, 1952, and the duty was leviable only on that basis on electricity supplied by Renusagar to Hindalco. It was held that the corporate veil should be lifted and Hindalco and Renusagar treated as one concern, and Renusagar’s power plant had to be treated as “own source of generation” of Hindalco and duty was leviable only on that basis.
4. When the Statute itself contemplates the lifting of the veil
In L.I.C. of India v. Escorts Ltd., it has been held that when the lifting of the corporate veil is necessary or permissible under a certain statute, the courts may do that. But even in such a case the corporate veil may be lifted to that extent and for that purpose only, and no more.
It was held by the Supreme Court that in such a case lifting the corporate veil is necessary and permissible only to find out the nationality or origin of the shareholders of the foreign companies seeking to invest in shares of Indian companies.
It was further held that the lifting of the corporate veil could not be done more than as stated above, i.e., there could not be lifting of the veil to find out the individual identity of each of the shareholders. It was, therefore, observed that “merely because more than 60% of shares of the several foreign companies who have applied for permission are held by a trust of which Mr. Swaraj Paul and the members of his family are the beneficiaries, the companies can be denied the facility of investing in Indian companies.”
The Companies Act itself contains certain provisions which lift the corporate veil to determine the liability of the real forces of action. For example, section where a contract is made misdescribing the name of the company; every officer of the company who is in default and contravenes the provisions relating to audit and auditors under Sections 139 to 146 shall be punished; the business is carried on only to defraud the creditors; business is carried on beyond six months after knowledge that the membership of the company has gone below statutory minimum. Under Section 138 read with Section 141, Negotiable Instruments Act, 1881, directors, etc, of a company can be held criminally liable for dishonor of the company’s cheque.
5. Personal liability of persons fraudulently conducting company’s business during winding up (Sec. 339 of the new Act).
Section 339(1) contains the following provision for the personal liability of persons responsible for fraudulent conduct of business during the winding up of the company :
“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 creditors of the company or any other persons, or for any fraudulent purpose, the Tribunal may, if it thinks proper so to do, declare that any 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 Tribunal may direct. “
6. Separate corporate personality may be ignored in holding and subsidiary companies
When the relationship between any two companies is such that one of them is in a position to exercise a certain kind of control over the other company, it is known as the holding company and the controlled one as the subsidiary company. According to Section 2(87) of the 2013 Act, “subsidiary company” or “subsidiary”, in relation to any other company (that is to say the holding company), means a company in which the holding Company-
(a) controls the composition of the Board of Directors; or
(b) exercises or controls more than one-half of the total voting power either at its own or together with one or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.
The holding and its subsidiary are two distinct legal entities, and the holding or controlling company cannot be held liable for the acts of the subsidiary company.
7. Separate corporate personality may be ignored for determining the legal character of a company
In times of war the court may ignore the place of registration of the company and lift the corporate veil to see whether the company is being controlled by enemy aliens or not, and determine the enemy character of the company by that. In other words, the court may find out the natural persons who constitute and control the company by lifting the veil. In Daimler Co. Ltd. V. Continental Tyre & Rubber Co., Continental Tyre & Rubber Company was incorporated in England, but the holders of all its shares except one, and also all the directors, were Germans, residing in Germany. After the outbreak of the First World War, Continental Tyre Company brought an action against Daimler Co. Ltd. To recover trade debt. It was held by the House of Lords that though the Continental Tyre Company was incorporated in England, its effective control was in the hands of Germans and, therefore, the company had acquired the enemy character. Hence, it was not allowed to proceed with the action in English courts.
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