A firm or company has an independent legal character that is separate from its members such as its shareholders, board of directors, etc. Such an independent character is necessarily implied when it comes to actions related to the company such as when it sues someone, it is being sued, it files for bankruptcy, etc. Under common law, a company is treated as a legal person or a legal entity separate from its members and capable of surviving after the death of its members. This character of individuality has been present for a long period of time and has been evolving in the judiciary for a long period of time.
The lifting of the corporate veil is an exception to the principle that a company is a separate legal entity and holds the status of an entity different from the creditors of the company or the management of the company. The company assets are different than those of its members and the entity is separate from its shareholders. The doctrine of the corporate veil was developed to prevent individuals from misusing companies without having any liabilities, or companies were formed to evade the law or legal obligations. There have been few cases where this doctrine has been used as an exception in company law.
There have been certain exceptions only under which the corporate veil of a company can be lifted by the court. The court has done so mainly on a principle of public property, or on the principle that devices used to perpetrate frauds will be treated as nullities or on a presumption of agency or trusteeship which was prohibited in the Salomon case. When the court does so, the independent character or identity of the company is disregarded and the focus of the court has been to find out where the real owner or controller of the company lies. Certain instances when the veil can be lifted are expanded or developed upon in various judgements of Indian courts, which are explained as follows.
The doctrine of the corporate veil was first developed in the case of Salomon v Salomon, in which this doctrine was first expanded upon. The facts of the case were such that a certain businessman had converted his private business into a limited liability company, he held the majority of the shares of the company and thereby had limited liability in the company. The court of appeal declared the company to be a myth and reasoned that Salomon had incorporated the company contrary to the true intent of the Companies Act,1862 and the company had been an agent of Salomon who should be held responsible for the debt incurred by the company. The House of Lords, however, reversed this ruling and ruled that the company was an independent person with its rights and liabilities attached to itself and not connected to the promoter of the company. This case established the precedent of the separate legal entity of a company, which was later expanded upon by courts in different countries.
Development of the doctrine in India
The doctrine was incorporated from the case of Salomon v Salomon and various other cases from the UK. In the case of LIC v Escorts Ltd, it was observed by the hon’ble court that the corporate veil should be lifted when company subsidiaries are inexplicitly connected with each other as to be part of one concern. Classification of cases for seeing if the doctrine should be used could be arbitrary as the same depends on various factors such as the relevant legal provisions, the conduct of the company and whether public interest should be taken into consideration as was observed in the above case.
In the case of State of UP v Renusagar ltd, the court was confronted with the issue of a company called Renusagar ltd which was a subsidiary of Hindalco and it was to decide whether the former was just a tool used by the latter to circumvent the possibility of it being acquired by the state electricity board. In this case, the conduct of the main company- Hindalco was examined, also other factors such as controlling the subsidiary by Hindalco were observed. All such factors were examined in concluding whether the two companies were independent of each other or not. In concluding that Hindalco was the main entity controlling Renusagar and the intention of Hindalco in forming Renusagar was avoiding the complications that would arise if its power stations were acquired by the state government.
While noting the issues of the case, the hon’ble court also observed that just because a company has bought the entire shares or major shares of another company, that does not mean that the independent character or separate legal identity of the latter is diminished or destroyed. (Turner Morrison and co v Hungerford Investments trust Ltd).
Another court in LIC v Escorts ltd emphasized that the corporate veil should be lifted where the associated companies are inextricably connected as to be part of one concern. The court in the present case further reiterated that while the lifting of the corporate veil is permissible, it depends upon the individual circumstances of the case. Thereby, analyzing the facts of the present case, Hindalco was held to be in complete control of Renusagar and it had brought the latter to avoid complications in case of taking over the company’s power station by the state board. Therefore, in this case, the corporate veil of the company was lifted to look at the real reasons for setting up the company. By doing so the court treated the power stations of Renusagar as the power stations of Hindalco.
LIC v escorts ltd, This was a case in which this doctrine of lifting the corporate veil was applied to a limited extent. In this case, the court was to examine the source of investment of a company. In the case, it was held that this doctrine was to be used only till the extent specified under the now-defunct FERA and the portfolio investment scheme which provided for lifting the corporate veil to find out if at least 60% of its shares were held by non-resident Indians. Lifting of the veil was necessary to identify the nationality of the company’s investors. The corporate veil may be lifted to that extent and no further than that. The court had to identify thirteen foreign companies who had invested in an Indian company, 60% of which was held by a certain Swaraj Paul and members, and to examine whether the investors had done anything to circumvent the rules related to investment by non-resident Indians or by companies 60% shares of whom were held by non-resident Indian.
Another reason for lifting the corporate veil is when a company tries to evade certain legal obligations by transferring its profits to another company. A similar set of facts was present in Workmen employed in the Associated rubber industry v Associated rubber industry limited. In this case, a company namely the Associated rubber industry set up another firm namely Aril holdings Pvt ltd, transferred some of its assets to the new company. There had been no direct evidence that the second firm was set up to avoid paying a bonus to workmen, but the circumstances were such that the court held that no direct or circumstantial evidence was necessary to confirm the allegations against the company, as the device used by the company was obvious to conclude. There was also no explanation by the company in question as to why the new firm was created without any assets other than those transferred to it and why it was closed, further making clear the intentions of the company of avoiding its legal obligation of paying bonuses according to its profits.
This doctrine was also applied in a case where there had been an issue of carrying out illegal transactions of transferring mining rights from one company to another company, which was prohibited. In the case of the state of Rajasthan v Gothan Lime Stone Pvt Ltd, the lessee had transferred their lease to another company with the permission of the competent authority and then it had sold all its shares for share price and therefore the mining lease was acquired by the holding company without there being any lease price. By doing so the partnership firm holding the mining rights had successfully transferred the said rights to a third party for consideration in the form of share price which ultimately is nothing but the price for the sale of mining lease which was not allowed and nor was permission for which was granted. Therefore, it can be observed that a corporate entity was used to conceal the real transaction of transferring the mining lease to another company which was not allowed. Thus, the doctrine of the lifting of the corporate veil was applied to enforce the law which was sought to be circumvented.
An important field in which the court has used this doctrine is in the case of tax evasion. An important case related to this was the Vodafone holdings BV v union of India, in which the defendant had procured companies in tax havens to avoid taxes. The Hon’ble Bombay HC pierced the corporate veil held that the actions of acquiring if shares in offshore private companies amounted to avoidance of taxes. It further held that once it has been proved that certain transactions are ‘fraud, sham or a device designed to defeat the interests of the shareholders, investors, parties to the contract and for tax evasion, the court can always lift the corporate veil.’
There are also instances in which the court refused to apply this doctrine to acknowledge specific rights or privileges of companies. One such example is found in the case of Telco v state of Bihar. In this case, it was argued that the doctrine should be used to acknowledge the shareholders of the company, and the shareholder being the owners of a company, the company’s right under Article 19 should be recognized and its petitions based on the merits of the case be examined. The court, in this case, refused to accept the contention of the petitioners and held that if the drafters of the constitution wanted companies to be included under the articles as contended, they would have added these companies as beneficiaries of such rights.
A major area of challenge to the Indian judiciary in the field of lifting or piercing the corporate veil is the way in which tax evasion is carried out by individuals and how government authorities, as well as the legislative authority, entangle the trail created by individuals to catch tax evasion. One example of such a challenge is that of the Panama papers scandal, in which tax evasion was done through the setting up of shell companies in tax haven countries. It naturally follows that issues such as the Panama papers leak is closely related to this doctrine of piercing the corporate veil, as in the issue of Panama papers, it was evident that multiple shell companies with foreign ownership were created and assets were stashed away in such shell companies It is imperative that a certain process must be devised to identify the real owners behind such shell companies. As such, this doctrine should be used judiciously in order to derive proper results from it and also to make sure that the doctrine is not misused or overextended which could cause harm to companies or individuals connected to it.
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