Corporate Law

Exploring the Legal Doctrine of Veil of Incorporation

calendar12 Dec, 2023
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Veil of Incorporation

The concept of “Lifting the Corporate Veil” or ‘Veil of Incorporation’ develops as a profound legal doctrine in the convoluted web of corporate jurisprudence. This theory serves as a window into the world beyond the corporate façade, allowing the law to hold individuals accountable for the activities of the corporation. The theory of lifting Veil of Incorporation has a long history in Indian law, as well as a variety of case law that explains its application. Let us go into this legal complication, investigating its legal history, origins in business law, and major case laws that have shaped its contours.

Why Veil of Incorporation Important under the Companies Act?

The legal entity idea of a corporation remains the foundation notion upon which all corporate law is founded. However, because the company’s independent personality is a statutory privilege, it must only be used for legitimate business purposes. When a corporate body’s legal structure is abused for fraudulent and unethical purposes, it cannot hide behind the corporate identity of the individual involved. In these circumstances, the court must pierce the corporate veil and apply the “Veil of Incorporation“theory, which means that the court must look behind the corporate body.

This concept is a legal fiction that deals with the distinct entity associated with the body of people. Normally, the corporation cannot be considered a separate entity from its members because they are the firm’s beneficiaries. When there is illegality or fraud in the firm, the doctrine of veil of incorporation is used. In this instance, the owners, shareholders, or members are personally liable for the companies’ debts and responsibilities.

In the case of Salomon v. Salomon, it was decided that in “questions of property and capacity, of acts done and rights acquired or liabilities assumed thereby… the personalities of the natural persons who are the company’s corporators are to be ignored.”

The Supreme Court has taken a similar approach, which can be seen through the corporate veil in some cases. Thus, in “Central Inland Water Transport Corporation Ltd. v. BrojoNathGanguly,” the Supreme Court observed, inter alia, that “for the purpose of Article 12, one must necessarily see through the veil of incorporation to ascertain whether behind that veil is the face of an instrumentality or agency of the State.”

“Again, in the State of Uttar Pradesh. v. Renusagar Power Company, the Supreme Court observed”: “The veil of incorporation even though not lifted sometimes, is becoming more and more transparent in modern company jurisprudence.”

Legal Understanding

The precedent-setting judgement in Salomon v. Salomon & Co. (1897), a landmark case in both English and Indian company law, is where the idea first emerged. The idea that a company is a separate legal entity from its stockholders was supported in this case. This idea of limited liability is made possible by the fact that usually speaking, shareholders are not responsible for the debts and liabilities of the corporation. The doctrine of lifting the corporate veil was made possible by the absolute nature of this principle, which seeks to avoid its abuse.

Origin in Corporate Laws

The Companies Act of 1956 gave the veil of incorporation theory its first formal expression in India. Under Section 627 of Companies Act, provides the guidelines for holding corporation leaders accountable for specific violations on a personal level. Over time, Indian courts began to recognise situations where the corporate veil may be broken to reveal the true substance of transactions or operations carried out by a corporation, inspired by English precedents.

Piercing the corporate veil

In UK and India Over the years, several interpretations have been given to the phrase “piercing the corporate veil.” One of the most talked-about corporation law theories is this one. The “separate legal entity” perspective has not been widely recognised, and many have provided numerous justifications for this. Prest v. Petrodel Resources Ltd, is one of the important cases in this area that have occurred in the United Kingdom, among other cases. According to Lord Sumption, if the person in charge of running the business is at fault, he can be held accountable. He offered two guidelines. The concealing principle and the evasion principle are two.According to the concealment principle, a corporation engages in a transaction in order to conceal the true purpose of the transaction. According to the “evasion principle,” when a company is put in the middle of a legal claim made against a person in charge of running it, the claim is defeated because the company is seen as a different legal entity. If we examine the strategy used by the European unions, we will notice that they extend and shift the burden. The limited responsibility of the companies is weakened as a result, and the liability of the group is increased. Similar cases have been heard by Indian courts, and judgements have been rendered in a manner akin to that of the United Kingdom.

 In Delhi Development Authority v Skipper Construction Co.(P) Ltd, according to the Supreme Court, the court has the authority to examine beyond the corporate character of the corporation when the company character is being used to conduct fraud. Another case that occurred in 2003 was KapilaHingorani v. the State of Bihar, the court observed that, if a firm is judged to be harmful to the interests of the general public or workers, the corporate veil might be lifted.

These examples demonstrate that common law nations have upheld the Saloman case ruling and permitted the piercing of the corporation veil in rare circumstances. In the UK, piercing of the veil is an uncommon alternative because any fraud or illegal activity performed by the firm does not constitute a case at law.

Grounds for lifting the doctrine of the veil of incorporation

The doctrine of the veil of incorporation can be lifted by on two grounds, which we will understand them in detail:

  1. Judicial Provisions
  2. Judicial interpretation

Let’s try and understand these more in detail.

Judicial provisions

Reduction of the number of members below the statutory minimum: If the minimum number of members of a company falls below two in the case of a private company or below seven in the case of a public company at any time;then the company can continue doing business for a period of six months while the number is so reduced. Every member of the company during this time, knowing that the minimum number of members is now lower and the grace period of six months has ended, will then be held responsible and can sue for the money they made during those six months, or the company and its members will be held ineligible.

Failure to refund application fee: If the directors of the company fail to repay the application money without interest within 120 days when the company fails to allocate shares, they will be jointly and severally liable to pay the money (application money) with interest of 6% per year starting on the date of the expiration of 130 days.

Misdescription of company’s name: If an officer of an organisation (company) signs a bill of trade, hundi, promissory note, or cheque without properly referencing the organization’s name, the holder of the bill of trade, hundi, or cheque may hold the official personally liable unless the bill of trade,  or cheque is properly paid by the company. 

Fraudulent trading: According to Section 339 of the Companies Act of 2013, the Tribunal, upon request from the Official Liquidator, the Company Liquidator, or any creditor or contributory of the company, may, if it thinks it appropriate so to do, declare that any person, who is or has been engaged in any business of the company, has engaged in it with the intent to defraud creditors of the company or any other persons or for any fraudulent purpose,for all or any of the company’s debts or other liabilities, as the Tribunal may order, without any limitation of liability.

For investigating the company’s ownership: According to Section 216 of the Companies Act of 2013, the Central Government may appoint Inspectors to look into and report on the membership of the company in order to identify the actual parties with financial stakes in it and who are in charge of establishing its policies. Thus, the Corporate Veil may be disregarded by the Central Government.

Judicial interpretation

  1. Determination of Character -This notion is used to determine the character of a company; the court may assess the character of individuals in relation to control of corporate operations at its discretion.
  2. Tax Evasion – Every working person is required to pay taxes. The corporation is not free from this liability in any manner. It is an infraction if the company illegally evaded paying taxes.
  3. To avert Fraud or Improper behaviour – Since human agency is required, the organisation cannot engage in fraud or improper behaviour on its own. The corporate veil theory may be upheld by the court in situations involving fraud, deceit, and money laundering.
  4. Government companies – In some cases, a company may be viewed as acting as a trustee or agent for its members, losing its unique identity in favour of its guiding principles.
  5. Sham corporations – In order to expose the sham corporations, the court may lift the corporate veil. Sham organisations are merely cloaks, and it is possible to discern the members’ true nature by looking past their personalities.
  6. Ultra-Vires Acts – Any action taken in violation of the Companies Act of 2013’s Memorandum of Understanding and Articles of Association is considered ultra vires, and the court must apply the doctrine in such cases.
  7. To uphold public policy – The corporate veil doctrine may be lifted by the court when the defendant violates public policy or the interests of the public.

Important Case laws for Veil of Incorporation

Subhra Mukherjee v. Bharat Coking Coal Ltd.

In this instance, a hoax or façade is being discussed. Before the company was nationalised, a private coal company sold the executive spouses their real properties. The truth is that documents were altered and backdated to show that the sale of real estate to the wives of directors took place prior to the company’s nationalisation. Where such an exchange is alleged to be a hoax and dishonest, the Court was assisted in veil of incorporation to discover the true idea of the exchange in order to realise who the genuine parties to the deal were and whether the exchange was real and done in good faith or whether it was between married couples hiding behind the façade of the different entity of the company.

Bajrang Prasad Jalan v. Mahabir Prasad Jalan

This is a case involving a Subsidiary Holding Company. To assess an objection of abuse, the court concluded that the veil of incorporation might be pierced where both a holding company and its subsidiary belong to the parent organisation.

N.B. Finance Ltd. v. Shital Prasad Jain

In this case, the High Court of Delhi granted the offended party organisation a stay order preventing the defendant’s company from alienating the properties that they owned on the grounds that the defendant had borrowed money fraudulently from the plaintiff companies and had purchased properties in their names. The court in this case did not grant protection under the corporate veil piercing doctrine.

Jones v. Lipman

In this case, the merchant of a real estate property attempted to avoid the specific execution of a contract for the clearance of the land by transferring the land to a company he formed for the purpose, and thus, he attempted to avoid finishing the property deal of his home to the offended party. Russel J. described the firm as a “devise and a hoax, a veil which he holds before his face and endeavours to avoid recognition by the eye of equity,” and asked both the claimant and his company specifically to satisfy the contract’s responsibilities to the offended party. 

What Are the Exceptions to Veil of Incorporation in India

Theveil of incorporation can only be lifted in exceptional cases, in this section the author has talked about them in detail.

Reduction of the number of members below the statutory minimum

When a private company has less than two members and two directors, or when a public company has fewer than seven members and three directors liable jointly and severally for the full amount of the company’s obligations accrued during that period and liable in separate actions for those debts.

Failure to refund application fee

When the company fails to allocate shares, and the director fails to repay the application money without interest within 120 days, they are jointly and severally liable under Section 39 of the Companies Act, 2013, to pay back that money with interest at a rate of 6 per cent per year starting at the end of the 133-day grace period.

Mis-description of company’s name

According to Section 12 of the Companies Act of 2013, in addition to criminal penalties, an officer of a company who signs or causes to be signed on its behalf any bill of exchange, hundi, promissory note, endorsement, cheque or order for money or goods without mentioning its name is also personally liable for those instruments.

Fraudulent Trading

According to Section 339 of the Companies Act of 2013, anyone who is knowingly a party to the carrying on of the business in the way aforesaid is penalised by imprisonment for a term of up to two years or a fine of up to INR 50,000, or both.

For investing in a company’s ownership

The Central Government may appoint inspectors to investigate and report on the membership of any business under Section 216 of the Companies Act, 2013, in order to determine the authentic persons who are financially involved in the firm and who manage its policy. As a result, the central government has the capacity to lift the Veil of Incorporation.

Direct Precedents on Veil of Incorporation

  • Life Insurance Corporation of India v. Escorts Ltd. (1986)

This case demonstrated the idea that courts can disregard the corporate personality and hold individuals accountable when a company is used as a front for illegal activity.

  • Gilford Motor Co. Ltd. v. Horne (1933)

The court ruled in the aforementioned case that the veil of Incorporation can be lifted to reveal the people behind a company if it was formed to engage in illegal behaviour.

  • JuggilalKamlapat v. CIT (1969)

The court determined that the veil of incorporation can be lifted to reveal the true nature of an arrangement if a corporation is set up to evade taxes.

  • Tata Engineering and Locomotive Co. Ltd. v. State of Bihar (1964)

In the present instance, it was established that the corporate veil might be lifted by the courts if the shareholders’ funds were misappropriated and the corporate structure was exploited to avoid culpability.

  • Satyam Computer Services Ltd. Scandal (2009)

The Satyam scandal revealed that courts can lift the corporate veil to identify those guilty for a large financial fraud.

  • BalwantRaiSaluja and Another V. Air India Limited and Others, 2015 AIR SC 375.

In the case mentioned above, the court ruled that mere ownership and control are insufficient grounds for penetrating the corporate veil. It must be proven that the appellant’s legal rights were violated as a result of the control and impropriety.

  • Kuber (India) Sales Pvt. Ltd V. Govt. of Tripura, 2019 SCC ONLINE TRI 553.

In this instance, the court ruled that the respondent’s dues could not be recovered from the Private Limited Company unless and until the corporate veil was lifted. A registered corporation, whether private Limited or public, has its own identity and is different from its members. Personal dues of members or directors are not recoverable unless the veil of incorporation lifted.

Conclusion

In India, the notion of veil of incorporation is a potent instrument for ensuring that the principle of limited liability does not become a shield for illegal acts. The theory has grown via notable case laws, solidifying its significance in the corporate legal environment, and has a deep legal background. As corporate structures grow, the doctrine’s application will surely expand further, ensuring that justice is served and corporate entities are held accountable for their actions.

The business world has experienced several false statements, scams, and insider trading as a result of expanding economic development and innovations inside the corporate framework. The concept of ‘veil of incorporation’ arose in order to protect members from the company’s actions.

Frequently Asked Questions

1. What does veil of in corporation do?

The corporate veil is a notion that is recognised by law as isolating an organization’s actions from those of its shareholders.
Additionally, it protects the shareholders from being held accountable for the company’s decisions. The decision on who is guilty rests with the court. Veil of incorporation is the term used by the court to describe the process by which it can directly hold the company’s investors accountable for debts or frauds while ignoring the shareholders’ restricted culpability. In closed, tiny firms with few stockholders and assets, the effectiveness of lifting the corporate veil can most often be seen. But unless there is a significant violation of affairs or wrongdoing, it is more practical to refrain from raising this veil.

2. When can the veil of incorporation pierced?

Following are the list of scenarios:
In accordance with the Companies Act of 2013, certain circumstances may allow courts to pierce the corporate veil, such as:
Sham Transactions: If a transaction or arrangement is determined to be a sham, intended to defraud creditors or avoid duties under the law, the court may overlook the corporate entity and hold stockholders personally accountable.
Corporate Façade: When a company is incorporated and operated as a mere facade, concealing the true nature of its activities or the interests of those controlling it, the courts have the power to pierce the corporate veil and hold the individuals behind it accountable.
Fraudulent operations: The courts may pierce the corporate veil and hold the shareholders accountable for such actions personally liable if a corporation engages in fraudulent operations with the purpose of deceiving or injuring others.
Failure to Comply with Legal Requirements: The court may disregard the corporate veil and hold shareholders personally accountable if shareholders fail to maintain correct books of accounts, conduct required audits or file required returns.

3. What are the two reasons to lift the veil of incorporation?

The following are the two main categories for lifting the Corporate Veil:
Judicial rules; and
Statutory rules

4. What effect does veil of incorporation have?

Shareholders could be held personally responsible for the duties, debts, or wrongdoing-related damages of the corporation if the corporate veil is removed. This implies that in order to satisfy the company’s obligations, creditors or harmed parties may pursue the personal assets of shareholders.

5. What are some typical justifications for removing the corporate curtain in India?

In India, the corporate veil may be raised in situations involving fraud, the avoidance of legal duties, phoney transactions, unethical behaviour, and situations in which the business was established solely to serve as a puppet for its controlling entities.

Read Our Article: What Is Lifting Of Corporate Veil Under Companies Act, 2013

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