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2.5 Lifting of Corporate Veil
The term “Lifting of Corporate Veil” means ignoring the separate legal entity of the company,
and looking in to the realities. It is an important doctrine in the company law according to which
in certain circumstances, the separate legal entity of the company is not taken in to the account.
The company and its members are treated as one person.
We know the chief characteristics of a company is that it is a separate legal entity independent
and different from its members. And also to this characteristic, many other advantages are
enjoyed by the company. The fact is not denied that, by fiction of law, a company is a separate
legal entity, independent and different from its members. But in reality, it is an association of
persons, who are in fact the beneficial owners of all the corporate property (i,e, companies
property ). As a matter of fact, the business of a company is carried on by some human beings
who are the ultimate beneficiaries of corporate advantages. Due to separate legal entity of the
company, these real beneficiaries behind the company are disregarded once they have formed a
company and given to their association the status of legal entry.
Ordinary, the separate legal entity of the company is to be respected. As a matter of fact, the
whole law of corporation is based on the principle of corporate personality ( i e, separate legal
entity ) of a company. However, the statutory privilege of separate personality of the company
must be used for legitimate business purpose only. Sometimes, it becomes necessary to find out
the real person who control the company e.g., in case when this corporate personality (legal
entity) of the company is misused for fraudulent or improper conduct or for doing things against
public policy. In such cases, the courts ignore the separate entity. In other words, the corporate
veil of the company probed into and lifted up. This however, is the discretionary power of the
court, and will depend upon the underlying social, economic and moral factors as they operate in
and through the company. When the corporate personality of a company is used as a shield to
cover its wrong doings, such as for evasion of tax, the court may lift the corporate veil.
[(BSN (UK) Ltd. v . Janardan M. Rajan Pillai. (1996) 86 Comp. Cas 371 (Bombay)]
The cases, in which the corporate veil is lifted i.e , the separate legal entity of the company is
ignored, may be discussed under the two heads namely:
1. Judicial interpretations
2. Express statutory provisions
2.6Lifting of corporate veil under judicial interpretations
Following are some of the judicially decided cases in which the corporate veil is lifted i.e , the
separate legal entity of the company is ignored:
1. Determination of character of the company: Sometimes, it becomes necessary to
determine the character of a company e.g., to see whether it has assumed as enemy
character. The doubts may arise that the company is owned and controlled by the enemies
of the country. In such cases, the court may lift the corporate veil (i.e., ignore the separate
entity of the company) and examine the character of the persons who are in real control
of the company affairs. As a matter of fact, the lifting of the corporate veil in such cases
is necessary because trading with an enemy is against the public policy.
EXAMPLE 2.12, A company was incorporated in England for the purpose of selling
tires manufactured in German Company. The bulk of the shares in English Company
were held by the German company. And the remaining shares (except one) were held by
the German residing in German. Thus, in fact, the real control of the England Company
was in German hands during the First World War, the English company brought legal
actions to recover the trade debts. The question arose whether the English company had
become an enemy company and, therefore, should not be allowed to proceed with the
action. It was held that the company has assumed an enemy character, and was debarred
from maintaining the action i.e., it it was not allowed to proceed with the action.
[Daimler Co. Ltd. v. Continental Tyres Rubber Co. (1916) 2 AC 307]
In the above case, the following observations of the House of Lords are worthnoting:
“Company is not a natural person with a mind or conscience. It can be neither loyal nor
disloyal. It can be neither friend nor enemy. But it may be assume an enemy character
when persons in the facto control of its affairs, are residents in any enemy country, or
wherever resident, are acting under the controls of enemies.”
2. Protection of revenue: Sometimes, the lifting of corporate veil is necessary for the
benefit of revenue, e.g., where the separate entity of the company (i.e corporate entity) is
used for the evasion of tax. In such cases, the court may lift the corporate veil (i.e., ignore
the separate entity of the company), and the incomes of the company and its members
may be taxed as that of one person.
EXAMPLE 1.13. A, assessee, was a wealthy man receiving huge dividend and interest
incomes. He formed four companies and transferred his investments (from which he was
receiving dividends and interest income) to these companies. Thereafter, the income
received from A’s investments are credited to the accounts of companies, but the
companies handed back the same to A as a pretended loan. In this way, A dividend has
income into four parts, and reduce his tax liabilities. It was held that the companies were
formed by A purely and simply as a means of avoiding his tax liabilities., and the
companies were nothing more than the assessee himself. In this case, the companies were
created as legal entities simply, for the purpose of receiving the dividends and interest
from A’s investments, and then handling over the same to him (A) as pretended loan.
[Re Sir Dinshaw, Maneekjee Patil, AIR 1927 Bombay371]
It may, however be noted that the members themselves are not allowed to claim that they
should be regarded as economically identical with the company, particularly when this is
not in the interest of justice.
EXAMPLE 2.14., A was a shareholder of tea company. Under the Income Tax Act then
in force, the income of the tea company was exempted from tax up to 60% as
agricultural income, and 40% was taxed as income from manufacture and sale of tea. A
received certain amount as dividend in respect of the shares held by him in the company.
He claimed that this dividend income should be regarded as agricultural income up to
60% and should be exempted from tax. It was held that although the income in the hands
of the company was particularly agricultural, but the same when received by the
shareholders could not be regarded as agricultural income.
[Bacha F. Guzdar v. The Commissioner of income Tax, Bombay, AIR 1955 SC 74]
3. Protection of companies own justified interest: Sometimes, a company, itself, wants
that its separate entity should be ignored and treated alike with the members. In such
cases, the court may lift the corporate veil i.e., ignore the separate identity of the
company if it is in company’s own interest. Thus, the corporate veil may be lifted for
company’s own benefit if the court thinks it to be justified. The Honourable Supreme
Court of India has taken this view in a case, which is illustration below;
EXAMPLE 2.15, A firm of transporters was a tenant in the premises belonging to A, the
landlord. After sometime, certain differences arose among the partners, and consequently
the firm was split up into two firms. Each firm agreed to operate in the area allocated to
it, and a condition was attached that one firm could not enter upon the area of the other.
In the course of time, one of the firms floated a private limited company. Both, the firm
and the company had their offices in the same premises in which the original firm was a
tenant. The landlord of the premises filed an eviction petition (i.e., for vacation of the
premises) against the original firm of the ground that it hand handed over (i.e., sublet or
assigned) the possession of the premises to a private limited company, which is a separate
legal entity, without obtaining his (landlords) consent. And thus, there is a violation of
the premises by the firm of the company. The Supreme Court observed that the company,
thought a separate legal entity, was in fact a creature of the partners of the firm and was
the very image of the firm. The limited company and the partnership firm were two only
in name but one for practical purposes. There was substantial identity between the limited
company and the firm.
[Madras Bangalore Transport Co, (West) v. Inder Singh, (1986) 3 SCC 62)
Thus, in this case, the court ignored the separate legal entity of the company. It, therefor,
follows that lifting of corporate veil is not always to the disadvantages of the company’s
promoters. In New Horizons Ltd. v. Union of India, (1995) I SCC 478 ; (1997) 89 Comp.
Cas. 849 (SC), the Supreme Court has gain upheld this view. In this case, the court lifted
the veil and held that where the joint – venture sponsers of the company were qualified
for participating in a government tender, their company should also be treated as a
qualified tenderer.
4. Avoidance of legal obligations imposed by welfare legislation: Sometimes, it appears
to the court that the company is formed just to avoid the legal obligations imposed by a
welfare legislation. In such cases, the court may lift the corporate veil i.e., ignore the
separate entity of the company. e.g., where in order to reduce the liability to pay bonus to
its workers, the company splits up its profits by creating another company, the court may
refuse to recognise the new company. In fact, the legislation requiring the payment of
bonus to workers is for the welfare of the workers, and the company should not be
allowed to escape liability imposed by such legislation. The avoidance of welfare
legislation is as common as avoidance of taxation, and the approach of the court in
considering problems arising out of such avoidance has necessarily to be the same as
avoidance of taxation. This has been recognized by the Supreme Court as a evident from
the following example.
EXAMPLE 2.16, A company was earning handsome profits, and therefore its liability to
pay bonus was also high. In order to split up the profits into two hands and thereby to
reduce its liability to pay bonus to the workers, the company created another company as
its subsidiary, and transferred some of the investments and securities for the new
company. The Supreme Court held that the purpose of working out of the amount of
bonus payable by the former company to its workers, the separate existence of the new
company would be disregarded. The Court observed as under;
“If we look at the facts of the case, what do we find? A company is credited wholly
owned by the principle company with no assets of its own except those transferred to it
by the principle company, with no business or income of its own except receiving
dividends from shares transferred to it by the principal company and serving no purpose
whatsoever except to reduce the gross profits of the principal company”.
[Workmen of Association Rubber Industries Ltd. v. Association Rubber Industry Ltd.,
(1986) 59 Company Cases 134 (SC) : AIR 1986 SCI]
5. Avoidance of contractual obligation: Sometimes, a company is formed simple to avoid
the obligations arising out of contracts. In such cases, the court may lift the corporate veil
i.e., ignore the separate entity and decide the case assuming that no company is in
existence.
EXAMPLE 2.17. A and B were carrying on an auto parts business in partnership. They
sold their business to C and agree not to start a competitive business for two years.
Immediately thereafter, they (i.e., A & B) wanted to start the similar business. In order to
avoid the contractual obligation of not to start a similar business for two years, they
formed a private limited company, became the major shareholders and directors, and
started the similar business. In this case the court may ignore the separate entity of the
company and restrain it from starting the similar business. Here, it is clear that the
company has been formed by A and B simple to avoid their contractual obligation with
C.
6. Prevention of fraud or improper conduct: Sometimes, it appears to the court that the
company is formed for some fraudulent or improper purpose e.g., to defraud creditors, to
avoid legal obligations, or to defeat the provisions of law. In such cases, the court may
lift the corporate veil i.e., ignore the separate entity of the company. Thus, where the
company is a mere sham i.e., formed to deceive or defraud, the court will lift the
corporate veil and look into the ownership of the company.
EXAMPLE 2.18, A borrowed a huge amount of money in his own name from B and
Co., a finance company. He formed three different companies, and invested the entire
money borrowed from B & Co. in these companies. The members of these companies
were A and his son only. When the loan was not repaid, B and Co. filled a suit for the
recovery of the loan amount, and also sought it to be recovered out of the assets of the
companies. It was held that the amount can be recovered out of the assets of the
companies as these were credited only to deceive the creditor i.e., leading company.
[See P.N.B. Finance v. Shital Pd. Jain, (1983) 54 Company Cases 66 (Delhi)]
EXAMPLE 2.19, A was appointed as managing director of B and Co. A’s appointment
was on the condition that “he shall not at any time while he shall hold the office of a
managing director or afterwards, solicit or entice away the customers of the company”.
His employment was terminated under an agreement. After sometime, he formed a
company to carry on his own business. The company formed by A started soliciting and
enticing away the customers of B & Co. The company was formed by A merely to avoid
the breach of agreement with B & Co. under which agreed not to entice away the
customers of B & Co, as he himself was not allowed to solicit the customers. It was held
that the company formed by A was a mere sham (or cloak) formed for the purpose of
enabling him to solicit the customers of B & Co. In fact, A’s company was a mere
channel used by him for the purpose of enabling, for his own benefit, to obtain the
advantages of customers of B & Co. In this case, A and his company was restrained from
carrying on the business.
[Gilford Motor Co. v. Horne, (1933) I Ch.935]
EXAMPLE 2.20, A agreed to sell his certain land to B. But subsequently he changed his
mind. In order to avoid the specific performance of the agreement to sell land to B, A
formed a company, and sold his land to this company. B filed a suit against the company
formed by A and also against A for specific performance of the agreement under which A
had agreed to sell the land to B. The court looked into the reality of the situation, and
treated the company as a mere sham. The transfer (i.e., sale) of land to the company was
ingnored and the land was ordered to be sold to B as already agreed between A and B.
[Jones v. Lipman, (1962) All. E.R. 342]
In a case before the Supreme Court, a company created a subsidiary company and
transferred its investment holding to the subsidiary with a view to reduce its liability to
pay bonus to its workers. In this case, the Supreme Court ignored the separate existence
of the subsidiary company.
[Workmen v. Associated Rubbers India Ltd. (1985) 4 SCC 114]10
7. Company acting as an agent of its members or of another company: Sometimes, a
company acts as an agent or trustee of its members or another company. In such cases,
the court may lift the corporate veil (i.e., ignore the separate entity of the company), and
the principal (i.e., for whom the company acts) may be held liable for the acts of the
company. Whether the company is acting an agent or not is a question of fact, and
generally the courts insist upon very strong evidence to prove this fact. Thus, the
relationship of agency should be substantively established to enable the court to lift the
corporate veil.
EXAMPLE 2.21, A, an American company, produced a film in the name of B, a British
company, in order to avoid certain technical difficulties. The British company (B) had a
total capital of 100 shares out of which 90 were held by an American director of the
company. All the funds of the British company for production of the film were provided
by the American company. The film produced in the name of British company was
sought to be registered as an English Film. The court upheld the decision of the Board of
Trade of Films. In this case, the separate entity of the British company was ignored, and
the court observed that it acted merely as an agent and nominees of the American
company for producing the film.
[In Re F.G. (Films) Ltd. 1953 I WLR 483; (1953) I All ER 615 (Ch, D.)]
8. Holding and Subsidiary company relationship: A holding company is one, which has
control over another company. And the company, over which the control is exercised, is
called a subsidiary company. Sometimes, the holding company completely controls and
dominates the activities of its subsidiary company in such a way that the latter becomes
purely an agent of the holding company. In such cases, the court may lift the corporate
veil and consider the subsidiary company a part and parcel of the holding company. Thus,
where the facts and circumstances show that the holding as well as its subsidiary
company may be ignored by the courts. In the following circumstance, the corporate veil
may be lifted, and the holding company and its subsidiary as a whole may be held liable
for the debts and other liabilities of either or both of such companies.
(a) Where business transactions, property, bank and other accounts, employees,
management etc.of both the holding company and its subsidiary are intermingled.
(b) Where the subsidiary is inadequately financed, as a separate business, so as to meet
its normal obligations.
10 In New Horizons Ltd, v, Union of India, AIR 1994 Delhi 126, a person who had incurred a
disqualification due to his blacklisting as a contractor, was not allowed to hide his
disqualifications by forming a company and submitting the tender in company’s name; See also
New Horizons Ltd case (1997) 89 Comp. Cas. 849 SC.
© Where the business of both the companies are not held to the public as separate.
(d) Where the holding company and the subsidiary company are operating portions (i.e.,
parts) of a single business, and the financial and managerial controls is entirely in the
hands of holding company.
(e) Where the subsidiary is formed for some improper use of unfair advantages e.g., for
dividing profits, so as to reduce the tax or other liability of the holding company, to
defraud creditors, to evade the law or any other obligations.
Thus, is case of holding and subsidiary company relationship, the courts may lift the corporate
veil, whenever it is necessary to achieve a just and equitable result. Sometimes, the corporate veil
may be lifted even at the instance of the holding company for the protection of its own interest.
EXAMPLE 2.22, A, a company acquired one partnership concern, and got it registered
as a company and then continued to carry it on as a subsidiary company. The company A
held all the shares (except few) of its subsidiary company, and treated the profits of
subsidiary company as its own. In fact, the effective control of the subsidiary company
was in the hands of the parent company (A). Subsequently, the business of subsidiary
company was acquired by B a corporation. A claimed compensation from the corporation
in respect of acquisition of its business. It was held that A was entitled to receive
compensation from the corporation. The court observed that there was no distinction
between the two companies as the subsidiary company was operative of its own behalf,
but on behalf of the parent company (A).
[Smith Stone & Knight Ltd v. Brimingham Corpon., (1936) KB 116]
The lifting of corporate veil in cases of holding and subsidiary company relationship has
also been approved by the Supreme Court in a recently decided case of State of U.P. &
Others v. Renusagar Power Co. & others, AIR 1988 SC 1737 ; (1991) 70 Comp. Cas. 127
(SC). The following example is based upon the facts of this case.
EXAMPLE 2.23, A & Co. Ltd was formed for the manufacture of aluminium. Another
company, B & Co Ltd was form for generating electricity which was to be wholly
supplied to A & Co Ltd to be used in the manufacture of aluminium. B & Co Ltd was
wholly owned subsidiary of A & Co Ltd, and was completely controlled by it ( A & Co
Ltd). Under the local laws of the State, the ‘electricity duty’ was imposed on the
electricity consumed by the consumers. However, in case of electricity consumed from
one’s own source the rate of electricity duty was less as compared to other cases. The
Supreme Court held that the corporate veil should be lifted and A & Co Ltd and B & Co
Ltd . should be treated as one concern. And B & Co Ltd’s., power plant must be treated
as the ‘own source of generation’ of A & Co Ltd., and should be liable to electricity duty
on that basis. The court also observed that the persons generating and consuming the
energy were the same, and thus the consumption of energy by A & Co Ltd, was clearly
the consumption by it from its ‘own source of generation’.
In Mehra (UK) v. Union of India, 1997 (88) Comp, Cas, 213 Delhi, the High Court has
also held that a parent company and its subsidiary are usually treated as one economic
entity.
9. Dummy Companies: Sometimes, a company formed by certain persons is not intended
to be a corporate body i.e., a separate legal entity. It is formed simple to carry on their
own personal business. In such cases, the court may lift the corporate veil, if it appears
that the separate entity of the company is being misused.
EXAMPLE 2.24, A was carrying a jewellery business. He formed a company with
himself and his wife as the only members. No business was taken over by the company.
Only a banking account was opened in the name of the company in which A deposited a
small amount. A was carrying on his business exactly in the same manner in which he
was doing prior to the formation of the company. The company has practically no asstes.
B, a customer, entrusted some jewellery with A for ornamentation, which was stolen
from his custody. B files a suit against A for the recovery of the value of the jewellery. A
contended that the jewellery was delivered to him in his capacity as a managing director
of the company, and thus he could not be held personally liable. The court ignored the
separate entity of the company formed by A, and he was held personally liable for the
value of the jewellary entrusted to him.
[Hurwitz v. Berman, The time, October 29, 1932]
10. Prevention of Fraud upon public: Sometimes, a company commits a fraud upon the
public and the people suffer financial loss due to the company’s such fraudulent act. In
such cases, the court can lift the corporate veil so as to expose any person to liability who
have committed a fraud upon the public from their sheltered position.
EXAMPLE 2.25, A construction company advertised a scheme for booking of flats.
Many people deposited their hard earned money with the company under the scheme.
The scheme was operated with utter dishonesty and fraud, and no flat was given under
the scheme. In this way, a large number of persons were deceived by the company. Here,
the persons playing such fraud, though in the name of a company, can be held personally
liable to public.
[See Delhi Development Authority v. Skipper Constructions (P) Ltd 1997 89 Comp. Cas.
362 (SC)]
In Ali Javed Ameerhasan Rizvi v. Indo French Biotech Enterprises Ltd, (1995) 95 Comp,
Cas, 373 (Bombay), the Bombay High Court has also held that the corporate veil can be
lifted where large number of investors were being defrauded by persons in charge of the
companies by employing the corporate veil. In this case the promoters promised
unattainable high return to the tune of 1025% on investments, diverted the so collected
funds to the firms of directors or their relatives. In this way the promoters defrauded
innocent investors by employing the corporate veil. The High Court lifted the corporate
veil to do justice to the investors.
11. Misuse of exemptions given by the government: Sometimes, Certain exemptions are
given by the government to a particular sector such as to small scale industries, which are
misused by forming a company to carry on small scale industry. In such cases, the court
may lift the corporate veil to known whether or not such company is entitled to
exemptions. Thus, where small scale industries were given certain exemptions, and a
company was owning a small scale industry, the court held that it was permissible to lift
the corporate veil in order to know whether or not such company was subsidiary of
another company. Such a company would not be entitled to the proposed exemtions if it
was shown that it was a subsidiary of another company.
[Inalsa Ltd v. Union of India, (1996) 87 Comp. Cas. 599 (Delhi)]
Thus, in appropriated cases, the court may disregard the separate entity of the company
and lift the corporate veil i.e., look behind the legal person to know the actual position.
So far we have discussed some of the circumstances under which the corporate veil may
be lifted i.e., the separate legal entity of the company may be ignored. It may be noted
that though the separate entity of the company is ignored, but it does not mean that the
company ceases to be an independent legal entity. As a matter of fact, legal status of the
company is not denied, it is only ignored where the company attempts to misuse the
same. As regards the ture legal position of a company and the circumstances in which its
separate legal entity will be ignored, the following observation of the Supreme Court are
worthnoting;
1. The true legal position in regard to the character of a corporation or a company,
which ows its corporation to a statutory authority, is not in doubt or dispute. 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 separated and distinct
from those of its members; it can sue and be sued exclusively for its own purpose;
its creditor cannot obtain satisfaction from the assets of its members; the liabilities
of the members or the shareholders is limited to the capital invested by them;
similar the creditors or the members have no rights to the assets of the
corporation. The position is well established ever since the decision in the case of
Salomon v Salomon & Co., 1897 AC 22 was pronounced in 1897 and indeed, it
has always been the well recognized principle of common law. However, in
course of time, the doctrine, that a corporation or company has legal and separate
entity of its own has been subjected to certain exceptions by the application of the
fiction that the veil of the corporation can be lifted and its face examined in
substance. The doctrine of the lifting of the veil thus marks a change in the
attitude that law had originally adopted towards the concept of separate entity or
personality of the corporation. A a result of the impact of complexity of the
economic factors, judicial decisions have some time recognised, exception to the
rule about juristic personality of the corporation”.
[Tata Engg. & Locomotive Co. Ltd v. State of Bihar, AIR 1965 SC 40]
2. “It is true that from the juristic point of view, the company is a legal personality
entirely distinct from its members, and the company is capable of enjoying rights
and being subjected to duties which are not the same as those enjoyed or borne by
its members. But in certain exceptional cases, the court is entitled to lift the veil of
corporate entity and to par regards to the economic realities behind the legal
façade”.
[C.I.T. v. Sri Meenakshi Mills Ltd., (1967) 63 ITR 609 (SC)]
2.7. Lifting of Corporate veil under express statutory Provisions (Liability of Directors and
members)
We have discussed in the last article, that in certain cases the court may lift the corporate
veil (i.e., ignore the separate entity of the company), and deal directly with the persons
(members) behind it. The Companies Act, itself, also provides certain cases in which the
directors or members of the company are held liable. It may, however, be noted that in these
cases the separate entity of the company is not ignored i.e., independent existence of the
company is maintained. The only point is that the directors or members are also held personally
liable along with the company. Thus, the distinction between the lifting of corporate veil under ‘a
judicial interpretation’ and under ‘express statutory provisions’ is that, in the former the separate
entity of the company is ignored. But in the latter the separate entity of the company is
maintained with the exception that the persons behind it are also held personally liable.
Following are the main provision, where the members are personally liable:
1. Reduction of membership below statutory limit: The Company must have a minimum
number of members as provided in the Companies Act. The statutory minimum limit of
members is two in case of a ‘a private company’, and seven in case of a ‘public
company’. If at any time the number of members of a company is reduced below this
statutory limit and the company carries on business for more than six months with
reduced members, then every member which is aware of this fact, shall be jointly and
severally liable for all the debts of the company which were contracted during the period
[Section 45]. It may be noted that the personal liability of the members starts after six
month of carrying on business with reduced members. Moreover, the liabilities is only for
debts contracted after these six months.
EXAMPLE 2.26, A, a public company, was carrying on T.V. manufacturing business.
On 1.1.98, the membership of the company was reduced to six. But the company
continued the business with the six members. On 1.12.98 the company took a loan of 12
lacs from a Bank. Subsequently, due to depression in trade the company went in
liquidation, and the company assets were not sufficient to pay its out standing liabilities.
In this case, the members are personally liable for the repayment of the laon. The reason
for the same is that after the reduction in membership, the companys’ business was
continued for more than six months, and the loan was also contracted after six months.
EXAMPLE 2.27, A, B and five others were the only members of a public limited
company each holding fully paid u shares. On 1.1.98, B’s shares were sold in court
auction, and A purchased them. Thereafter, the company continued its business, and on
15th
Dec. 1998 the company borrowed 10 lacs from a financial corporation. In this case,
the members shall be personally liable for the loan obtained on 15th
Dec. 1998.The reason
for the same is that after the purchased of B’s share by A, the company’s membership is
reduced from seven to six, and the company its business for more than six months after
the reduction in membership.
2. Misdescription of company’s name: The name of the company should be properly
described (i.e., in legible character) in all business communication. Moreover, the name
should also indicate that the acts are done on behalf of the company. If the name of the
company is properly not used, and there is no indication that the acts are done on behalf
of the company, then the persons, who have actually done the act, will be personally
liable [Section 147]
EXAMPLE 2.28, A was a director of a company named AB Agencies Ltd. He signed a
cheque on behalf of the company mentioning company’s name as A & B Agencies. In
this case, the name of the company is not properly described, and thus A will be
personally liable to pay the amount of the cheque.
[See Hendon v. Adelman, (1973) New LJ 637]
Similarly, where a bill of exchange is drawn upon a company, but a director accepts a bill
of exchange in his personal capacity (i.e., there is no indication that the bill of exchange
is accepted in behalf of the company), then he will be personally liable to pay the amount
due on the bill of exchange.
3. Fraudulent conduct of business: The members of the company are also personally
liable for fraudulent conduct of the company’s business [Section 542]. Sometimes, in the
course of winding up, it may appear that the business of the company has been carried on
with the intention to defraud creditors of the company or any other person, or for any
fraudulent purpose. In such cases, the Tribunal* may declare that the persons who were
knowingly parties to such business shall be personally responsible for such debts of the
company as the Tribunal* may direct. The Tribunal* may declare such personal liability
on the application made by the liquidator, or any creditor or contributory of the company.
Note: On the Commencement of winding up proceeding, the shareholders of a company are
called contributories [Section 426 of the Companies Act]
EXAMPLE 2.29, A was a furniture manufacture and his business was is sound condition.
He formed a company and transferred his business to the company formed by him. The
members of the newly formed company were A and his other family members. A himself
became the managing director of the company. A’s early business transferred to his company
1,00,00. In payment of this consideration A took 4000 shares of 10 each, and debntures
worth 30,000. These debentures imply that the company owed 30,000 and for the repayment
of this, a charge was created in A’s favour on the assets of the company. Due to trade
depression, the company was involved in financial difficulties, and it was heavily indebted
and was unable to pay its debts. Knowing this position of the company A purchased, on
credit, raw material (timber) worth 50,000 for the company. Soon thereafter, the company
went it to liquidation. After paying the debts of A as secured creditor, nothing was left for the
other unsecured creditors. In this case, the separate legal entity of the company may be
disregarded, and A may be held liable for the debt of 50,000 which was incurred by him
knowing the fact that the company was already heavily indebted. The following judicial
observation are worthnoting in this regard:
“ If a company continues to carry on business and to incur debt at a time when there
is to the knowledge of its directors, no reasonable prospect of the creditors ever receiving
payments of those debts, it is, in general, a proper inference that the company is carrying on
business with intent to defraud creditors”.
4. Mis-statement in the prospectus: A ‘prospectus’ , is a document issued by the company
inviting offers from the public for the purchased of its shares or debentures, or to invest
money with the company. The prospectus must, therefore, represent to the public the true
fact relating to the affairs of the company. If the prospectus contains any mis-statement
(i.e., untrue statement), then every director, promoter of the company, and every person
who authorized the issue of prospectus, shall be liable to pay compensation to the
subscriber (i.e., who purchases shares or invests money in the company) for any loss
sustained by him by reason of any untrue statement contained in the prospectus [Section
62]. Thus, the directors, promoters etc., incur personal liability for the issue of false
prospectus. Moreover, they are also liable for damages for deceit under the law of torts
(i.e., for civil wrong)
EXAMPLE 2.30, The directors of the company issued a prospectus inviting subscription
for debentures. The prospectus stated that the objects of loan (i.e., issue debentures) were
to complete alterations in the building of the company, to purchases horses and van, and
to develop the trade of the company. But in fact, the real object of the loan was to enable
the directors to pay off the old liabilities. Relying upon the statement contained in the
prospectus, A advanced some money to the company. Soon thereafter, the company went
into liquidation and A filed a suit against the directors for damages for fraud. It was held
that the directors were liable to pay damages. The court observed that “a man who lends
money reasonably wishes to know for what purpose it is borrowed, and he is more
willing to advance if he knows that it is not wanted to pay off the liabilities already
taken”.
[Edgington v. Fitzmaurice, (1885) 29 Ch, D. 459)]
5. Failure to repay application money: The application money is that which is paid to the
company along with the application for the purchased of its shares. As a matter of fact,
the persons desirous of purchasing the shares of the company, submit their applications to
the company, along with the application money. If the allotment of shares is not made by
the company, then the application money must be repaid to the applicants within 130
days after the issue of prospects. And if the application money is not repaid within this
period, then the directors of the company shall be personally liable to repay the
application money along with the interest at the rate of 6% from the expiry of 130th
day
[Section 69(5)]. However, a director may escape his liability if he proves that the default
in repayment of money was not due to the misconduct or negligence on his part.
Note: The allotment of shares is not made by the company unless the conditions of allotment
are fulfilled. The conditions of allotment will be discussed in Art, 7.12.
6. Directors with unlimited liability: Generally, the liability of the directors of a limited
company is limited like the other members of the company. However, the memorandum
of the company may contain a provision that the liability of the directors shall be
unlimited. It may be noted that either the memorandum may originally contain such
provision, or it may be subsequently altered by passing a special resolution, so as to make
directors’ liability unlimited. However, the memorandum may be altered only if the
company is so authorized by its articles of association [Section 322, 323]. In case of
unlimited liabilities of directors, they shall be personally liable for the debts of the
company.
7. Non-payment of income tax: Sometimes a private company is wound up, and the
income tax is respect of its any income of any previous year is unpaid. In such cases,
every person who was a director of the company at any time during the relevant precious
year shall be personally liable for the payment of the income tax. It may be noted that the
unpaid tax may be assessed before the winding up, in the course of winding up, or after
the winding up of the company. The directors will remain liable for the payment of the
same in all such cases.
8. Liability for pre-incorporation contracts: A pre-incorporation contracts is one which is
entered in to i.e., made, by the promoters before the formation of the company.
Sometimes, after the formation of the company, it does not adopt (accept) the pre-
incorporation contracts. In such cases, the promoters are personally liable for all such
contracts which are not adopted by the company after its formation.
Note: Pre-incorporation contracts and promoters’ liability for the same will be discussed in
detail in Arts, 3.15 and 3.16.
9. Ultra virus acts: The ultra vires acts are those which are not the authorized acts i.e.,
which are beyond powers. The directors of a company are personally liable for all the
ultra vires acts even if they are done on behalf of the company. The ultra vires acts may
be grouped into two categories, namely;
(a) Acts ultra vires company.
(b) Acts ultra vires directors.
The directors are also personally liable for the acts which are in the nature of tort (i.e., civil
wrong)
Note: the ultra vires acts will be discussed in detail in Art. 4.20.
10. Group accounts of holding and subsidiary companies: We know that a holding
company is one which has control over another company. And the company over which
the control is exercised, is called the subsidiary company. In certain cases, a subsidiary
company may lose its separate identity to some extent e.g., where both the holding and
subsidiary companies are required to present the joint picture of their state of affairs (i.e.,
group accounts) , the separate identity of the subsidiary company is disregarded. The
provisions in respect of the group accounts are primarily designed to give better
information, of the account and financial position of the group as a whole, to the
creditors, shareholders and the public. Sometimes, the court may also treat the subsidiary
company as an agent of the hiding company.
2.8.Refusal to lift the corporate veil
We have discussed, in Art, 2.5, the cases in which the corporate veil is lifted i.e., the
separate entity of the company is ignored by the courts. As a matter of fact, the purpose of
lifting the veil, in those cases, is to prevent the misuse of corporate entity by the companies.
It is to be noted that the lifting of the corporate veil may also be refused by the courts where
the lifting of the veil itself is sought to be misused. For example, where the lifting of veil
would not be in the interest of Government revenue or national interest etc. Thus, in these
cases, the separate entity of the company is generally maintained by the courts even if it is
sought to be ignored. Following are the judicially recognized cases in which the court have
refused the lift the corporate veil i.e., the separate entity of the company is maintained:
1. Protection of revenue: Sometimes, the separate entity is sought to be ignored for the
purpose of escaping i.e., avoiding the liability to pay the tax, such as property tax,
income tax etc. In such cases, the court may refuse to lift the corporate veil, and
separate entity of the company may be maintained.
EXAMPLE 1.31, The entire capital of the company was held by the Government of
India. Under the law then in force, the buildings and lands owned by or vested in the
Union of India were exempted from property tax. On this ground, the company
sought the exemption from the payment of property tax and contented that the land
and the building of the company was property of the Government as entire share
capital of the company was held by the Government of India. The court refused to
accept the contention of the company and held that the company was a separate legal
entity and that the land and building owned by the company were the property of the
company itself and not of the Government of India. Thus, the company was held
liable to pay the property tax.
[Western Coalfield Ltd v. Special Area Development Authority, AIP 1982 SC 697]
Thus, for the protection of revenue, the court may refuse to lift the corporate veil even if asked
by the company itself. The decision of Supreme Court in the case of Bacha F. Guzdar discussed
in Example 2.14 is also relevant on the point.
2. National Interest: Sometimes, the maintenance of the separate legal entity of a
company is necessary in the interest of the nation. In such cases, the court may refuse
to lift the corporate veil, and the separate entity of the company may be maintained.
Thus, where the lifting of the corporate veil will go against some national policy, the
court will not do so.
EXAMPLE 2.32, A group of 13 companies, incorporated abroad, separate applied
for permission under the Foreign Exchange Regulation Act, 1973 (FERA) for
purchases of the shares of an Indian company. The FERA encouraged the flow of
such investments from non-resident Indians and from the companies belonging to
them. However, the Act also imposed a ceiling on such investment so that this
privilege may not be used to destabilize the Indian Companies. It was prayed before
the Supreme Court that all the 13 companies belonged to one family trust which was
operated by a single person, and the purchase of shares in the name of 13 persons
was in fact by a single person, and therefore ceiling imposed by FERA was violated.
The Supreme Court did not accept this argument, and refused to lift the corporate
veil i.e., all the 13 companies were considered separate and independent for the
purpose of FERA is to attract investment by non-resident Indians. The lifting of
corporate veil would go against that policy and the national interest because it would
discourage the flow of investment by non-resident Indians.
[L.I.C, v. Escorts Ltd. (1986) I SCC 264]
3. Government Companies: A government company is one which majority of the
shares are held by the Central Government or the State Government or by both of
them. In case of such companies where almost all the shares are held by the
Government, the courts generally refuse to lift the corporate veil i.e., the company is
treated as a separate legal entity and not the part of the Government itself.
EXAMPLE 2.33, A government company contended that it cannot be subjected to
development tax, as it is not a separate entity but a part of the Government itself. The
court refused to lift the corporate veil as requested by the company, and regarded the
Government company to be a separate entity for the purpose of enabling the
Development Authority to impose a development tax on the company.
[Bharat Aluminium Co. v. Special Area Development Authority, (1981) 51 Company cases 114
(MP)]
Similarly, where transport services were provided by a company all of whose shares were owned
by the Transport Commission, the court refused to lift the corporate veil and held that the
transport services were provided by the company itself and not by the Government (i.e.,
Transport Commission) . Thus, a Government company is not regarded as the Government itself
or its agent. It can be regarded as an agent of the Government only when it is performing in
substance governmental or sovereign function, and not merely commercial function.
2.5 Lifting Of Corporate Veil

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2.5 Lifting Of Corporate Veil

  • 1. 2.5 Lifting of Corporate Veil The term “Lifting of Corporate Veil” means ignoring the separate legal entity of the company, and looking in to the realities. It is an important doctrine in the company law according to which in certain circumstances, the separate legal entity of the company is not taken in to the account. The company and its members are treated as one person. We know the chief characteristics of a company is that it is a separate legal entity independent and different from its members. And also to this characteristic, many other advantages are enjoyed by the company. The fact is not denied that, by fiction of law, a company is a separate legal entity, independent and different from its members. But in reality, it is an association of persons, who are in fact the beneficial owners of all the corporate property (i,e, companies property ). As a matter of fact, the business of a company is carried on by some human beings who are the ultimate beneficiaries of corporate advantages. Due to separate legal entity of the company, these real beneficiaries behind the company are disregarded once they have formed a company and given to their association the status of legal entry. Ordinary, the separate legal entity of the company is to be respected. As a matter of fact, the whole law of corporation is based on the principle of corporate personality ( i e, separate legal entity ) of a company. However, the statutory privilege of separate personality of the company must be used for legitimate business purpose only. Sometimes, it becomes necessary to find out the real person who control the company e.g., in case when this corporate personality (legal entity) of the company is misused for fraudulent or improper conduct or for doing things against public policy. In such cases, the courts ignore the separate entity. In other words, the corporate veil of the company probed into and lifted up. This however, is the discretionary power of the court, and will depend upon the underlying social, economic and moral factors as they operate in and through the company. When the corporate personality of a company is used as a shield to cover its wrong doings, such as for evasion of tax, the court may lift the corporate veil. [(BSN (UK) Ltd. v . Janardan M. Rajan Pillai. (1996) 86 Comp. Cas 371 (Bombay)] The cases, in which the corporate veil is lifted i.e , the separate legal entity of the company is ignored, may be discussed under the two heads namely:
  • 2. 1. Judicial interpretations 2. Express statutory provisions 2.6Lifting of corporate veil under judicial interpretations Following are some of the judicially decided cases in which the corporate veil is lifted i.e , the separate legal entity of the company is ignored: 1. Determination of character of the company: Sometimes, it becomes necessary to determine the character of a company e.g., to see whether it has assumed as enemy character. The doubts may arise that the company is owned and controlled by the enemies of the country. In such cases, the court may lift the corporate veil (i.e., ignore the separate entity of the company) and examine the character of the persons who are in real control of the company affairs. As a matter of fact, the lifting of the corporate veil in such cases is necessary because trading with an enemy is against the public policy. EXAMPLE 2.12, A company was incorporated in England for the purpose of selling tires manufactured in German Company. The bulk of the shares in English Company were held by the German company. And the remaining shares (except one) were held by the German residing in German. Thus, in fact, the real control of the England Company was in German hands during the First World War, the English company brought legal actions to recover the trade debts. The question arose whether the English company had become an enemy company and, therefore, should not be allowed to proceed with the action. It was held that the company has assumed an enemy character, and was debarred from maintaining the action i.e., it it was not allowed to proceed with the action. [Daimler Co. Ltd. v. Continental Tyres Rubber Co. (1916) 2 AC 307] In the above case, the following observations of the House of Lords are worthnoting: “Company is not a natural person with a mind or conscience. It can be neither loyal nor disloyal. It can be neither friend nor enemy. But it may be assume an enemy character when persons in the facto control of its affairs, are residents in any enemy country, or wherever resident, are acting under the controls of enemies.”
  • 3. 2. Protection of revenue: Sometimes, the lifting of corporate veil is necessary for the benefit of revenue, e.g., where the separate entity of the company (i.e corporate entity) is used for the evasion of tax. In such cases, the court may lift the corporate veil (i.e., ignore the separate entity of the company), and the incomes of the company and its members may be taxed as that of one person. EXAMPLE 1.13. A, assessee, was a wealthy man receiving huge dividend and interest incomes. He formed four companies and transferred his investments (from which he was receiving dividends and interest income) to these companies. Thereafter, the income received from A’s investments are credited to the accounts of companies, but the companies handed back the same to A as a pretended loan. In this way, A dividend has income into four parts, and reduce his tax liabilities. It was held that the companies were formed by A purely and simply as a means of avoiding his tax liabilities., and the companies were nothing more than the assessee himself. In this case, the companies were created as legal entities simply, for the purpose of receiving the dividends and interest from A’s investments, and then handling over the same to him (A) as pretended loan. [Re Sir Dinshaw, Maneekjee Patil, AIR 1927 Bombay371] It may, however be noted that the members themselves are not allowed to claim that they should be regarded as economically identical with the company, particularly when this is not in the interest of justice. EXAMPLE 2.14., A was a shareholder of tea company. Under the Income Tax Act then in force, the income of the tea company was exempted from tax up to 60% as agricultural income, and 40% was taxed as income from manufacture and sale of tea. A received certain amount as dividend in respect of the shares held by him in the company. He claimed that this dividend income should be regarded as agricultural income up to 60% and should be exempted from tax. It was held that although the income in the hands of the company was particularly agricultural, but the same when received by the shareholders could not be regarded as agricultural income.
  • 4. [Bacha F. Guzdar v. The Commissioner of income Tax, Bombay, AIR 1955 SC 74] 3. Protection of companies own justified interest: Sometimes, a company, itself, wants that its separate entity should be ignored and treated alike with the members. In such cases, the court may lift the corporate veil i.e., ignore the separate identity of the company if it is in company’s own interest. Thus, the corporate veil may be lifted for company’s own benefit if the court thinks it to be justified. The Honourable Supreme Court of India has taken this view in a case, which is illustration below; EXAMPLE 2.15, A firm of transporters was a tenant in the premises belonging to A, the landlord. After sometime, certain differences arose among the partners, and consequently the firm was split up into two firms. Each firm agreed to operate in the area allocated to it, and a condition was attached that one firm could not enter upon the area of the other. In the course of time, one of the firms floated a private limited company. Both, the firm and the company had their offices in the same premises in which the original firm was a tenant. The landlord of the premises filed an eviction petition (i.e., for vacation of the premises) against the original firm of the ground that it hand handed over (i.e., sublet or assigned) the possession of the premises to a private limited company, which is a separate legal entity, without obtaining his (landlords) consent. And thus, there is a violation of the premises by the firm of the company. The Supreme Court observed that the company, thought a separate legal entity, was in fact a creature of the partners of the firm and was the very image of the firm. The limited company and the partnership firm were two only in name but one for practical purposes. There was substantial identity between the limited company and the firm. [Madras Bangalore Transport Co, (West) v. Inder Singh, (1986) 3 SCC 62) Thus, in this case, the court ignored the separate legal entity of the company. It, therefor, follows that lifting of corporate veil is not always to the disadvantages of the company’s promoters. In New Horizons Ltd. v. Union of India, (1995) I SCC 478 ; (1997) 89 Comp. Cas. 849 (SC), the Supreme Court has gain upheld this view. In this case, the court lifted the veil and held that where the joint – venture sponsers of the company were qualified
  • 5. for participating in a government tender, their company should also be treated as a qualified tenderer. 4. Avoidance of legal obligations imposed by welfare legislation: Sometimes, it appears to the court that the company is formed just to avoid the legal obligations imposed by a welfare legislation. In such cases, the court may lift the corporate veil i.e., ignore the separate entity of the company. e.g., where in order to reduce the liability to pay bonus to its workers, the company splits up its profits by creating another company, the court may refuse to recognise the new company. In fact, the legislation requiring the payment of bonus to workers is for the welfare of the workers, and the company should not be allowed to escape liability imposed by such legislation. The avoidance of welfare legislation is as common as avoidance of taxation, and the approach of the court in considering problems arising out of such avoidance has necessarily to be the same as avoidance of taxation. This has been recognized by the Supreme Court as a evident from the following example. EXAMPLE 2.16, A company was earning handsome profits, and therefore its liability to pay bonus was also high. In order to split up the profits into two hands and thereby to reduce its liability to pay bonus to the workers, the company created another company as its subsidiary, and transferred some of the investments and securities for the new company. The Supreme Court held that the purpose of working out of the amount of bonus payable by the former company to its workers, the separate existence of the new company would be disregarded. The Court observed as under; “If we look at the facts of the case, what do we find? A company is credited wholly owned by the principle company with no assets of its own except those transferred to it by the principle company, with no business or income of its own except receiving dividends from shares transferred to it by the principal company and serving no purpose whatsoever except to reduce the gross profits of the principal company”. [Workmen of Association Rubber Industries Ltd. v. Association Rubber Industry Ltd., (1986) 59 Company Cases 134 (SC) : AIR 1986 SCI]
  • 6. 5. Avoidance of contractual obligation: Sometimes, a company is formed simple to avoid the obligations arising out of contracts. In such cases, the court may lift the corporate veil i.e., ignore the separate entity and decide the case assuming that no company is in existence. EXAMPLE 2.17. A and B were carrying on an auto parts business in partnership. They sold their business to C and agree not to start a competitive business for two years. Immediately thereafter, they (i.e., A & B) wanted to start the similar business. In order to avoid the contractual obligation of not to start a similar business for two years, they formed a private limited company, became the major shareholders and directors, and started the similar business. In this case the court may ignore the separate entity of the company and restrain it from starting the similar business. Here, it is clear that the company has been formed by A and B simple to avoid their contractual obligation with C. 6. Prevention of fraud or improper conduct: Sometimes, it appears to the court that the company is formed for some fraudulent or improper purpose e.g., to defraud creditors, to avoid legal obligations, or to defeat the provisions of law. In such cases, the court may lift the corporate veil i.e., ignore the separate entity of the company. Thus, where the company is a mere sham i.e., formed to deceive or defraud, the court will lift the corporate veil and look into the ownership of the company. EXAMPLE 2.18, A borrowed a huge amount of money in his own name from B and Co., a finance company. He formed three different companies, and invested the entire money borrowed from B & Co. in these companies. The members of these companies were A and his son only. When the loan was not repaid, B and Co. filled a suit for the recovery of the loan amount, and also sought it to be recovered out of the assets of the companies. It was held that the amount can be recovered out of the assets of the companies as these were credited only to deceive the creditor i.e., leading company. [See P.N.B. Finance v. Shital Pd. Jain, (1983) 54 Company Cases 66 (Delhi)]
  • 7. EXAMPLE 2.19, A was appointed as managing director of B and Co. A’s appointment was on the condition that “he shall not at any time while he shall hold the office of a managing director or afterwards, solicit or entice away the customers of the company”. His employment was terminated under an agreement. After sometime, he formed a company to carry on his own business. The company formed by A started soliciting and enticing away the customers of B & Co. The company was formed by A merely to avoid the breach of agreement with B & Co. under which agreed not to entice away the customers of B & Co, as he himself was not allowed to solicit the customers. It was held that the company formed by A was a mere sham (or cloak) formed for the purpose of enabling him to solicit the customers of B & Co. In fact, A’s company was a mere channel used by him for the purpose of enabling, for his own benefit, to obtain the advantages of customers of B & Co. In this case, A and his company was restrained from carrying on the business. [Gilford Motor Co. v. Horne, (1933) I Ch.935] EXAMPLE 2.20, A agreed to sell his certain land to B. But subsequently he changed his mind. In order to avoid the specific performance of the agreement to sell land to B, A formed a company, and sold his land to this company. B filed a suit against the company formed by A and also against A for specific performance of the agreement under which A had agreed to sell the land to B. The court looked into the reality of the situation, and treated the company as a mere sham. The transfer (i.e., sale) of land to the company was ingnored and the land was ordered to be sold to B as already agreed between A and B. [Jones v. Lipman, (1962) All. E.R. 342] In a case before the Supreme Court, a company created a subsidiary company and transferred its investment holding to the subsidiary with a view to reduce its liability to pay bonus to its workers. In this case, the Supreme Court ignored the separate existence of the subsidiary company. [Workmen v. Associated Rubbers India Ltd. (1985) 4 SCC 114]10
  • 8. 7. Company acting as an agent of its members or of another company: Sometimes, a company acts as an agent or trustee of its members or another company. In such cases, the court may lift the corporate veil (i.e., ignore the separate entity of the company), and the principal (i.e., for whom the company acts) may be held liable for the acts of the company. Whether the company is acting an agent or not is a question of fact, and generally the courts insist upon very strong evidence to prove this fact. Thus, the relationship of agency should be substantively established to enable the court to lift the corporate veil. EXAMPLE 2.21, A, an American company, produced a film in the name of B, a British company, in order to avoid certain technical difficulties. The British company (B) had a total capital of 100 shares out of which 90 were held by an American director of the company. All the funds of the British company for production of the film were provided by the American company. The film produced in the name of British company was sought to be registered as an English Film. The court upheld the decision of the Board of Trade of Films. In this case, the separate entity of the British company was ignored, and the court observed that it acted merely as an agent and nominees of the American company for producing the film. [In Re F.G. (Films) Ltd. 1953 I WLR 483; (1953) I All ER 615 (Ch, D.)] 8. Holding and Subsidiary company relationship: A holding company is one, which has control over another company. And the company, over which the control is exercised, is called a subsidiary company. Sometimes, the holding company completely controls and dominates the activities of its subsidiary company in such a way that the latter becomes purely an agent of the holding company. In such cases, the court may lift the corporate veil and consider the subsidiary company a part and parcel of the holding company. Thus, where the facts and circumstances show that the holding as well as its subsidiary company may be ignored by the courts. In the following circumstance, the corporate veil may be lifted, and the holding company and its subsidiary as a whole may be held liable for the debts and other liabilities of either or both of such companies.
  • 9. (a) Where business transactions, property, bank and other accounts, employees, management etc.of both the holding company and its subsidiary are intermingled. (b) Where the subsidiary is inadequately financed, as a separate business, so as to meet its normal obligations. 10 In New Horizons Ltd, v, Union of India, AIR 1994 Delhi 126, a person who had incurred a disqualification due to his blacklisting as a contractor, was not allowed to hide his disqualifications by forming a company and submitting the tender in company’s name; See also New Horizons Ltd case (1997) 89 Comp. Cas. 849 SC. © Where the business of both the companies are not held to the public as separate. (d) Where the holding company and the subsidiary company are operating portions (i.e., parts) of a single business, and the financial and managerial controls is entirely in the hands of holding company. (e) Where the subsidiary is formed for some improper use of unfair advantages e.g., for dividing profits, so as to reduce the tax or other liability of the holding company, to defraud creditors, to evade the law or any other obligations. Thus, is case of holding and subsidiary company relationship, the courts may lift the corporate veil, whenever it is necessary to achieve a just and equitable result. Sometimes, the corporate veil may be lifted even at the instance of the holding company for the protection of its own interest. EXAMPLE 2.22, A, a company acquired one partnership concern, and got it registered as a company and then continued to carry it on as a subsidiary company. The company A held all the shares (except few) of its subsidiary company, and treated the profits of subsidiary company as its own. In fact, the effective control of the subsidiary company was in the hands of the parent company (A). Subsequently, the business of subsidiary company was acquired by B a corporation. A claimed compensation from the corporation in respect of acquisition of its business. It was held that A was entitled to receive compensation from the corporation. The court observed that there was no distinction between the two companies as the subsidiary company was operative of its own behalf, but on behalf of the parent company (A).
  • 10. [Smith Stone & Knight Ltd v. Brimingham Corpon., (1936) KB 116] The lifting of corporate veil in cases of holding and subsidiary company relationship has also been approved by the Supreme Court in a recently decided case of State of U.P. & Others v. Renusagar Power Co. & others, AIR 1988 SC 1737 ; (1991) 70 Comp. Cas. 127 (SC). The following example is based upon the facts of this case. EXAMPLE 2.23, A & Co. Ltd was formed for the manufacture of aluminium. Another company, B & Co Ltd was form for generating electricity which was to be wholly supplied to A & Co Ltd to be used in the manufacture of aluminium. B & Co Ltd was wholly owned subsidiary of A & Co Ltd, and was completely controlled by it ( A & Co Ltd). Under the local laws of the State, the ‘electricity duty’ was imposed on the electricity consumed by the consumers. However, in case of electricity consumed from one’s own source the rate of electricity duty was less as compared to other cases. The Supreme Court held that the corporate veil should be lifted and A & Co Ltd and B & Co Ltd . should be treated as one concern. And B & Co Ltd’s., power plant must be treated as the ‘own source of generation’ of A & Co Ltd., and should be liable to electricity duty on that basis. The court also observed that the persons generating and consuming the energy were the same, and thus the consumption of energy by A & Co Ltd, was clearly the consumption by it from its ‘own source of generation’. In Mehra (UK) v. Union of India, 1997 (88) Comp, Cas, 213 Delhi, the High Court has also held that a parent company and its subsidiary are usually treated as one economic entity. 9. Dummy Companies: Sometimes, a company formed by certain persons is not intended to be a corporate body i.e., a separate legal entity. It is formed simple to carry on their own personal business. In such cases, the court may lift the corporate veil, if it appears that the separate entity of the company is being misused. EXAMPLE 2.24, A was carrying a jewellery business. He formed a company with himself and his wife as the only members. No business was taken over by the company. Only a banking account was opened in the name of the company in which A deposited a small amount. A was carrying on his business exactly in the same manner in which he
  • 11. was doing prior to the formation of the company. The company has practically no asstes. B, a customer, entrusted some jewellery with A for ornamentation, which was stolen from his custody. B files a suit against A for the recovery of the value of the jewellery. A contended that the jewellery was delivered to him in his capacity as a managing director of the company, and thus he could not be held personally liable. The court ignored the separate entity of the company formed by A, and he was held personally liable for the value of the jewellary entrusted to him. [Hurwitz v. Berman, The time, October 29, 1932] 10. Prevention of Fraud upon public: Sometimes, a company commits a fraud upon the public and the people suffer financial loss due to the company’s such fraudulent act. In such cases, the court can lift the corporate veil so as to expose any person to liability who have committed a fraud upon the public from their sheltered position. EXAMPLE 2.25, A construction company advertised a scheme for booking of flats. Many people deposited their hard earned money with the company under the scheme. The scheme was operated with utter dishonesty and fraud, and no flat was given under the scheme. In this way, a large number of persons were deceived by the company. Here, the persons playing such fraud, though in the name of a company, can be held personally liable to public. [See Delhi Development Authority v. Skipper Constructions (P) Ltd 1997 89 Comp. Cas. 362 (SC)] In Ali Javed Ameerhasan Rizvi v. Indo French Biotech Enterprises Ltd, (1995) 95 Comp, Cas, 373 (Bombay), the Bombay High Court has also held that the corporate veil can be lifted where large number of investors were being defrauded by persons in charge of the companies by employing the corporate veil. In this case the promoters promised unattainable high return to the tune of 1025% on investments, diverted the so collected funds to the firms of directors or their relatives. In this way the promoters defrauded innocent investors by employing the corporate veil. The High Court lifted the corporate veil to do justice to the investors.
  • 12. 11. Misuse of exemptions given by the government: Sometimes, Certain exemptions are given by the government to a particular sector such as to small scale industries, which are misused by forming a company to carry on small scale industry. In such cases, the court may lift the corporate veil to known whether or not such company is entitled to exemptions. Thus, where small scale industries were given certain exemptions, and a company was owning a small scale industry, the court held that it was permissible to lift the corporate veil in order to know whether or not such company was subsidiary of another company. Such a company would not be entitled to the proposed exemtions if it was shown that it was a subsidiary of another company. [Inalsa Ltd v. Union of India, (1996) 87 Comp. Cas. 599 (Delhi)] Thus, in appropriated cases, the court may disregard the separate entity of the company and lift the corporate veil i.e., look behind the legal person to know the actual position. So far we have discussed some of the circumstances under which the corporate veil may be lifted i.e., the separate legal entity of the company may be ignored. It may be noted that though the separate entity of the company is ignored, but it does not mean that the company ceases to be an independent legal entity. As a matter of fact, legal status of the company is not denied, it is only ignored where the company attempts to misuse the same. As regards the ture legal position of a company and the circumstances in which its separate legal entity will be ignored, the following observation of the Supreme Court are worthnoting; 1. The true legal position in regard to the character of a corporation or a company, which ows its corporation to a statutory authority, is not in doubt or dispute. 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 separated and distinct from those of its members; it can sue and be sued exclusively for its own purpose; its creditor cannot obtain satisfaction from the assets of its members; the liabilities of the members or the shareholders is limited to the capital invested by them; similar the creditors or the members have no rights to the assets of the corporation. The position is well established ever since the decision in the case of Salomon v Salomon & Co., 1897 AC 22 was pronounced in 1897 and indeed, it
  • 13. has always been the well recognized principle of common law. However, in course of time, the doctrine, that a corporation or company has legal and separate entity of its own has been subjected to certain exceptions by the application of the fiction that the veil of the corporation can be lifted and its face examined in substance. The doctrine of the lifting of the veil thus marks a change in the attitude that law had originally adopted towards the concept of separate entity or personality of the corporation. A a result of the impact of complexity of the economic factors, judicial decisions have some time recognised, exception to the rule about juristic personality of the corporation”. [Tata Engg. & Locomotive Co. Ltd v. State of Bihar, AIR 1965 SC 40] 2. “It is true that from the juristic point of view, the company is a legal personality entirely distinct from its members, and the company is capable of enjoying rights and being subjected to duties which are not the same as those enjoyed or borne by its members. But in certain exceptional cases, the court is entitled to lift the veil of corporate entity and to par regards to the economic realities behind the legal façade”. [C.I.T. v. Sri Meenakshi Mills Ltd., (1967) 63 ITR 609 (SC)] 2.7. Lifting of Corporate veil under express statutory Provisions (Liability of Directors and members) We have discussed in the last article, that in certain cases the court may lift the corporate veil (i.e., ignore the separate entity of the company), and deal directly with the persons (members) behind it. The Companies Act, itself, also provides certain cases in which the directors or members of the company are held liable. It may, however, be noted that in these cases the separate entity of the company is not ignored i.e., independent existence of the company is maintained. The only point is that the directors or members are also held personally liable along with the company. Thus, the distinction between the lifting of corporate veil under ‘a judicial interpretation’ and under ‘express statutory provisions’ is that, in the former the separate
  • 14. entity of the company is ignored. But in the latter the separate entity of the company is maintained with the exception that the persons behind it are also held personally liable. Following are the main provision, where the members are personally liable: 1. Reduction of membership below statutory limit: The Company must have a minimum number of members as provided in the Companies Act. The statutory minimum limit of members is two in case of a ‘a private company’, and seven in case of a ‘public company’. If at any time the number of members of a company is reduced below this statutory limit and the company carries on business for more than six months with reduced members, then every member which is aware of this fact, shall be jointly and severally liable for all the debts of the company which were contracted during the period [Section 45]. It may be noted that the personal liability of the members starts after six month of carrying on business with reduced members. Moreover, the liabilities is only for debts contracted after these six months. EXAMPLE 2.26, A, a public company, was carrying on T.V. manufacturing business. On 1.1.98, the membership of the company was reduced to six. But the company continued the business with the six members. On 1.12.98 the company took a loan of 12 lacs from a Bank. Subsequently, due to depression in trade the company went in liquidation, and the company assets were not sufficient to pay its out standing liabilities. In this case, the members are personally liable for the repayment of the laon. The reason for the same is that after the reduction in membership, the companys’ business was continued for more than six months, and the loan was also contracted after six months. EXAMPLE 2.27, A, B and five others were the only members of a public limited company each holding fully paid u shares. On 1.1.98, B’s shares were sold in court auction, and A purchased them. Thereafter, the company continued its business, and on 15th Dec. 1998 the company borrowed 10 lacs from a financial corporation. In this case, the members shall be personally liable for the loan obtained on 15th Dec. 1998.The reason for the same is that after the purchased of B’s share by A, the company’s membership is reduced from seven to six, and the company its business for more than six months after the reduction in membership.
  • 15. 2. Misdescription of company’s name: The name of the company should be properly described (i.e., in legible character) in all business communication. Moreover, the name should also indicate that the acts are done on behalf of the company. If the name of the company is properly not used, and there is no indication that the acts are done on behalf of the company, then the persons, who have actually done the act, will be personally liable [Section 147] EXAMPLE 2.28, A was a director of a company named AB Agencies Ltd. He signed a cheque on behalf of the company mentioning company’s name as A & B Agencies. In this case, the name of the company is not properly described, and thus A will be personally liable to pay the amount of the cheque. [See Hendon v. Adelman, (1973) New LJ 637] Similarly, where a bill of exchange is drawn upon a company, but a director accepts a bill of exchange in his personal capacity (i.e., there is no indication that the bill of exchange is accepted in behalf of the company), then he will be personally liable to pay the amount due on the bill of exchange. 3. Fraudulent conduct of business: The members of the company are also personally liable for fraudulent conduct of the company’s business [Section 542]. Sometimes, in the course of winding up, it may appear that the business of the company has been carried on with the intention to defraud creditors of the company or any other person, or for any fraudulent purpose. In such cases, the Tribunal* may declare that the persons who were knowingly parties to such business shall be personally responsible for such debts of the company as the Tribunal* may direct. The Tribunal* may declare such personal liability on the application made by the liquidator, or any creditor or contributory of the company. Note: On the Commencement of winding up proceeding, the shareholders of a company are called contributories [Section 426 of the Companies Act] EXAMPLE 2.29, A was a furniture manufacture and his business was is sound condition. He formed a company and transferred his business to the company formed by him. The members of the newly formed company were A and his other family members. A himself became the managing director of the company. A’s early business transferred to his company
  • 16. 1,00,00. In payment of this consideration A took 4000 shares of 10 each, and debntures worth 30,000. These debentures imply that the company owed 30,000 and for the repayment of this, a charge was created in A’s favour on the assets of the company. Due to trade depression, the company was involved in financial difficulties, and it was heavily indebted and was unable to pay its debts. Knowing this position of the company A purchased, on credit, raw material (timber) worth 50,000 for the company. Soon thereafter, the company went it to liquidation. After paying the debts of A as secured creditor, nothing was left for the other unsecured creditors. In this case, the separate legal entity of the company may be disregarded, and A may be held liable for the debt of 50,000 which was incurred by him knowing the fact that the company was already heavily indebted. The following judicial observation are worthnoting in this regard: “ If a company continues to carry on business and to incur debt at a time when there is to the knowledge of its directors, no reasonable prospect of the creditors ever receiving payments of those debts, it is, in general, a proper inference that the company is carrying on business with intent to defraud creditors”. 4. Mis-statement in the prospectus: A ‘prospectus’ , is a document issued by the company inviting offers from the public for the purchased of its shares or debentures, or to invest money with the company. The prospectus must, therefore, represent to the public the true fact relating to the affairs of the company. If the prospectus contains any mis-statement (i.e., untrue statement), then every director, promoter of the company, and every person who authorized the issue of prospectus, shall be liable to pay compensation to the subscriber (i.e., who purchases shares or invests money in the company) for any loss sustained by him by reason of any untrue statement contained in the prospectus [Section 62]. Thus, the directors, promoters etc., incur personal liability for the issue of false prospectus. Moreover, they are also liable for damages for deceit under the law of torts (i.e., for civil wrong) EXAMPLE 2.30, The directors of the company issued a prospectus inviting subscription for debentures. The prospectus stated that the objects of loan (i.e., issue debentures) were to complete alterations in the building of the company, to purchases horses and van, and
  • 17. to develop the trade of the company. But in fact, the real object of the loan was to enable the directors to pay off the old liabilities. Relying upon the statement contained in the prospectus, A advanced some money to the company. Soon thereafter, the company went into liquidation and A filed a suit against the directors for damages for fraud. It was held that the directors were liable to pay damages. The court observed that “a man who lends money reasonably wishes to know for what purpose it is borrowed, and he is more willing to advance if he knows that it is not wanted to pay off the liabilities already taken”. [Edgington v. Fitzmaurice, (1885) 29 Ch, D. 459)] 5. Failure to repay application money: The application money is that which is paid to the company along with the application for the purchased of its shares. As a matter of fact, the persons desirous of purchasing the shares of the company, submit their applications to the company, along with the application money. If the allotment of shares is not made by the company, then the application money must be repaid to the applicants within 130 days after the issue of prospects. And if the application money is not repaid within this period, then the directors of the company shall be personally liable to repay the application money along with the interest at the rate of 6% from the expiry of 130th day [Section 69(5)]. However, a director may escape his liability if he proves that the default in repayment of money was not due to the misconduct or negligence on his part. Note: The allotment of shares is not made by the company unless the conditions of allotment are fulfilled. The conditions of allotment will be discussed in Art, 7.12. 6. Directors with unlimited liability: Generally, the liability of the directors of a limited company is limited like the other members of the company. However, the memorandum of the company may contain a provision that the liability of the directors shall be unlimited. It may be noted that either the memorandum may originally contain such
  • 18. provision, or it may be subsequently altered by passing a special resolution, so as to make directors’ liability unlimited. However, the memorandum may be altered only if the company is so authorized by its articles of association [Section 322, 323]. In case of unlimited liabilities of directors, they shall be personally liable for the debts of the company. 7. Non-payment of income tax: Sometimes a private company is wound up, and the income tax is respect of its any income of any previous year is unpaid. In such cases, every person who was a director of the company at any time during the relevant precious year shall be personally liable for the payment of the income tax. It may be noted that the unpaid tax may be assessed before the winding up, in the course of winding up, or after the winding up of the company. The directors will remain liable for the payment of the same in all such cases. 8. Liability for pre-incorporation contracts: A pre-incorporation contracts is one which is entered in to i.e., made, by the promoters before the formation of the company. Sometimes, after the formation of the company, it does not adopt (accept) the pre- incorporation contracts. In such cases, the promoters are personally liable for all such contracts which are not adopted by the company after its formation. Note: Pre-incorporation contracts and promoters’ liability for the same will be discussed in detail in Arts, 3.15 and 3.16. 9. Ultra virus acts: The ultra vires acts are those which are not the authorized acts i.e., which are beyond powers. The directors of a company are personally liable for all the ultra vires acts even if they are done on behalf of the company. The ultra vires acts may be grouped into two categories, namely;
  • 19. (a) Acts ultra vires company. (b) Acts ultra vires directors. The directors are also personally liable for the acts which are in the nature of tort (i.e., civil wrong) Note: the ultra vires acts will be discussed in detail in Art. 4.20. 10. Group accounts of holding and subsidiary companies: We know that a holding company is one which has control over another company. And the company over which the control is exercised, is called the subsidiary company. In certain cases, a subsidiary company may lose its separate identity to some extent e.g., where both the holding and subsidiary companies are required to present the joint picture of their state of affairs (i.e., group accounts) , the separate identity of the subsidiary company is disregarded. The provisions in respect of the group accounts are primarily designed to give better information, of the account and financial position of the group as a whole, to the creditors, shareholders and the public. Sometimes, the court may also treat the subsidiary company as an agent of the hiding company. 2.8.Refusal to lift the corporate veil We have discussed, in Art, 2.5, the cases in which the corporate veil is lifted i.e., the separate entity of the company is ignored by the courts. As a matter of fact, the purpose of lifting the veil, in those cases, is to prevent the misuse of corporate entity by the companies. It is to be noted that the lifting of the corporate veil may also be refused by the courts where the lifting of the veil itself is sought to be misused. For example, where the lifting of veil would not be in the interest of Government revenue or national interest etc. Thus, in these cases, the separate entity of the company is generally maintained by the courts even if it is sought to be ignored. Following are the judicially recognized cases in which the court have refused the lift the corporate veil i.e., the separate entity of the company is maintained:
  • 20. 1. Protection of revenue: Sometimes, the separate entity is sought to be ignored for the purpose of escaping i.e., avoiding the liability to pay the tax, such as property tax, income tax etc. In such cases, the court may refuse to lift the corporate veil, and separate entity of the company may be maintained. EXAMPLE 1.31, The entire capital of the company was held by the Government of India. Under the law then in force, the buildings and lands owned by or vested in the Union of India were exempted from property tax. On this ground, the company sought the exemption from the payment of property tax and contented that the land and the building of the company was property of the Government as entire share capital of the company was held by the Government of India. The court refused to accept the contention of the company and held that the company was a separate legal entity and that the land and building owned by the company were the property of the company itself and not of the Government of India. Thus, the company was held liable to pay the property tax. [Western Coalfield Ltd v. Special Area Development Authority, AIP 1982 SC 697] Thus, for the protection of revenue, the court may refuse to lift the corporate veil even if asked by the company itself. The decision of Supreme Court in the case of Bacha F. Guzdar discussed in Example 2.14 is also relevant on the point. 2. National Interest: Sometimes, the maintenance of the separate legal entity of a company is necessary in the interest of the nation. In such cases, the court may refuse to lift the corporate veil, and the separate entity of the company may be maintained. Thus, where the lifting of the corporate veil will go against some national policy, the court will not do so. EXAMPLE 2.32, A group of 13 companies, incorporated abroad, separate applied for permission under the Foreign Exchange Regulation Act, 1973 (FERA) for purchases of the shares of an Indian company. The FERA encouraged the flow of such investments from non-resident Indians and from the companies belonging to them. However, the Act also imposed a ceiling on such investment so that this
  • 21. privilege may not be used to destabilize the Indian Companies. It was prayed before the Supreme Court that all the 13 companies belonged to one family trust which was operated by a single person, and the purchase of shares in the name of 13 persons was in fact by a single person, and therefore ceiling imposed by FERA was violated. The Supreme Court did not accept this argument, and refused to lift the corporate veil i.e., all the 13 companies were considered separate and independent for the purpose of FERA is to attract investment by non-resident Indians. The lifting of corporate veil would go against that policy and the national interest because it would discourage the flow of investment by non-resident Indians. [L.I.C, v. Escorts Ltd. (1986) I SCC 264] 3. Government Companies: A government company is one which majority of the shares are held by the Central Government or the State Government or by both of them. In case of such companies where almost all the shares are held by the Government, the courts generally refuse to lift the corporate veil i.e., the company is treated as a separate legal entity and not the part of the Government itself. EXAMPLE 2.33, A government company contended that it cannot be subjected to development tax, as it is not a separate entity but a part of the Government itself. The court refused to lift the corporate veil as requested by the company, and regarded the Government company to be a separate entity for the purpose of enabling the Development Authority to impose a development tax on the company. [Bharat Aluminium Co. v. Special Area Development Authority, (1981) 51 Company cases 114 (MP)] Similarly, where transport services were provided by a company all of whose shares were owned by the Transport Commission, the court refused to lift the corporate veil and held that the transport services were provided by the company itself and not by the Government (i.e., Transport Commission) . Thus, a Government company is not regarded as the Government itself or its agent. It can be regarded as an agent of the Government only when it is performing in substance governmental or sovereign function, and not merely commercial function.