Lifting or Piercing the Corporate Veil
The company, in the contemplation of law, is a person distinct from the shareholders. In other words, the company alone is liable for all the acts done and the debts incurred by it and not the directors or the shareholders who are in fact the beneficial owners of the company. This principle is known as “The Veil of Incorporation“.
The Courts, in general, consider this principle as a basic one on which the entire Law of Corporation is based. Therefore, the Courts in many cases, were reluctant to break through the corporate veil and refused to identify a company with its members even a company was found as a mere fraud.
This magic corporate personality gave protection to fraudulent directors to conduct the affairs of the company to defraud the public interest. The experience of the past was very sad and so many investing public and creditors of various companies were badly hit. Therefore, the Courts, began to realize that the Doctrine of Corporate Entity should not be an unmixed blessing as it goes against natural justice. As such, it has become necessary to lift the corporate veil and to see the realities behind the veil.
Consequently, the Courts, both in India and England, if circumstances demanded so, have lifted corporate veil and identified the company with its members. In other words, the Courts, in compelling situations, ignored all the conceptions of the corporate personality and hold the directors and shareholders personally liable. This is known as lifting or piercing the corporate veil.
Circumstances in which the Court can lift the Corporate Veil
According to Palmer, there are seven instances where the corporate veil or the legal personality can be lifted or pierced by the Court. In those circumstances, the corporate veil cannot give any protection to the directors. The following are the instances in which the corporate veil can be lifted.
1. When Company tries to avoid Legal Obligations: When the corporate personality is used to avoid any legal obligation, the Court can disregard the legal personality and can identify with its members. In other words, the Court can hold the shareholders with unlimited liability.
2. Where the Character of the Company is to be Determined: In case doubt arises, that a company is owned or controlled by enemies of another country, the Courts, at their discretion, ignore the corporate fiction and examine the persons who exercise de facto (real) control over the affairs of the company.
To carry on business with an alien enemy is against public policy and hence Courts should not allow the corporate veil to conceal the identity of persons who are alien enemies. This proposition shall apply even if the company is incorporated in the same country.
3. Where a Fraud is Suspected: The corporate entity may also be disregarded where the veil is used for some fraudulent purpose or defeating the claims of the creditors.
4. Where it is essential to Protect the Interest of the Revenue: The Courts are also empowered to pierce the corporate shell if it is used for avoiding tax obligations. The Courts can break through the corporate veil, only when the sole object of its formation is tax evasion.
In other words, the Courts can disregard the corporate entity where it is essential to safeguard the interest of the revenue. But the shareholders on their own accord cannot consider themselves identical with the company.
5. Where the Company Acts as an Agent: A company may sometimes act as an agent or trustee of its members or of another company. In those circumstances, such company is deemed to have lost its individuality and shall be identified with its members.
6. Avoidance of Welfare Legislation: Avoidance of welfare legislation is as common as the avoidance of taxation. It is the duty of the Court in such cases to get behind the smoke screen and discover the true state of affairs.
7. Where the Company is a Clock: The Courts also lift the veil where a company is a mere cloak, which means to disguise or pretend.
8. Where the Welfare Legislation is Avoided: In case of avoidance of welfare legislation the Courts lift the corporate veil to get behind the smoke screen and discover the true state of affairs.
9. Where the Public Policy is to be Protected: The Courts invariably lift the corporate veil in order to protect the public policy and prevent transactions, which are contrary to public policy.