Lifting of Corporate Veil

8 August 2016

Lifting or Piercing the Corporate Veil is a Legal process or proceedings taken to uncover the common shield in respect of any suspicious event happened or to be happened or on the basis of allegation made or to be made against the Company. This piercing process can be compared to a person lifting the curtain of a Drama Stage to know what is actually happening without being the drama commenced. Piercing the Corporate Veil is a Premeditated process with an intention to curtail the unfair advantage enjoyed on forming of a Company. Merits on Incorporating a Company.

Incorporating a Company is always preferred by active entrepreneurs than commencing a Partnership firm or sometimes a sole proprietorship. The major boons of incorporating a Company are: 1. Limited Liability. Almost all the Companies are started with limited liability status. A Company with Limited Liability indicates that a Members’ loss in a Company is only up to the value of his shares or loan made, if any thing unfortunate happens to the Corporate. The Personal Assets or earnings of Director or the Officer will never be put at risk.

But if the event is a fraud or anything outside the purview of the Memorandum of Association (which means “Ultra Vires”) the Directors or “Officers in Default” {Section 5 of Companies Act} will be held for Personal Liability. 2. Protection of Name: The Company’s name will be protected immediately once it is approved by “Registrar of Companies” (herein after called as “ROC”). There will be no chance of another Company being started with the same name or even identical to the Companies Name. Whilst in the case of a Partnership Firm or Sole Proprietorship Concern, the name can be only protected by a Trademark Registration.

3. Existence. As an old proverb indicates, “Members may come and go, but the Company exists forever” is the gist of the Company formation. The Company will disappear only after the complicated winding up and liquidation process under the Specific order from Registrar of Companies or any other appropriate authority. 4. Raising Funds: There are not too many better options otherwise than incorporating the Company to raise funds for expansion of the markets for its products, commencing a new business, enter into a global market etc. Initially a Company will be floated as a Private Company (with a limit of 50

shareholders) and after rooting its base in the market, it may proceed with an Initial Public Offer to become a Public Company and gets listed in the Stock Exchange within 21 days of the closure of Public Offer (Usual Routine). A Company can also raise loan on its assets by creating a Charge (Fixed or Fluctuating) in favour of a Bank (Secured Creditor after Charge is being created) which is a very simple process done through MCA portal where the ROC is intimated by filing Form-8. 5. Taxation Benefits. The Taxation part is the most fruitful of all the benefits enjoyed by the Company.

The Company’s liability for tax when compared to partnership firms and sole proprietorship concern is very limited. A corporate is blessed with so many deductions and other tax allowances which can be charged against the profits of the Company which limits the liability to pay tax. When Companies began to show Nil Total Income after their tax planning, Section 115JB was introduced in the Income Tax Act vide Finance Bill 2002, which articulates Minimum Alternate Tax whereby a minimum tax obligation was put on the Company which is charged against their Book Profits.

Rising of Lifting the Corporate Veil concept. Any Company incorporated under the Companies Act, 1956, can enjoy all the fruits and permitted to do all the acts under the Laws of the land. But if the Companies start to get pleasure from other undue benefits prejudicial to the corporate habitat, the Lifting of Corporate of Veil concepts come into the picture. 1. Regular Company Law formalities are not followed. The Companies are required to abide with certain compliance formalities such as convening of Board Meetings and General Meetings, Filing of Balance Sheets with the RoC, filing Income Tax Return etc.

When these regular formalities are not met or complied invariably, with/without any reason, legal actions may be initiated for piercing the corporate veil. 2. Disinvestment and Diversion of Funds. On some occasions directors may on their discretion, having the controlling stake may opt to disinvest or divert the funds without intimating the Shareholders. Such disinvestments or diversion of funds may adversely affect the financial stability of the Company in general and the interests of the stake holders in specific which invites the court to pierce the corporate veil of the Company.

3. Seasonal Non Payment/Excessive Payment of Dividend. Non payment or excessive payment of dividend to the shareholders may sometimes bring suspicions on other stakeholders or legal/governmental authorities for which lifting corporate veil proceedings get attracted. 4. Alter Ego concept. The Company being blessed with so many merits, will be floated and all regularities will be done at the initial stages so as to make it appear as an active company.

But later, the alter ego of the Directors gradually starts visible and will occupy the driver’s seat of the company. When it is felt that there are some discrepancies being done placing Company as a shadow/mask, lifting corporate veil of the Company becomes indispensable. 5. Fraudulent Motive. When the judiciary feels that when there is any fraudulent activities are going on in a Company or there is a chance such malpractices, the Court has all the powers to pierce the corporate veil. 6. Enemy Character.

At any time, if any Country has become the alien enemy (War has been declared against another Company), the Court has the authority to pierce the corporate veil so as to analyze the Shareholding and other management and fiduciary interests of the Alien Company in that Company to protect the General Interests. 7. Tax Regulation. If any tax legislation insists the appropriate authority to pierce the Corporate Veil, the Court would not mind the Separate Legal personality of the Company and proceed with digging the core of the formation and other commotions of that Company.

Some Celebrated Case Laws related with Lifting the Corporate Veil of the Company: 1. Salomon Vs Salomon (1897) In this case, Mr. Saloman was dealing with shoe business. The Kingdom of Britain then enacted a statute providing for the incorporation of businesses and a corporation then had to have at least seven shareholders. Mr. Salomon formed a corporation, with all seven shareholders being members of his family. The business of the corporation eventually went under, leaving considerable unpaid debts and ever branching liabilities.

The creditors argued in court that the shareholders should be liable for the debts of the corporation, because they were all related to Old Man Salomon, and that the corporation was set up a mere sham. The court held in favour of the shareholders, Old Man Salomon’s relatives. The fact that the shareholders were all related to Old Man Salomon was irrelevant in determining that the corporation legitimately existed as a separate entity, and thus the individual shareholders were not held liable for the corporation’s debts.

This case law in a narrow aspect does not have any relevance with regard to Piercing Corporate Veil concept. But this judgment was taken as a trump card to taste the cream of formation of Companies. 2. Gilford Motor Company Vs Horne: In this case, the Court disregarded the judgment of Salomon Vs Salomon, questioning the distinct legal personality of a Company. Mr. Horne was an ex-employee of Gilford Motor Company and as per the terms of the employment, he should not solicit any of the Company’s customers. In order to defeat this provision, Mr.

Horne incorporated a Company in his wife’s name and solicited all the customers for which the Company brought up action against him. The Court analyzed the motive of incorporating the limited Company and it was ipso facto found that the Company’s main purpose was to perpetrate the fraud. 3. Jones Vs Lipman This case is similar to Gilford Motor Company Vs. Horne. Here, Lipman entered into contract with Jones to sell his land. Later, Lipman changed his mind and transferred the property to a Company in order to avoid Specific Performance.

But it was held that the Company as well as the transfer of property was only acting as a mask to avoid recognition by the eye of equity. 4. Edwards Company Inc Vs Monogram Company Inc: Monogram Industries acquired Entronic Corporation in the field of production of smoke detectors. Monogram made its purchases through its wholly owned subsidiary name Monotronics. Monotronics then entered a Limited Liability Partnership with Entronic Company and acted as a General Partner.

In the course of the business, Edwards Inc granted loan worth $ 350,000 to Entronic Corporation which it could not ply went the market slashed. However, Monotronics, being a General Partner could repay a part of the loan worth $ 10,000 from its estate to Edwards Company. But, Edwards filed a suit against Monogram Industries for the recovery of the debt against Entronics, an attempt to pierce its corporate veil on the basis of the following grounds: a. The Board of Directors, Office and Contact numbers of Monotronics and Monograms are same.

b. Monotronics was only a piece of paper or a dummy company as far as Monograms is concerned. But, the Honourable Court analyzed that: 1. There was nothing to prove or insist the court to order for lifting the corporate veil as there was no fraudulent act or injustice shown from the Company/Companies to escape from the liabilities. 2. There was no lack of separate existence of the 2 Companies. 3. There was no violation of any corporate formalities. 4. There was also no co-mingling of money and under capitalization in both the Companies.

Taking in view of the above analysis, the Court quashed the suit filed by Edwards Company against the Monogram Group. Conclusion: It is always fruitful for active and vibrant entrepreneurs to expose their skills and respond to the changing environment by incorporating a Company. The Incorporation of such a corporate must be in the true spirit of law. Once the Company is floated, in spite of enjoying all the merits, it also has to comply with all the procedural and legal formalities. A Director of a Company must be also aware of Section 322 of Companies Act, 1956 which makes their liability unlimited.

In the Era of Corporate Governance and Corporate Social Responsibility, the chance for lifting the Corporate Veil may not arise, but there are cases of “Fly by Night Entrepreneurs” and “Vanishing Companies” after the Initial Public Offer even after SEBI has framed vide variety of Guidelines for protecting investors and other stakeholders. In Taxation words, this can be compared with Tax Planning and Tax Evasion where the essence depends upon the intention of the assessee whether to apply all the loopholes available in the law or by pass the boundaries for unjust enrichment.

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