Doctrine of Lifting the veil of corporate entity

10th October 2022 0 By indiafreenotes

The Companies Act, 2013 clarifies that a company is a separate entity distinct from its members. But practically, it is an association of persons who are the beneficial owners of the company and its corporate assets. This fiction is created by a veil termed the corporate veil.

Here, lifting the corporate veil under the Companies Act, 2013 means ignoring that a company is a separate legal entity and has a corporate personality. Lifting of corporate veil as per Companies Act, 2013 ignores the separate identity of the company and looks back at the true owners who are in control of the company.

The separate personality is a regulatory advantage, and it must be used for a lawful purpose only. Whenever and wherever a fraudulent use is made of the legal establishment, the individuals will not be permitted to hide behind the curtain of corporate personality.

The concerned authority will break this company’s shell and sue the individuals who have committed such an offence. This lifting of the curtain is called lifting the corporate veil under the Companies Act, 2013.

Corporate Veil:

A legal concept that separates the personality of a corporation from the personalities of its shareholders, and protects them from being personally liable for the company’s debts and other obligations.

Lifting Of Corporate Veil:

At times it may happen that the corporate personality of the company is used to commit frauds and improper or illegal acts. Since an artificial person is not capable of doing anything illegal or fraudulent, the façade of corporate personality might have to be removed to identify the persons who are really guilty. This is known as ‘lifting of corporate veil’.

It refers to the situation where a shareholder is held liable for its corporation’s debts despite the rule of limited liability and/or separate personality. The veil doctrine is invoked when shareholders blur the distinction between the corporation and the shareholders. A company or corporation can only act through human agents that compose it. As a result, there are two main ways through which a company becomes liable in company or corporate law: firstly through direct liability (for direct infringement) and secondly through secondary liability (for acts of its human agents acting in the course of their employment).

There are two existing theories for the lifting of the corporate veil. The first is the “alter-ego” or other self-theory and the other is the “instrumentality” theory.

The alter-ego theory considers if there is in distinctive nature of the boundaries between the corporation and its shareholders.

The instrumentality theory on the other hand examines the use of a corporation by its owners in ways that benefit the owner rather than the corporation. It is up to the court to decide on which theory to apply or make a combination of the two doctrines.

The basis on which Corporate Veil is Lifted under Companies Act,2013

Misstatement in Prospectus

In a case where the company’s prospectus is misrepresented, the company and every director, promoter, and every other individual, who authorized such issue of prospectus shall be liable to compensate the loss to every person who subscribed for shares on the faith of misstatement.

Also, these individuals may be punished with a jail term for duration of not less than six months. This duration may be extended to ten years. The concerned company and person shall also be liable to a fine that shall not be less than the sum involved in the fraud but may extend to three times the amount involved in the fraud.

Misdescription of Name

As per the Companies Rule, 2014, a company shall have its name printed on every official document, including (hundis, promissory notes, BOE, and such other documents) as may be mentioned.

Thus, where a company’s officer signs on behalf of the company any contract, BOE, Hundi, promissory note or Cheque or order for money, that individual shall be liable to the holder if the name of the company is not properly mentioned.

Fraudulent conduct

In case of winding up of a company, it comes out that any business has been carried on with intent to cheat the creditors or any other individual, or for any illicit purpose, if the Tribunal thinks it proper so to do, be directed in person liable without limitation to obligation for all or any debts or other obligations of the company.

Liability under the fraudulent conduct may be imposed if it is proved that the company’s business has been carried on misguiding the creditors.

Ultra-Vires Acts

Directors and other officers of a company will be held liable for all those acts they have performed on the company’s behalf if the same is ultra vires the company.

Failure to return the application Money

In case of Public Issue, if minimum subscription, as per the prospectus, has not been received within thirty days of the issue of prospectus or such other period as may be mentioned, the application money shall be returned within fifteen days from the closure of the issue.

However, suppose any the application money is not so repaid within such specified time. In that case, the directors/officers of the company shall jointly and severally be liable to pay that money with 15% per annum.

Additionally, the defaulter company and its officer shall be liable for a penalty of 1000rs/day during which such default continues or Rs. 100000, whichever is less.

Under other Statues:

Apart from the Companies Act, 2013, the directors & other officers of the company may be held personally accountable under the provisions of other statutes. For Instance, under the Income-tax Act, 1962, where any private company is wound-up and if tax arrears in respect of any income of any previous year cannot be recovered, every individual who was director of that company during the relevant preceding year shall be jointly and severally accountable for payment of tax.

Under Judicial Interpretation

While initially the court, based on the principle of the separate entity as well as a district corporate persona, refused to lift the veil of corporate governance, However, due to the rise of corporations and the ever-growing conflict between corporations and their different stakeholders, courts have taken a more pragmatic strategy and have lifted the veil of corporate governance.

It isn’t easy to record every court decision in which the veil was lifted. However, there are various circumstances where the veil of corporate character can be taken off, and the people who are behind the corporate entities could be found out and punished.

  • Improper conduct and Prevention of Fraud.
  • Formation of the Subsidiary company to act as Agent.
  • Economic offence
  • Revenue Protection
  • The company used it for illegal purposes.
  • Company ignoring welfare legislations.
  • Company acting a mere fraud.