The corporate veil is a legalized concept separating the actions of the organization from that of its shareholders.
It also safeguards the shareholders from being guilty of the actions of the company. The court has the right to determine the guilty party. This method exercised by the court is called “piercing the corporate veil in which the court can directly charge the investors of the company as responsible for debts or frauds and put aside the limited liability of the shareholders. The effectiveness of piercing the corporate veil can be mostly observed in closed and small corporations which have limited shareholders and assets. But, it is more convenient to abstain from uplifting this veil unless some serious breach of affairs and misconduct take place.
Factors determining the Piercing of Corporate Veil
Public Interest
If a company has been set up against the public interest, then it is permissible for the Court to allow the lifting of the corporate veil to determine the reality. In such scenarios, it does not provide limited liability protection to the members of the company.
Presence of Fraud
The Supreme Court of India has observed that “The concept of corporate entity is to encourage and promote trade and commerce but not to commit illegalities or to defraud people. Where, therefore, the employment of corporate character is for the purpose of committing illegality or for defrauding others, the court would ignore the corporate character and will look at the realities behind the corporate veil so as to enable it to pass appropriate orders to do justice between the parties concerned. Hence, in the case of the presence of fraud or illegalities, it would lift the corporate veil to do justice.
Tax Evasion
The corporate veil can be lifted when a corporate entity is used in defence proceedings or as a shield to cover wrongdoings in tax matters or for a commission of tax evasion. Hence, the usage of a corporate veil for facilitating evasion of legal obligations like payment of taxes or denial of statutory benefits to employees, the Court has allowed for the lifting of the corporate veil.
Diversion of Funds
In transactions where a sale of property by a company in favour of the wives of the Directors has alleged to be sham or collusive, the court has allowed for the piercing of the corporate veil. Hence, collusion amongst promoters and diversion of funds of the company for personal uses are cases eligible for the piercing of the corporate veil to render justice.
Other Causes
The following are other situations or circumstances under which the corporate veil can be lifted:
- To determine if a company is an enemy company;
- If a company formed to defeat or circumvent the law or defraud creditors or to avoid legal obligations;
- If laws relating to foreign exchange control have been violated;
Corporate Veil
The corporate veil is a legal concept which separates the actions of an organization to the actions of the shareholder. Moreover, it protects the shareholders from being liable for the company’s actions. In this case a court can also determine whether they hold shareholders responsible for a company’s actions or not. Here comes the term of ‘Piercing the corporate veil’ which refers to a circumstance where courts set aside the limited liability of the shareholders and hold a company’s investors or directors personally liable for the organization’s fraudulent activities or failure in debts. Laws vary from state to state, but courts will generally abstain from piercing the corporate veil unless there have been signs of serious misconduct.
Piercing the Veil
The liability protection of a corporation is quite important, unfortunately, it is not always absolute. Piercing the corporate veil takes off the distinction between the owners and the business, the distinction is stripped away. The owners or the shareholders working on behalf of the company become personally responsible for the financial condition of the business, like as they would be if the company was a sole proprietorship.
Piercing of the corporate veil generally occurs when someone, like the creditor or a person who has been affected by a business, takes legal action. He would argue that the owners of the business should be held personally liable for the money that is at stake or frauded. The court will not easily agree to pierce the corporate veil in any random situations, since the entire purpose of creating the veil is to protect owners and allow the business to operate in its own independence. However, the court will pierce the corporate veil in situations where the owners, directors or shareholders commit frauds, fail to follow the corporate formalities or have acted inappropriately.
Piercing the Corporate Veil Factors
The Existence of Fraud or Wrongdoing to the Third Parties
One of the biggest factors that the court condemns is the existence of fraud or wrongdoing to the third parties, the court pierces the corporate veil in this case.
Failure to Maintain the Separate Identities Among the Companies
A common scene that may cause some checking is where there are several related companies acting under the umbrella of one company and the failure to maintain separate identities of the companies.
Failure to Maintain Separate Identities of the Company with its Owners or Shareholders.
This is the merging of the name of the company with the owners or shareholders of the company.
Inadequately Capitalize the Company
Courts will check the assets of the company to determine if the company’s quantum of assets available for the creditors is appropriate or not, whether it is a scene of undercapitalization.
Not in Accordance with the Corporate Formalities
Another red flag that could lead to piercing the corporate veil is the failure to follow corporate formalities. In cases where formalities are not legally followed, courts have held that the liability protection of the shareholders will be waived off and the personal assets of the owners can be tied in this case.
The Principle of Separate Legal Entity
The Salomon v. Salomon & Co. case established that a company has a separate legal identity from its members. This principle enables a business to conduct legal actions in its own name, shielding directors and shareholders from personal liability. While this principle is fundamental, courts have occasionally lifted the corporate veil to address misuse of the corporate form.
The Salomon v. Salomon & Co. Case
The Salomon v. Salomon & Co. case is a landmark decision that firmly established the principle of separate legal entity. Mr. Aron Salomon, a boot manufacturer, formed a company and sold his business to this newly formed entity. He held the majority of shares, with the remaining shares distributed among his family members. When the company went into liquidation, creditors sought to hold Mr. Salomon personally liable for the company’s debts. The House of Lords, however, ruled that the company was a separate legal entity distinct from Mr. Salomon and the other shareholders. This ruling underscored the concept that a company has its own legal personality, separate from its owners.
FAQs
Why is the corporate veil lifted?
- Fraud or improper conduct: If a company is used to carry out fraudulent activities or illegal purposes, the veil may be lifted to hold the perpetrators accountable.
- Avoiding personal liability: In cases where individuals try to use the company to avoid personal liability, courts may lift the veil.
- Injustice or unfairness: To prevent injustice or unfairness, especially when the company is used to evade legal obligations or to harm others.
- Agency or sham companies: When a company acts as an agent for its shareholders or is a sham to disguise personal activities.
What legal provisions allow the lifting of the corporate veil in India?
In India, the corporate veil can be lifted under various legal provisions, such as:
- Section 441 of the Companies Act, 2013: Courts can lift the veil if the company is engaged in fraudulent activities or to protect the rights of creditors.
- Judicial precedents: The Indian courts have developed the principle of lifting the veil in cases involving fraud, misrepresentation, or unlawful activities. Landmark cases like Gilford Motor Co. Ltd. v. Horne and Regal (Hastings) Ltd. v. Gulliver have highlighted situations where the corporate veil can be lifted.
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