Lifting the corporate veil

The concept of the ‘corporate veil’ is inherent in the doctrine of corporate personality. The effect of this principle is that there is a fictitious veil (and not a wall) between the company and its members.

This flows from the acceptance of limited liability

Lifting the corporate veil

However there had been a fraudulent use of the veil of corporate personality by members and directors. Due to this the courts may break through or lift the corporate veil or crack the shell of corporate personality.

i.e. the company and the owners are treated as the same

Clearly this is most significant where the company is insolvent and creditors wish to pursue the assets of the owners

Lifting the corporate veil

Cases where the court may lift the corporate veil

Given the significance of limited liability it is crucial to understand the circumstances which could possibly lead to avoidance of the ‘veil’

1. Protection of revenue

The courts may ignore the corporate entity of a company where it is used for tax evasion. Tax planning is legitimate provided it is within the framework of law.

Lifting the corporate veil

Case: Sir Dinshaw vs Maneckjee Petit

D, an assessee , who was receiving huge dividends and interest incomes, transferred his investments to 4 private companies formed for the purpose of reducing his tax liability. These companies transferred the income to D as a pretended loan.

Lifting the corporate veil

2. Prevention of fraud or improper conduct

The legal personality of a company may be disregarded if it has been used for some fraudulent purposes like defrauding creditors or defeating or circumventing law

Lifting of the Corporate Veil

Case: 1 Gilford Motor Co. Vs Horne

Horne, a former employee of GM company, had bound himself not to solicit to its customers.

He formed a Company to do his business and sent the employees of the so formed company to solicit the customers of GM & Co.

Lifting the Corporate Veil

Decision

The Court described the company as device stratagem and mere cloak or sham and issued injunction restraining Horne and his Company as well from dealing with the customers of GM Company.

Lifting the corporate veil

3. Determination of character of a company in case of war

During the war the court may lift the veil to enquire whether the company it is controlled by alien enemies.

4. Company avoiding legal obligations

The court may disregard the legal personality of the company if the use of the company is being made to avoid legal obligations

Lifting the Corporate Veil

Case 4: Diamler Co.Ltd vs Continental Tyre and Rubber Company Limited

A company was incorporated in England for the purpose of selling tyres manufactured in Germany by a German Company. The German Co. held the bulk of the shares in the English Co. The holders of the remaining shares (except 1) and all the directors were Germans, resident in Germany. Thus the real control was in the hands of the Germans. After the war broke out between Germany and England, the English Co. filled a suit for recovery of money for its trade debts

Lifting the Corporate Veil

DecisionThe House of Lords laid down that the Company incorporated in UK is a legal entity, a creation of law with status and capacity which the law confers. It is not a natural person with mind and conscience. It can be neither friend nor enemy. But it can assume an enemy character when persons in de facto control are residents in an enemy country.Accordingly the company was not allowed to proceed with the action . If the action would have been allowed the company would have been used as a machinery by which the purpose of giving money to the enemy would be accomplished

Lifting the corporate veil

5. Company acting as agent or trustee of the shareholders

In this situation the shareholders will be responsible for the acts of the company

6. Protecting Public policy

The courts may lift the corporate veil to prevent transactions contrary to public policy

Lifting the corporate veil

7. Reduction of membership

Where the number of members of the company is less than the statutory minimum, and the company carries on business for more than 6 months thereafter, every member who is aware of the fact shall be severally liable for the payment of the Company’s debt contracted during that time.

8. Misrepresentation in prospectus

Every company who proposes to raise funds through issue of equity shares must issue a prospectus or a Statement in lieu of prospectus. In case there is misrepresentation, every director, every promoter and every other person who authorises such issue is liable towards those who subscribe for shares on faith of untrue statements.

Lifting the corporate veil

9. Misdescription of name

When the Company’s name is not mentioned or not mentioned properly in any document, then any person signing such a document shall be personally liable.