File Copyright Online - File mutual Divorce in Delhi - Online Legal Advice - Lawyers in India

Should the Corporate Veil Piercing be Abolished?

This research paper intends to understand the evolution of the doctrine of piercing the corporate veil and the reasons associated with it with a special focus on the case of State of U.P v. Renusagar Power Corporation Ltd.[1] It would be followed by an analysis of the doctrine to understand its importance and criticisms. Further, to conclude there would be a discussion based on evidence if the exception of lifting the corporate veil should be abolished or not.

Introduction
The word company has no technical meaning but according to Section 2(20), The Companies Act, 2013 (CA 2013),[2]it means any company which is formed and registered under the said act or any former company law. There are no restrictions placed under CA, 2013 on the term 'Company' rather it includes the corporate body, any corporation which includes both incorporated and unincorporated bodies such as municipal corporations, etc. However, it does not include Cooperative Society as it is registered under the Cooperative Society Act.[3]

A company is considered as an artificial person and a separate legal entity as was laid down in Salomon v. Salomon & Co. Ltd.,[4] which means it can survive beyond the existence of its members which is called perpetual succession (Section 9, CA 2013). Therefore, the fate of the members has no effect on the company which will survive until it is winded up only by law (Section 270, CA 2013).

By the virtue of being a separate legal entity, there exists a separation between the said company and the people who are responsible for its birth and its continued existence. That separation between a company and its members is called the corporate veil. It is an invisible mask that separates the liabilities of the company from that of its members. However, the principle of a separate entity is not absolute.

This general rule in company law has been misused by its members for fraudulent activities and therefore in circumstances relating to any mischief or fraud the court across different jurisdictions breaks through this veil and depart from the general rule. The courts in order to prevent certain circumstances are willing to look through the veil to ascertain the offender by finding out about its members and the reasons behind the formation of the company among other things. This power of courts to depart from the general rule is known as lifting or piercing the corporate veil.

Rationale for Piercing the Corporate Veil
The doctrine of piercing the veil will make the rights, liabilities, and activities of the company as that of its members or shareholders.[5] This will help in making the members liable who have done any wrong or taken advantage of the corporate veil. There are different circumstances under which the court will consider lifting the corporate veil for example fraud or improper conduct or in other situations where the statute itself demands the veil to be lifted.

In the case of LIC of India v. Escorts Ltd.,[6] the court highlighted this point and observed there should not be an exhaustive list of situations where the corporate veil is permitted to be lifted rather it should rest on a case-to-case basis, that is, depending upon any relevant statutory provisions, conduct, public interest and how much impact it has created in the concerned parties, etc.

As a result, there is no final rule concerning the doctrine, rather the courts have the discretion to lift the corporate veil or not depending upon the special circumstances and unique fact scenarios of every incident. However, broadly the situations under which the corporate veil may be pierced can be divided into two sections namely: Statutory Provisions and Judicial Interpretation.

Statutory Provisions
Section 2(60), CA 2013 defines the expression 'officer who is in default' which means any officer of the company who is in default is to be held liable for punishment or penalty or fine as the case may be. This section further provides a list of officers who comes under the expression and therefore would be liable.

Section 3A, CA 2013 elaborates the situation when the members of the company are reduced below the required limit, that is, below seven in the case of a public company and less than two in the case of a private company. Additionally, the business of the company is to be carried on for more than 6 months. On the fulfilment of both the requirements, every member who is part of the company after those six months would be liable for the payment of all the debts that the company contracted at that time and may also be sued.

According to Section 66(10), CA 2013, if an officer misrepresents or conceals or is privy to such misrepresentation or concealment then the officer shall be liable under Section 447, CA 2013.

Under Section 4, CA 2013 all companies are required to use the suffix 'Limited' in case of a public limited company and 'Private Limited' in case of a private limited company. Therefore, any officer who signs any contract or cheque, etc. on behalf of the company and if the name is incorrect on such negotiable instrument, then the officer would be personally liable.[7]

These are the major liabilities of the officers of the company under the CA, 2013 where the general rule of separate entity is not applicable.

Judicial Interpretations
In comparison, there are lesser statutory provisions but 'lifting the veil' through judicial interpretation is more. One of the prominent characteristics of a company is the separate legal entity which creates a divide between the company from its members. The landmark judgment of Salomon v. Salomon illustrates the very concept of the separate legal entity.

The court while upholding the incorporation of the company was of the opinion that the said company fulfilled the statutory requirement and that Mr Salomon is separate from his company Salomon & Co. Ltd. The court further was of the opinion that it does not matter even if Mr Salomon was the majority shareholder, director, creditor and exercised a very high level of control on the said company, it is not one and the same thing.

The debts and liabilities of a company are it's own and not the personal liabilities of its members. However, as evident from the doctrine of piercing the corporate veil, there are exceptions to the principle of a separate legal entity.

There have been many financial scams such as Satyam, Kingfisher which have raised concerns and while the corporate sector plays an important role in the economic system worldwide there still are numerous circumstances where they can be misused.[8] They can be misused for illicit purposes such as money laundering, tax evasion, market fraud, defrauding assets, etc.

These exceptions were recognized by different courts as early as Salomon v Salomon where Lord Halsbury said that they recognize the principle of separate entity provided there is no fraud and if the company is a real one and not a fiction. Lord Denning in Littlewoods Mail Orders Ltd. v. IRC[9] explains this exception with precision when he says that anyone can cast a veil over the company by which the court cannot see but it is not an absolute right and therefore 'the courts can and often do, pull off the mask.' They need to look beyond the mask to see what and who is behind the veil.

The exceptions to the principle of the separate legal entity have been in debate but it can justify, for example, if there is a strict interpretation of the principle will lead to unfair outcomes as the concerned parties can hide behind the shield of limited liability and it can harm any party or person dealing with the company.

Further, even though a company is identified as an artificial person it cannot necessarily be treated as a natural person in every aspect because the company per se is not capable of committing a crime which for instance requires mens rea, the company cannot be loyal or disloyal, a friend or a foe[10] and therefore courts need to overlook the principle and discover the intentions of the people controlling the company.

State of U.P. & Ors. v. Renusagar Power Co. & Ors.
The case[11] is a classic example to explain concepts related to the harmonious construction of special and general law, but it also made larger points with respect to the lifting of the corporate veil. The fact in issue was whether the first respondent i.e., Renusagar Power Company Ltd. (Renusagar) was the own source of electricity generation for the second respondent i.e., M/s. Hindustan Aluminium Corporation Ltd. (Hindalco) under section 3 of the U.P Electricity (Duty) Act, 1952?

The agreement and relationship between Renusagar and Hindalco did not indicate a conventional sale-purchase agreement between independent parties at arm's length. All facts pointed to the direction that Hindalco had complete control over Renusagar from its day-to-day activities to any loan that was required by Renusagar. All parties including the State authorities considered both the entities as one and the same, that is, Renusagar was treated as its own source of electricity generation of Hindalco. Consequently, according to section 22B, Indian Electricity Act, 1910 there was a 100% power cut imposed on Hindalco on the ground that it had its own source of electricity.

The court considered the expression 'own source of generation' as a question of lifting the corporate veil as according to the general rule any wholly-owned subsidiary (WOS) is considered to be a separate entity from that of its holding company. However, in this case, the existence of Renusagar was brought by Hindalco to gain economic benefit and to avoid any kind of complications related to takeovers.

The court further made a distinction between WOS in law and WOS for the purpose of accounting and financing. But looking at the facts in hand and the implied acceptance it was held that the corporate veil should be lifted as Renusagar had no independent existence and both the entities were one and the same.

The court rightly pointed out that the horizon of the corporate veil and the applicability of the doctrine is expanding, thereby making an important point that the list where the corporate veil can be pierced is not exhaustive and will depend on the facts and realities of the situation. The judgment comes as a relief to any party who might be affected by the companies who in the name of the principle of separate entity commit fraud or try to get away from corrupt conduct.

Analysis
Cases concerning the lifting of the corporate veil as discussed above are highly specific to the facts in issue; the fact-specific nature of the doctrine is considered a blessing whereas it has also been condemned. The difference between successful and unsuccessful claims of corporate veil piercing does not differ in kind but only in degree.[12] As a result, it creates vague notions and rules which in turn leads to no standards that the court can use to determine corporate criminal liability thereby making it arbitrary.[13]

The courts in different cases have tried to come up with certain principles such as alter ego theory. The theory can be traced to a Texas Supreme Court decision[14] where it was said that under the theory the entities unite in a way that they cease to show any independent existence.

Also, if the court fails to pierce the veil it will result in injustice and unfairness to the affected party. Another theory is enterprise liability where companies operate as a single business enterprise to achieve a single goal which in this case would be a fraud.[15] The court laid down four instances when the corporate veil may be pierced such as cases where it is envisaged by the statute itself, or in cases of fraud or misconduct, or for tax evasion, or where companies so united that they can be considered one and the same.[16]

Even though there seem to be certain widely accepted instances where the corporate veil would be lifted, the courts seem to have a wide discretion to give the final decision on the imposition of criminal liability by piercing the corporate veil or otherwise. As a result, it creates uncertainty and doubtfulness as the judges can apply any theory or come up with a theory of their own.

Another criticism[17] frequently talked about is judicial errors that might occur considering the doctrine itself has no standards or rule and as it is face-specific there are chances that the judiciary might wrongly decide a case or two. Additionally, it has also been shown that the corporate piercing cases related to tort are fewer than those which were related to contractual obligations.[18]

The doctrine particularly affects the small businesses wherein they need to take extra precautions which increases their expenditure and they can further become a victim of lengthy, expensive, and complex litigation because of the absence of any standard rule related to the doctrine which can create confusion among small business owners and entrepreneurs.

The court in the case of Chiranjit Lal Chowdhuri v. Union of India[19] while referring to the principle of separate legal entity was of the opinion that the fundamental rights enshrined in the constitution are not only available to natural persons but also corporate bodies unless specifically made available only to natural persons. Therefore, in instances where not specifically mentioned, the companies can move to the courts in order to enforce any of their fundamental rights guaranteed by the Constitution.

Numerous scholars and academics have questioned the doctrine in the light of this judgement that if the company has been provided with fundamental rights, then how can it be taken away by no fault of the company but that of its member and people controlling it. The argument holds no water since a company is considered as an artificial person and not a natural person. Therefore, companies per se is not capable of committing fraud.[20]

Conclusion
The doctrine is in its formative stage, still evolving, its horizon expanding. The court in different cases uses the doctrine of lifting the corporate veil whenever necessary to promote justice and rightly so because companies have been provided with a wide range of powers and the doctrine comes in handy to keep a check if these powers are being misused or used for perpetrating fraud. As discussed earlier, the doctrine also comes with a few setbacks related to the vagueness and uncertainty surrounding the doctrine and in what circumstances it would be used.

Abolishing the lifting of the corporate veil should not be considered an option because it is needed. The legislators or the courts cannot envisage all the possible frauds that any individual can commit in the future. Therefore, the discretion given to the courts becomes essential otherwise the loopholes in the rules of standards can lead to unfairness and would defeat the purpose of law and justice.

Meanwhile, courts can continue to give clarity on how and why the doctrine is applied and list down certain essential elements that need to be fulfilled for the doctrine to be applicable with protection to small businesses in cases that result because of ambiguity and vagueness. However, the doctrine should exist!

End-Notes:
  1. AIR 1988 SC 1737
  2. The Companies Act 2013
  3. The Cooperative Society Act 1912
  4. (1897) AC 22
  5. Atlas Maritime Co. SA v. Avalon Maritime Ltd., (1991) 4 All ER 769
  6. AIR 1986 SC 1370 [5]
  7. Basudeo Lal Modi v. Madanlal Chhapdia, AIR 1967 Ori 107
  8. Organisation for Economic Co-operation and Development, Behind the Corporate Veil: Using Corporate Entities for Illicit Purposes (2001) page 7
  9. (1969) 1 WLR 124
  10. Daimler Co. Ltd. v. Continental Tyre & Rubber Co. Ltd., (1916) 2 A.C 307
  11. State of U.P v. Renusagar Power Corporation Ltd., AIR 1988 SC 1737
  12. Stephen M Bainbridge, 'Abolishing LLC Veil Piercing' (2005) 2005 U III L Rev 77, 91
  13. ibid 96.
  14. Mancorp, Inc. v. Culpepper, 802 S.W.2d (Tex 1990)
  15. Stephen M Bainbridge, 'Abolishing LLC Veil Piercing' (2005) 2005 U III L Rev 77, 91
  16. LIC of India v. Escorts Ltd., (1986) 59 Comp Cas 548 [5]
  17. Stephen M Bainbridge, 'Abolishing LLC Veil Piercing' (2005) 2005 U III L Rev 77, 102
  18. id 97.
  19. AIR 1951 SC 41 [45]
  20. Daimler Co. Ltd. v. Continental Tyre & Rubber Co. Ltd., (1916) 2 A.C 307

Law Article in India

Ask A Lawyers

You May Like

Legal Question & Answers



Lawyers in India - Search By City

Copyright Filing
Online Copyright Registration


LawArticles

Section 482 CrPc - Quashing Of FIR: Guid...

Titile

The Inherent power under Section 482 in The Code Of Criminal Procedure, 1973 (37th Chapter of th...

How To File For Mutual Divorce In Delhi

Titile

How To File For Mutual Divorce In Delhi Mutual Consent Divorce is the Simplest Way to Obtain a D...

Whether Caveat Application is legally pe...

Titile

Whether in a criminal proceeding a Caveat Application is legally permissible to be filed as pro...

The Factories Act,1948

Titile

There has been rise of large scale factory/ industry in India in the later half of nineteenth ce...

Constitution of India-Freedom of speech ...

Titile

Explain The Right To Freedom of Speech and Expression Under The Article 19 With The Help of Dec...

Copyright: An important element of Intel...

Titile

The Intellectual Property Rights (IPR) has its own economic value when it puts into any market ...

Lawyers Registration
Lawyers Membership - Get Clients Online


File caveat In Supreme Court Instantly