Lifting up of the Corporate Veil

Saumya Garg ( 3RD Year, BBA LL.B.(H.), School of Law University of Petroleum and Energy Studies, Dehradun) has Written this Article LIFTING UP OF THE CORPORATE VEIL

INTRODUCTION

The concept of the corporate veil is a legal principle that shields the shareholders of a company from being held personally liable for the company’s debts and obligations. It separates the legal identity of the company from that of its owners, allowing the company to act as a separate entity in the eyes of the law. However, in certain situations, the courts may lift the corporate veil, and hold the shareholders personally liable for the company’s actions. In this article, we will examine the circumstances under which the corporate veil may be lifted and the legal implications of doing so.

WHAT IS THE CORPORATE VEIL?

The corporate veil refers to the legal separation between a company and its shareholders. When a company is incorporated, it becomes a separate legal entity from its owners. This means that the company can enter into contracts, own property, and sue or be sued in its own name. Shareholders are not personally liable for the company’s debts and obligations, as long as they have complied with their legal duties and have not engaged in any fraudulent or wrongful conduct.

The corporate veil is a fundamental principle of company law, and it provides many benefits to shareholders and investors. It encourages entrepreneurship by allowing investors to pool their resources and share the risks of starting and running a business. It also protects shareholders from being held personally liable for the company’s debts and obligations, which would discourage investment and innovation.

However, the corporate veil can also be abused and used to shield shareholders from the consequences of their actions. This is where the courts may lift the corporate veil, and hold the shareholders personally liable for the company’s actions.

REQUIREMENT OF LIFTING UP OF THE CORPORATE VEIL

As unscrupulous persons began utilizing the corporate veil as a tool to conceal fraud in a company’s dealings, the principle of removing the corporate veil became required. As a result, it has become necessary for the government and courts to adapt and uncover the corporate veil in order to determine who is behind the corporation and who the true beneficiaries of the corporate body are.

The Supreme Court stated in the Andhra Pradesh State Road Transportation Case that the concept that a corporation is a separate legal entity is so deeply ingrained in our notions inherited from common law that it is rarely essential to deal with it in detail.

THE IDEA BEHIND THE CORPORATE VEIL LIFTING DOCTRINE

A crucial part of company law is the idea of the corporate veil. This is a shield for people who exist behind the veil. According to Pickering, there are two basic grounds for exclusions to the distinct entity concept. To begin, he claims that a company cannot be treated as an ordinary independent person at all times and in all circumstances. 

Second, if there were no exemption to the distinct entity requirement, Directors and members may hide behind the shield of limited responsibility, potentially having devastating consequences. As a result, the notion of uncovering the corporate veil is primarily utilised as a versatile weapon to enforce justice.

The theory of removing the veil was created as a means of avoiding the difficulties associated with the doctrine of corporate personhood. It might be seen as a company’s identification with its members. Members of a corporation frequently use corporate veils to shield themselves from the firm’s responsibilities. These business veils are sometimes employed as a cover for fraud or tax avoidance. To avoid unfair and fraudulent conduct, it is vital to raise the curtain and look beneath the legal veneer, holding each individual member of the firm accountable for their actions. Courts and legislators have removed the corporate veil in the interests of equity, justice, and moral conscience.

The doctrine of removing the corporate veil is not specified in the text of Indian Company Law, but it may be deduced from several laws.

WHEN CAN THE CORPORATE VEIL BE LIFTED?

The courts may lift the corporate veil in certain situations where it is necessary to prevent fraud or other wrongful conduct. The following are some of the circumstances under which the corporate veil may be lifted:

1) FRAUD OR WRONGFUL CONDUCT

If the company is used as a vehicle for fraud or other wrongful conduct, the courts may lift the corporate veil and hold the shareholders personally liable for the company’s actions. This may happen, for example, if the company is used to conceal illegal activities or to defraud creditors.

In the case of Gilford Motor Co Ltd v Horne [1933] Ch 935, the court lifted the corporate veil and held the shareholders personally liable for the company’s breach of a non-compete clause in an employment contract. The company was set up by the shareholders to evade the clause, and the court found that it was a mere façade for the shareholders’ personal business.

2) CORPORATE FORMALITIES

A company is required to comply with certain formalities, such as keeping accurate records and holding regular meetings, to maintain its separate legal identity. If a company fails to comply with these formalities, the courts may lift the corporate veil and treat the company as an extension of its owners or shareholders. For example, if a company does not maintain separate bank accounts or does not keep proper records of its transactions, the courts may lift the corporate veil and hold the owners or shareholders liable.

3) ALTER EGO OR AGENCY

If the company is found to be the alter ego or agent of its shareholders, the courts may lift the corporate veil and hold the shareholders personally liable for the company’s actions. This may happen, for example, if the shareholders treat the company as a mere extension of their personal affairs, or if they fail to observe the formalities of company law.

The alter ego doctrine allows the courts to disregard the separate legal identity of a company where the company and its owners or shareholders are so closely intertwined that they are effectively the same entity. This may occur where the owners or shareholders have total control over the company’s affairs and use it to further their personal interests rather than the interests of the company.

In the case of Jones v Lipman [1962] 1 WLR 832, the court lifted the corporate veil and ordered the transfer of a property from the company to the shareholder. The shareholder had transferred the property to the company to avoid a specific performance order, but the court found that the company was a mere façade for the shareholder’s personal business.

4) IMPROPER USE OF CORPORATE STRUCTURE

If a company is set up in a way that is intended to evade legal obligations or liability, the courts may lift the corporate veil and hold the owners or shareholders liable. For example, if a company is set up as a shell company with no real business activity and is used to hide assets or avoid paying taxes, the courts may lift the corporate veil and treat the company as an extension of its owners or shareholders.

5) GROUP OF COMPANIES

If the company is part of a group of companies, the courts may lift the corporate veil and look at the group as a whole to determine the economic reality of the situation. This may happen, for example, if the group is structured in a way that is designed to avoid legal or tax obligations.

In the case of Adams v Cape Industries plc [1990] Ch 433, the court held that the corporate veil should be lifted to look at the economic reality of a group of companies.

In conclusion, the grounds for lifting the corporate veil are varied, and the circumstances in which the courts will do so are often complex. However, the courts will generally only lift the corporate veil where there is evidence of wrongdoing, fraud, or other misconduct, and where it is necessary to prevent injustice or protect the interests of third parties.

JUDICIAL PRONOUNCEMENTS ON THE LIFTING UP OF THE CORPORATE VEIL

There have been several important cases over the years that have helped to shape the legal principles surrounding the corporate veil. Here are a few notable examples:

1) SALOMON V. SALOMON & CO. LTD. (1897)

This case is often considered the leading authority on the principle of corporate personality and the separate legal identity of a company. Mr. Salomon, a shoe manufacturer, incorporated his business as a limited liability company. When the company went bankrupt, Mr. Salomon’s creditors argued that the company was not a separate legal entity and that Mr Salomon would be made personally liable for debts of the company. However, the court held that the company was a separate legal entity and as Mr Salomon was not personally liable for the debts of the company.

2) GILFORD MOTOR CO. LTD. V. HORNE (1933)

In this case, Mr. Horne, a former employee of Gilford Motor Co., started a competing business that was incorporated as a separate company. However, Mr. Horne continued to use the trade secrets and confidential information of his former employer to compete with them. The court held that the new company was simply a “cloak” or “sham” used by Mr Horne to avoid his legal obligations to his former employer. As a result, the court lifted the corporate veil and held Mr. Horne and his new company liable for the damages caused by his breach of contract.

3) DHN FOOD DISTRIBUTORS LTD. V. TOWER HAMLETS LONDON BOROUGH COUNCIL (1976)

In this case, the company DHN Food Distributors Ltd. was part of a group of companies that were jointly liable for a tax debt owed to the local council. The company argued that it should not be held liable for the debt because it was a separate legal entity from the other companies in the group. However, the court held that the companies were all part of a single economic entity and that the corporate veil should be lifted to allow the council to recover the debt from the group as a whole.

4) ADAMS V. CAPE INDUSTRIES PLC (1990)

In this case, a group of companies owned by Cape Industries plc operated asbestos mines in South Africa. A group of employees who were exposed to asbestos and developed related illnesses sued Cape Industries in the UK for damages. Cape Industries argued that it could not be held liable for the actions of its subsidiary companies because they were separate legal entities. However, the court held that the subsidiaries were not autonomous and that the group as a whole should be treated as a single entity. As a result, Cape Industries was held liable for the damages caused by the subsidiary companies.

These cases demonstrate the range of circumstances under which the corporate veil may be lifted, including fraud, wrongful conduct, conflicts of interest, and group structures designed to evade legal obligations or liability. While the courts are generally reluctant to lift the corporate veil, they will do so when necessary to prevent abuse or protect the rights of creditors or other parties.

SUGGESTIONS AND RECOMMENDATIONS

While the lifting of the corporate veil is a rare and exceptional circumstance, it is important for companies to be aware of the potential risks and to take steps to minimize the likelihood of it happening. Here are some suggestions and recommendations for companies to consider:

1) OBSERVE FORMALITIES OF COMPANY LAW

One of the main reasons why the corporate veil may be lifted is if the company fails to observe the formalities of company law. This includes things like keeping accurate records, holding regular meetings, and filing all necessary documents with the relevant authorities. Companies should ensure that they comply with all legal obligations to minimize the risk of the corporate veil being lifted.

2) AVOID FRAUDULENT OR WRONGFUL CONDUCT

The courts are more likely to lift the corporate veil if the company is used for fraudulent or wrongful conduct. Companies should avoid engaging in any illegal activities or fraudulent behaviour to prevent the corporate veil from being lifted.

3) AVOID CONFLICTS OF INTEREST

Shareholders should avoid conflicts of interest and ensure that they act in the best interests of the company. If the shareholders use the company to further their own personal interests or gain, the corporate veil may be lifted, and they may be held personally liable for the company’s actions.

4) AVOID GROUP STRUCTURES DESIGNED TO AVOID LEGAL OBLIGATIONS

If a company is part of a group of companies, the courts may look at the group as a whole to determine the economic reality of the situation. If the group is structured in a way that is designed to avoid legal obligations or liability, the corporate veil may be lifted. Companies should avoid complex group structures that are designed to evade legal obligations or liability.

5) OBTAIN PROFESSIONAL ADVICE

If a company is unsure about its legal obligations or risks related to the corporate veil, it should obtain professional advice from lawyers or accountants. Professional advisors can help companies understand their legal obligations and how to comply with them to minimize the risk of the corporate veil being lifted.

6) MAINTAIN SEPARATE LEGAL IDENTITY

To maintain the corporate veil, companies should ensure that they maintain a separate legal identity from their shareholders. This includes keeping separate accounts and finances, entering into contracts in the company’s name, and ensuring that the company is run as a separate entity.

Companies should be aware of the potential risks related to the lifting of the corporate veil and take steps to minimize the likelihood of it happening. By observing the formalities of company law, avoiding fraudulent or wrongful conduct, avoiding conflicts of interest, avoiding group structures designed to evade legal obligations, obtaining professional advice, and maintaining a separate legal identity, companies can help protect themselves and their shareholders from the consequences of the corporate veil being lifted.

CONCLUSION

In conclusion, the lifting of the corporate veil is a complex issue that must be considered on a case-by-case basis. While the corporate veil provides important benefits to shareholders and investors, it can also be abused to shield individuals from the consequences of their actions. The courts have developed a range of circumstances under which the corporate veil may be lifted, including fraud, alter ego or agency, and a group of companies.

These situations are usually rare and exceptional, and it is important for the courts to balance the interests of the shareholders with the need to prevent fraudulent or wrongful conduct. Companies should ensure that they comply with all legal obligations and observe the formalities of company law to avoid the risk of the corporate veil being lifted. Ultimately, the principle of the corporate veil is an important foundation of company law, and it must be preserved to encourage entrepreneurship and innovation while protecting the interests of shareholders and the public.