Corporate Veil is a legal concept that separates the personality of a corporation from the personalities of its shareholders and protects them from being personally liable for the company’s debts and other obligations. A company is separate and is a distinct legal entity, separate from the identity of its members too. A company is not a living body hence the members work on behalf of the company behind the veil. This, in simple terms, is known as the ‘Corporate Veil’.
LIFTING THE CORPORATE VEIL
Lifting or piercing the corporate veil means looking beyond the company as a legal person. Or, disregarding the corporate identity and paying regard to humans instead. At times it may happen that the corporate personality of the company is used to commit frauds and improper or illegal acts. Since an artificial person is not capable of doing anything illegal or fraudulent, the façade of corporate personality might have to be removed to identify the persons who are really guilty. This is known as ‘lifting of corporate veil’.
It refers to the situation where a shareholder is held liable for its corporation’s debts despite the rule of limited liability and/or separate personality. The veil doctrine is invoked when shareholders blur the distinction between the corporation and the shareholders. A company or corporation can only act through human agents that compose it. As a result, there are two main ways through which a company becomes liable in the company or corporate law: firstly through direct liability (for direct infringement) and secondly through secondary liability (for acts of its human agents acting in the course of their employment).
There are two existing theories for the lifting of the corporate veil. The first is the “alter-ego” or other self-theory, and the other is the “instrumentality” theory. The alter-ego theory considers if there is in distinctive nature of the boundaries between the corporation and its shareholders. The instrumentality theory on the other hand examines the use of a corporation by its owners in ways that benefit the owner rather than the corporation. It is up to the court to decide on which theory to apply or make a combination of the two doctrines.
CONCEPT OF LIMITED LIABILITY
One of the main motives for forming a corporation or company is the limited liability that it offers to its shareholders. By this doctrine, a shareholder can only lose what he or she has contributed as shares to the corporate entity and nothing more.
FACTORS AFFECTING LIFTING OF CORPORATE VEIL
The corporate veil is generally lifted when someone like a creditor or a person who has been affected by a business takes legal action. 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, if any of the following factors are satisfied the Court may allow lifting of the corporate veil:
- Existence of Fraud or Wrongdoing to third parties
- Failure to maintain the separate identities among the Companies
- Failure to maintain separate identities of the company with its owners and shareholders.
- Inadequate capitalization of the Company
- Not in accordance with Company Law or Corporate Formalities
The concept of a separate legal entity was first discussed in the case of Solomon v. Solomon & Co. Ltd. The company in less than one year ran into difficulties and liquidation proceedings commenced. The assets of the company were not even sufficient to discharge the debentures (held entirely by Salomon itself) and nothing was left to the insured creditors. The House of Lords unanimously held that the company had been validly constituted since the Act only required seven members holding at least one share each and that Salomon is separate from Salomon & Co. Ltd. It was held that the company is a real and legal company, fulfilling all legal requirements. It had an identity different from its members and therefore, the unsecured creditors were to be paid at priority from the secured debentures.
As to when the corporate veil shall be lifted, the observations of the Supreme Court in Life Insurance Corporation of India v. Escorts Ltd. is worth noting. “While it is firmly established ever since in Solomon v. Solomon & Co. Ltd. that a company is an independent and legal personality distinct from the individuals who are its members, it has since been held that the corporate veil may be lifted, the corporate personality may be ignored and the individual members recognised for who they are in certain exceptional circumstances. Generally, and broadly speaking the corporate veil may be lifted where the statute itself contemplates lifting the veil or fraud or improper conduct is intended to be prevented, or a taxing statute or a beneficent statute is sought to be evaded or where associated companies are inextricably connected as to be, in reality, part of one concern. It is neither necessary nor desirable to enumerate the classes of cases where lifting the veil is permissible since that must necessarily depend on the relevant statutory or other provisions, the object sought to be achieved, the impugned conduct, the involvement of the element of public interest, the effect on parties who may be affected, etc.”
In Cotton Corporation of India Ltd. v. G.C. Odusumathd, the Karnataka High Court has held that the lifting of the corporate veil of a company, as a rule, is not permissible in law unless otherwise provided by clear words of the Statute or by very compelling reasons such as where fraud is needed to be prevented or trading with an enemy company is sought to be defeated.
Again, in State of U.P. v. Renusagar Power Co., the Supreme Court observed: The concept of lifting the corporate veil is a changing concept. The veil of corporate personality, even though not lifted sometimes, is becoming more and more transparent in modern jurisprudence. It is high time to reiterate that, in the expanding horizon of modern jurisprudence, lifting of the corporate veil is permissible, its frontiers are unlimited. But it must depend primarily on the realities of the situation.
Under Article 21 a company also has the right to life and personal liberty as a person. This was laid down in the case of Chiranjitlal Chaudhary v. Union of India where the Supreme Court held that fundamental rights guaranteed by the constitution are available not merely to individual citizens but to corporate bodies as well except where the language of the provision or the nature of right compels the inference that they are applicable only to natural persons.
A company has a legal personality just like all other natural individuals, the only difference between the two is that a company even with its legal personality cannot run or conduct its affairs as a natural person does. The company acts on the concept of the corporate veil, this veil when misused for fraudulent acts will reveal the true nature and real beneficiaries of the company, thus, called the lifting of the corporate veil. The courts from time to time implemented this rule and also brought in a few changes suitable for the situations and for future reference.