What is the Doctrine of Lifting of the Corporate Veil in company law?

The doctrine of lifting the corporate veil allows courts to look beyond a company’s separate legal identity to hold individuals accountable for misuse. While Salomon v. Salomon & Co. established corporate independence, courts pierce this veil in cases of fraud, tax evasion, sham operations, or enemy

What is the Doctrine of Lifting of the Corporate Veil in company law?

Introduction

The corporate veil signifies the legal separation between a corporation and the individuals who own or manage it, treating the corporation as an independent legal entity distinct from its shareholders.

The incorporation of companies by registration was introduced in 1844, followed by the doctrine of limited liability in 1855. In the landmark case of Salomon v. Salomon & Co.[1], the House of Lords solidified these principles into English law, establishing the concepts of corporate entity and limited liability.

The court ruled that a company is a distinct legal entity, separate from its members, a principle known as the “veil of incorporation.” The primary advantage of incorporation is the separate legal personality of the company. However, in practice, the business of the company is always conducted by and for the benefit of individuals.

Ultimately, some individuals are the real beneficiaries of corporate advantages. While the law views the company as a separate entity, it is essentially an association of individuals who own the corporate assets. The Salomon case affirms that in matters of property, capacity, actions, and liabilities, the individual identities of the company’s members are irrelevant.

This corporate entity theory forms the foundation of corporate law, with courts often upholding the integrity of the corporate veil. However, the principle is not absolute. Courts will “lift the veil” to examine the realities behind the corporate structure when necessary, either as authorized by statute or at their discretion.

Lifting of Corporate Veil

  • “Lifting the corporate veil” refers to disregarding a company’s separate legal personality to identify the individuals who control it.
  • When the corporate entity is used for fraudulent or dishonest purposes, the involved individuals are not allowed to hide behind the company’s legal identity.
  • In such instances, the court will penetrate the corporate structure, applying the principle known as “lifting or piercing through the corporate veil.”
  • Although a corporation is legally recognized as a distinct entity, it is, in reality, an association of persons who are the true owners of the corporate property.
  • In the United States v. Milwaukee Refrigerator Co.[2], the principle was stated as: “A corporation will be looked upon as a legal entity as a general rule…but when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons.”
  • Similarly, in Littlewoods Mail Order Stores Ltd v. Inland Revenue Commrs[3], Lord Denning remarked: “The doctrine laid down in Salomon v. Salomon and Salomon Co. Ltd. has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited liability company through which the courts cannot see. But, that is not true. The courts can and often do draw aside the veil. They can and often do, pull off the mask. They look to see what really lies behind.”

Grounds for Lifting of Corporate Veil

1. Fraud or Improper Conduct

  • Courts have consistently been willing to pierce the corporate veil when they suspect fraud is being or could be committed behind it.
  • The courts do not allow the Salomon principle to be exploited as a tool for fraud.
  • In the case of Gilford Motor Company Ltd v. Horne[4], Mr. Horne, a former employee of Gilford Motor Company, had a contractual obligation not to solicit the company’s customers.
  • To circumvent this, he incorporated a company in his wife’s name and began soliciting customers. The Court of Appeal found that “the company was formed as a device, a stratagem, in order to mask the effective carrying on of business by Mr. Horne.” The court viewed the incorporation as a sham intended to cloak his misconduct.
  • In Jones v. Lipman[5], the defendant had contracted to sell his land but changed his mind and transferred the property to a company to avoid specific performance.
  • Citing Gilford v. Horne, Judge Russell observed that the company was “a mask which (Mr. Lipman) holds before his face in an attempt to avoid recognition by the eye of equity.”
  • The court ordered specific performance against both Mr. Lipman and the company.

2. For the Benefit of Revenue

  • Courts also have the authority to disregard corporate entities when used to evade taxes.
  • A notable example is Dinshaw Maneckjee Petit, Re[6]. The assessee, a wealthy man, created four private companies to hold investments as his agents.
  • The companies received income from these investments, which they returned to him as supposed loans, thereby reducing his tax liability.
  • It was held that “the company was formed by the assessee purely and simply as a means of avoiding super tax, and the company was nothing more than the assessee himself.”
  • The companies conducted no real business and were merely created as legal entities to receive dividends and interest, which were then disguised as loans.

3. Enemy Character

  • A company may be regarded as having an enemy character when those in actual control of its operations are residents of an enemy country.
  • In such cases, the court may investigate the identity of the individuals in real control and declare the company to be an enemy entity.
  • In Daimler Co. Ltd. v. Continental Tyre and Rubber Co. Ltd.[7], a company was incorporated in England to sell German-made tyres.
  • The majority of the shares were held by a German company, with all directors except one being Germans residing in Germany.
  • During World War I, the English company sued for a trade debt. The court held that the company was essentially an alien entity and that paying the debt would constitute trading with the enemy.
  • As a result, the company was barred from proceeding with the claim.

4. Where the Company Is A Sham

  • The concept of a company being a “sham” means that when the corporate structure is misused or does not reflect the true nature of the business or its activities, and the company is used to mask the identity of individuals engaging in illegal activities, it may be treated as a sham.
  • Courts will also pierce the corporate veil when a company is merely a front or sham.
  • When an incorporated company is used to evade legal obligations, the court may disregard its separate legal identity and treat it as though the company does not exist.

6. Single Economic Entity

  • In certain cases involving a group of enterprises, the Salomon principle may not apply. Courts may lift the veil to examine the economic realities of the group as a whole.
  • In D.H.N. Food Products Ltd. v. Tower Hamlets[8], the Court of Appeal ruled that it was appropriate to lift the corporate veil, treating the three subsidiary companies as part of the same economic entity, which entitled them to compensation. The case established that courts may disregard Salomon when it is just and equitable to do so.
  • Lord Denning has observed that groups of companies are often treated collectively for financial reporting purposes, such as accounts, balance sheets, and profit and loss statements.
  • Gower also notes a general trend towards ignoring the separate legal identities of companies within a group.
  • However, whether the court will pierce the corporate veil depends on the specifics of each case. Indicators such as the nature of shareholding and control can influence this decision. Indian courts have recognized that the ‘single economic unit’ argument can be applicable under certain conditions, based on factual control.
  • This perspective is supported by the Supreme Court’s decision in New Horizons v. Union of India[9] and is reinforced by the 1988 State of UP v. Renusagar[10]case, which followed prior English law acknowledging the ‘single economic unit’ argument.

7. Agency or Trust

  • When a company acts as an agent for its shareholders, the shareholders may be held liable for the company’s actions.
  • Whether a company is acting as an agent is determined by the facts of each case, which could involve either an express agreement or be implied from the circumstances.
  • In In Re F.G. Films Ltd.[11], an American company financed a film production in India through a British company.
  • With the American company holding 90% of the British company’s capital, the Board of Trade of Great Britain refused to register the film as British.
  • The court upheld this decision, finding that the British company was merely a nominee for the American company.

8. Avoidance Of Welfare Legislation

  • Avoidance of welfare legislation is as prevalent as tax avoidance, and courts generally approach these cases similarly.
  • The courts are tasked with looking beyond superficial arrangements to uncover the true nature of the situation when parties attempt to circumvent welfare legislation.

Statutory Provisions for Lifting of Corporate Veil

Companies Act, 2013

  • Section 241-246: These sections allow the shareholders to file applications for relief against “oppression and mismanagement.” If the court finds that the company’s operations are unfairly prejudicing the interests of shareholders or if there is a lack of good faith in managing the company, it may choose to lift the veil.
  • Section 339: This provision allows the court to hold directors personally liable for the company’s debts if the company was formed with fraudulent intent or is being run to defraud creditors. It also reinforces the accountability of corporate leaders, ensuring that the protection offered by a corporation does not become a tool for irresponsible or fraudulent conduct.
  • Section 340: This section specifically helps prevent individuals from hiding behind the corporate entity to evade responsibility for their actions and allows courts to hold individuals liable for their fraudulent actions that harm the company or its stakeholders.
  • Section 341: This section specifically penalizes individuals who make false statements in documents related to the company, which can mislead shareholders or the public. Those who provide inaccurate information allow for the potential lifting of the corporate veil to identify responsible individuals.
  • Section 447: This section deals with punishment for fraud. If it is established that a company was involved in fraudulent activities, the courts can hold individuals responsible, regardless of the company’s separate legal status.

Conclusion

“Honest enterprise, by means of companies is allowed; but the public are protected against kitting and humbuggery.”[12]The integrity of a separate legal entity is preserved only to the extent that it aligns with the fundamental policies that sustain it. Therefore, those who benefit from the advantages of incorporation must ensure that the capital structure is sufficient for the scale of their business. They must avoid withdrawing corporate assets or combining personal finances with those of the corporation. Courts have occasionally used these circumstances as grounds for holding shareholders liable. The practice of piercing the corporate veil remains one of the most debated topics in corporate law. Categories such as fraud, agency, sham or facade, unfairness, and group enterprises are considered primary reasons for piercing the veil, but these categories serve merely as guidelines and are not exhaustive.


[1] 1896 UKHL 1.

[2] 142 F. 247.

[3] [1969] 1 WLR 1241.

[4] [1933] Ch 935.

[5] [1962] 1 WLR 832.

[6]AIR 1927 BOMBAY 371.

[7] 1916 AC 307.

[8] (1976) 1 WLR 852.11.

[9] (1995) 1 SCC 478.

[10] (1998) 4 SCC 59.

[11] [1953] 1 WLR 483.

[12] Denning v. British & International Stores Ltd, [1964] 1 WLR 456.

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