What is Corporate Veil ?

As per Doctrine of Corporate Veil, there is a veil or a curtain between the company, being a separate legal entity, and its members.

A company is not a living body hence the member work on behalf of the company behind the veil.

If anything goes wrong in the company or if the company suffers any liability, members may take the protection of this doctrine pleading that they are not empowered to look inside the curtain raised by the company.

So, In this case there is veil between shareholders/members and company. In simple terms it is known as corporate veil.

CASE : Salomon Vs. Salomon and Co.Ltd

The verdict in the case of "Salomon Vs. Salomon and Co. Ltd." is an important illustration of the separate legal entity of a company.

In this case, Salomon was a trader in shoes who formed a company which named Salomon and Co. of which he, his wife, daughter and four sons were the members. He sold his business to the company for $30,000 in consideration of which the company alloted him $20,000 worth of shares and $10,000 worth of debentures.

The company was later wound up because of excessive financial loss. At the time of winding up, the assets of the company amounted to $6,000, whereas its liabilities included $10,000 of debentures and $7,000 of unsecured creditors.

The creditors put up the claim that since Salomon and Salomon and Co. Were the same entity unsecured creditors should get priority over the debenture-holder (who was Salomon himself).

It was held than Salomon and Salomon & Co were two separate entities and the debenture-holder should have priority in payment.

When can it be lifted ?

The special circumstances under which the court may lift corporate veil may broadly be grouped under the following two heads :

A) Lifting of Corporate Veil under Judicial Interpretations - Under judicial interpretations, those cases are discussed where courts have found it necessary to lift the corporate veil, identify the persons behind the corporate entity and penalise them.

The list of cases given below where the court may disregard the separate entity of the company -

1) For Determination of the Enemy Character of the Company.

2) To Prevent Evasion of Tax.

3) To prevent Avoidance of Statutory Obligations.

4) To Fix Responsibility in case of Crime.

5) In Case of Economic Offences & So on.

1) For Determination of the Enemy Character of the Company -

Although, a company enjoys a distinct entity, yet, its affairs are run by individuals.

Sometimes it becomes necessary to locate whether these individuals are friends or enemies, more so during war.

2) To Prevent Evasion of Tax -

The court will ignore the separate entity of the company if it found to have been formed solely for the purpose of evading tax.

Courts, here, may identify the shareholders/directors with the company when it is found to be against the interests of the government resulting in the loss of revenue.

3) To Prevent Avoidance of Statutory Obligations -

Where formation of a company has been used for committing fraud or avoiding contractual obligations, the courts have lifted the veil and looked at the real situation.

4) To Fix Responsibility in Case of Crime -

The Doctrine of 'Lifting the Corporate Veil' has sometimes been applied in case of criminal activities conducted by the company.

5) In Case of Economic Offences -

In cases of economic offences, the courts lift the corporate veil of corporate entity and pay regard to the realities behind the veil.

B) Lifting of Corporate Veil under Statutory Interpretations - The Company Act expressly makes a mention of the circumstances under which corporate veil of a company can be disregarded. Below are discussed some these cases.

1) Misrepresentation in the Prospectus (Section 34 and 35).

2) Failure to Return Application Money (Section 39 and SEBI Guidelines).

3) Fraudulent Conduct of Business (Section 339).

4) Mis-description of Name.

5) Ultra Vires Acts.

1) Misrepresentation in the Prospectus (Section 34 and 35) -

If a prospectus issued by the company contains misleading statement, then every director, promoter or any person who authorised the issue of such a prospectus shall be responsible and answerable to the investors who bought the shares on the faith of the untrue statement.

These person shall also be criminally liable and punishable for frauds with imprisonment ranging from 6 months to 10 years and liable to be fined.

2) Failure to Return Application Money (Section 39 and SEBI Guidelines) -

In this case of a public issue, if the amount as stated (as minimum subscription) in the prospectus has not been received within 30 days of the date of the issue of the prospectus the amount shall be returned within such time as may be prescribed.

So, In this case, the company and its officer, who is in default shall be liable to be fined Rs 1000 for every day of default or Rs 1,00,000 whichever is less.

3) Fraudulent Conduct of Business (Section 339) -

In this case, During winding up of a company it appears that at any point of time, business of the company has been carried on with an intent to defraud creditors or any other person, or for any fraudulent purpose, those who were knowingly party to such conduct of business.

May be made personally liable for all or any of the debts of the company, as the Tribunal may direct.

4) Mis-description of Name -

In this Directors and other officers of the company will be personally liable for all the contracts made by them on behalf of the company in their personal names.

For example - Not using the word 'Ltd.' as a part of the company's name.

5) Ultra vires Acts -

In this Directors of the company will be personally liable for all those acts which they have done on behalf of the company, if they are :

i) ultra-vires the company, or

ii) ultra-vires the directors if the company does not adopt their acts.

Learning Point | Easy & Simple Notes

Search This Blog