Explained: lifting the corporate veil

The author has understood the meaning and concept of undoing the Corporate veil in a generic way.

introduction

According to Section 2 (20) of the Companies Act, 2013A company is defined as a company registered under this Act or any other earlier corporate act in force.

A company may be incorporated in accordance with the provisions of Section 3 which provides for the formation of a company.

A company has the following functions:

  1. Incorporated association,
  2. Independent legal person,
  3. Common seal,
  4. Eternal existence
  5. Limitation of Liability, etc.

What is a corporate veil??

A company’s separate or independent legal entity is one of the most important and unique characteristics of a company.

A separate legal entity means that the promoters and owners of a company have a separate identity from that of the company. Official documents are signed on behalf of the company and not the organizer or owner. It protects the promoters and owners of a company from liability, unlike a sole proprietorship or partnership where the owners have unlimited liability.

If the company goes into debt or is involved in a violation of the law, the company’s liability, not the promoters or owners, so their liability is limited.

The purpose of the corporate veil doctrine is to ensure business effectiveness and convenience, since one of the attractive features of a company is limited liability. Limited liability means that each shareholder’s liability is to the extent of his or her ownership of the company.

So essentially, A corporate veil is something that separates the personality of a company from the personality of its shareholders and protects them from being personally liable for the company’s obligations.

One of the landmark cases in relation to the corporate veil is – Salomon v Salomon & Co. Ltd.[i]

Here, Mr. Salomon started the shoe and boot manufacturing business under the name “Salomon & Co. Ltd” and the company had seven shareholders who were his family members.

He, his wife, daughter and four sons were the company’s shareholders.

He sold his sole proprietorship business to the company and kept 6 of the shares and received £ 10,000 worth of bonds.

The company got into trouble and was unable to pay the interest on the bonds. Salomon made a claim on the grounds that he was a secure creditor and that the company had defaulted on its payments.

It was determined that the company’s debts were not Mr. Salomon’s debts as it was legally incorporated and both are separate legal entities.

Understand the lifting of the corporate veil

There may be instances when it is necessary to know who the people behind the corporate veil are, and in those cases the corporate veil must be lifted and the real culprits punished.

The courts usually lift the corporate veil when fraud has been committed, improper conduct, when the public interest is at large or when the sole purpose of starting the business is for tax evasion, etc.

Reasons for lifting the corporate veil

The circumstances under which the corporate veil can be lifted can be divided into two types:

Legal provisions:

  • § 45 – Reduction of membership below the legal limit: The minimum number of members or shareholders in a stock corporation is seven and in a private company two. If membership is lowered below that, the corporate veil must be lifted.
  • Section 147 – Incorrect description of name: If a company executive who signs a bill of exchange in which the company name is not mentioned in the prescribed manner, it is that executive, and not the company, that is liable.
  • Section 239 – Inspector’s Power to Investigate: This section provides the inspector’s power to investigate a company’s affairs for allegations of mismanagement, repression, etc.
  • Sections 307 and 308 – These Sections apply to any Director and a Director in charge. It is said that the nature of their participation must be indicated in the register of shareholders and failure to comply will result in the lifting of the corporate veil.

Judicial interpretations:

The following are the cases in which the judiciary can lift the corporate veil.

  • Tax evasion: If it is obvious that the company is trying to evade taxation, the courts can lift the company veil and punish those responsible.
  • Fraud: To prevent fraudulent activity or inappropriate behavior, the courts can lift the corporate veil. Since the fraudulent or inappropriate behavior cannot be committed by the company, which is an artificial legal person, the persons who manage it are responsible. in the Gilford Motor Company Ltd. against horns[ii]It was found that companies cannot be used by members as a cloak for their misconduct.
  • Determination of Hostile Character: In certain situations it is important to break the corporate veil, examine the characters of the people and determine if they are enemies of the country. in the Daimler Co. Ltd. against Continental Tire and Rubber Co. Ltd.[iii]– A company selling tires was established in England, the company was a German company and most of the control was held by German people. During the First World War, the England-based company embarked on a recovery process and it was eventually determined that the company was a hostile character and so the court decided to lift the corporate veil.
  • Liability for Ultra-Vires actions: Every company is obliged to only carry out the actions specified in its articles of association. However, when ultra-vires acts, which are the statutes, are carried out, the corporate veil must be lifted.

Conclusion

The one in Salomon against Salomon Co & Ltd. established principle is the rule, and the above legal and judicial provisions are an exception to the rule of the corporate veil.

A company’s separate identity is paramount, but there must be a balance and the corporate veil lifted whenever necessary.

[i] Salomon v Salomon & Co. Ltd. [1897] AC 22 (upper house)

[ii] Gilford Motor Company Ltd v Horne [1933] CH. 935 (CA)

[iii] Daimler Co. Ltd. against Continental Tire and Rubber Co. Ltd. 53 SLR 845

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