Lifting Of Corporate Veil Due To Fraud And Improper Conduct

Coverage of this Article

Key takeaways

 -Incorporation of the company does not always and in every situation eliminate personal liability.

What is limited liability

-The limited liability that a company provides to its shareholders is one of the primary reasons for founding one. According to this idea, a shareholder may only lose the shares they have provided to the company, not more. This idea is in complete conflict to the concept of lifting the veil since they cannot coexist.

Separate Legal entity 

-The fundamental principle on which company law is based is separate legal entity. The legal entity of the corporation determines how a company is created, how it is managed, and how it operates. -

Reduction of members 

-According to the Indian Companies Act, 2013, if a company continues to operate for longer than six months after the number of its members has been reduced to seven for a public company and two for a private company, each member who is a member during the time that the company continues to operate after the six months is responsible jointly and severally with the company for the payment of debts incurred after six months.

Trading fraudulently

-According to the Indian Companies Act of 2013, anybody who was knowingly a party to a company's business being conducted with the intent to mislead creditors of the company or creditors of any other person or for any fraudulent purpose is subject to imprisonment, a fine, or both. 

Misdescription of company

-If an officer of the company or another person acting on its behalf signs or authorises to be signed on the company's behalf any bill of exchange, promissory note, endorsement, check, or order for money or goods in which the company's name is not mentioned in legible letters, he is subject to a fine and is personally liable to the holder of the instrument, unless the company has already paid the amount.

Subsidiary companies

-The holding company is a separate legal entity from its subsidiaries in the eyes of the law. 

Case Laws

-Daimler Co. Ltd. v. Continental Tyre and Rubber Co. (Great Britain) Ltd.: This is a case of identifying a company's competitor.

Conclusion

-It is fairly evident that incorporation of the company does not always and in every situation eliminate personal liability.

Key takeaways

•     Incorporation of the company does not always and in every situation eliminate personal liability.
•     The members of the corporation have minimal accountability, but they may be held accountable in exceptional situations if the court believes the principle has been abused and improper conduct has taken place.
•     The theory of removing the corporate veil elaborates on the legal principle that a person cannot profit from their own wrongdoings and is a versatile instrument that aids in delivering justice.

Aristotle says, “when one talks of lifting status of an entity corporate veil, one has in mind a process whereby the corporate is disregarded and the incorporation conferred by statute is overridden other than the corporate entity an act of the entity.”

Since an artificial person cannot commit a crime or commit fraud, it may be necessary to strip away the corporate identity in order to find the true offenders. It occasionally happens that frauds and other inappropriate or unlawful conduct are carried out using the corporate identity of the company. Lifting the corporate veil is the term meant by this. This principle states that the firm is a distinct legal entity with its own duties and rights. In the regular course of business, the members of the corporation have minimal accountability, but they may be held accountable in exceptional situations if the court believes the principle has been abused and improper conduct has taken place. 

Let's use an example: If "A," a member of the firm, engages in any fraud or criminal activity on the company's behalf. The court then has the power to remove the corporate veil's cover and name "A" as the actual guilty party who will be held accountable for the unlawful behaviour. Thus, this concept is also known as "disregarding the corporate veil" or "disregarding the corporate veil."

What is limited liability

The limited liability that a company provides to its shareholders is one of the primary reasons for founding one. According to this idea, a shareholder may only lose the shares they have provided to the company, not more. This idea is in complete conflict to the concept of lifting the veil since they cannot coexist.

Separate Legal entity 

The fundamental principle on which company law is based is separate legal entity. The legal entity of the corporation determines how a company is created, how it is managed, and how it operates. The idea of a separate legal entity is not new, but on the contrary, there are numerous cases and legal disputes pertaining to this idea and its jurisdiction. Salomon v. Salomon and Lee v. Lee are two highly significant rulings on separate legal entities; though they are both foreign cases, they are both worldwide relevant and recognised.

It was determined in both of these cases that "The Company was a separate person member, It had an identity different from its members, and As a result, The Unsecured Creditors Were To Be Paid At Priority From The Secured Debentures." A company has a separate legal entity and can engage into contracts with its own members, which makes this judgement crucial in terms of Indian company law.

Theories for lifting of corporate veil

The "alter-ego" or other self-theory is the first, while the "instrumentality" theory is the second.

The alter-ego theory examines whether the borders between the company and its stockholders are distinct in nature.

The instrumentality theory, on the other hand, looks at how a company is used by its owners in a way that serves their interests rather than that of the company. The court will determine which theory to use or how to combine the two concepts.

Jurisprudence of the doctrine’s evolution 

As the various provisions of the Companies Act 2013, Income Tax Act, 1961, and the Foreign Exchange Regulation Act, 1973 list the situations in which the idea of distinct company should be abandoned to reach the real forces of action, the removal of the corporate veil has received legal recognition. The following sections of the Companies Act address this concept:

Section 12 – Misdescription of Name

Section 34 & 35 – Misstatements in Prospectus

Section 39 – Failure to return application money

Section 76A – Punishment for contravention of section 73 and 76

Section 219 – For facilitating the task of an inspector appointed .

Section 339 – Fraudulent Conduct

Reduction of members 

According to the Indian Companies Act, 2013, if a company continues to operate for longer than six months after the number of its members has been reduced to seven for a public company and two for a private company, each member who is a member during the time that the company continues to operate after the six months is responsible jointly and severally with the company for the payment of debts incurred after six months. Only the member who is still active after six months may be sued.

Trading fraudulently

According to the Indian Companies Act of 2013, anybody who was knowingly a party to a company's business being conducted with the intent to mislead creditors of the company or creditors of any other person or for any fraudulent purpose is subject to imprisonment, a fine, or both. This holds true whether the firm has already been wound up or is in the process of being so. 

Misdescription of company

If an officer of the company or another person acting on its behalf signs or authorises to be signed on the company's behalf any bill of exchange, promissory note, endorsement, check, or order for money or goods in which the company's name is not mentioned in legible letters, he is subject to a fine and is personally liable to the holder of the instrument, unless the company has already paid the amount.

Subsidiary companies

The holding company is a separate legal entity from its subsidiaries in the eyes of the law. The subsidiary may, however, lose its status as a separate legal entity, following the situation; when a company has subsidiaries at the end of its fiscal year, it is required to present not only its own accounts to the members of the general meeting, but also the annual accounts of each of its subsidiaries, along with a copy of the board's and auditor's report and a statement of the holding company's interest in the subsidiary. Depending on the specifics of a case, the court may regard a subsidiary as nothing more than a branch office or division of a single sizable holding company-owned business.

Case Laws

Daimler Co. Ltd. v. Continental Tyre and Rubber Co. (Great Britain) Ltd.: This is a case of identifying a company's competitor. There was a German corporation which  set up a British subsidiary company and signed a tyre supply agreement with Continental Tyre and Rubber Co. (Great Britain) Ltd. Because business with foreign companies is forbidden during a war, the British company declined to pay.

The Court lifted the veil to determine whether the company was a German or a British company, and it discovered that because Germans controlled the decision-making bodies, the board of directors, and the overall body of shareholders, the company was a German company and not a British company, making it an enemy company.

Bajrang Prasad Jalan v. Mahabir Prasad Jalan: It concerns a subsidiary holding company in this situation. The court concluded that the corporate veil can be lifted in cases involving not only a holding company but also its subsidiary where both are affiliated with the parent company in order to evaluate an objection of mistreatment.

Conclusion

It is fairly evident that incorporation of the company does not always and in every situation eliminate personal liability. A corporate entity's sanctity is only sustained insofar as it is in accordance with the fundamental principles that give it existence. The theory of removing the corporate veil elaborates on the legal principle that a person cannot profit from their own wrongdoings and is a versatile instrument that aids in delivering justice.

The incorporation of a veil is essential to the existence of every company since it forms the basis of the same, but occasionally its lifting is also necessary to verify that there are no wrongdoings taking place under the cover of a corporate body. Although the courts have worked to improve this concept for many years, stricter application and the establishment of some objective standards are necessary to prevent any ambiguity regarding the use of judicial discretion.

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