Doctrine of Corporate Veil/Separate Legal Entity

Concept of Corporate Veil or Doctrine of Separate Legal Entity

On registration, the company becomes a separate legal entity. It is also issued a Corporate Identification Number (CIN). According to the principle of independent corporate existence, there exists a veil (parting though fictional) between the company and the rest of the world. This corporate existence different from others is known as Concept or Doctrine of Corporate Veil. The entire edifice of the company form of organization is based on the Corporate Veil.

Lifting (or Piercing) the Corporate Veil

A company’s acts are the acts of the company. Powers of the company are defined and confined by its Memorandum of Association (M/A). Those who form and manage the company are supposed to form and run the company bona fide in the best interests of the company and work within the powers of the company.

In case the persons acting on behalf of company misuse the concept of a separate legal entity for ulterior motives, shall it be allowed like that? The answer is in negative. Whenever the corporate entity is wrongly used to defeat the purpose of law or for personal gain, the corporate entity shall be ignored, and the wrongdoers shall be made to pay for their wrongdoings. Wherever the ‘Separate Corporate Entity’ is disregarded or ignored to see behind the obvious and question the real intentions of the persons involved, it is known as ‘Lifting up the Corporate Veil’. The corporate Veil can be lifted in several situations. Situations where corporate veil is lifted, or separate legal entity of company is ignored can be categorized into the following:

2.1 Under Judicial Interpretations

The courts have ignored the corporate veil in several cases so far. Some of the important judgments are being discussed here in the following points:

1. When it is used to avoid or reduce tax liability: Where the companies were formed just to avoid payment of tax by investing huge dividend income in such companies and taking it back in form of pretended loans (and not genuine loans) separate legal entity of company was ignored and the assessee (i.e., Dinshaw) was made to pay tax (Re Dinshaw Maneckjee Petit, 1927). As the companies created by him were found to be sham and not doing any real business.
   Similarly in CIT v. Sri Meenakshi Mills Ltd., 1967, the corporate veil was ignored where it was used for tax evasion.
2. When it is used as a mask to avoid legal obligation: Where a person (Mr. Horne) who left the firm subject to a condition not to solicit the customers of the firm, formed a company and started soliciting the customers of firm, on being questioned pleaded that it is the company which is doing the business and not he, his argument was not held to be valid. As the company was used as an instrument of fraud to conceal Mr. Horne’s illegal intentions. The court did not allow such a misuse of concept of separate legal entity and ordered discontinuation of such mischief (Gilford Motor Co. Ltd. v. Horne, 1933).
3. When it is used to avoid legal performance of the contract: Where ‘A who agreed to sell a piece of land to ‘B’, later on due to increase in land prices changed his mind and in order to avoid such a sale formed a company and transferred it to the company took the excuse that he is unable to perform the contract as land no longer belongs to him, corporate entity was disregarded as company was not doing any business and it was used as a cloak for non-performance of contract (Jones v. Lipman, 1962).
4. In order to know the real character of the company: If those who run the company assume the enemy character (because of outbreak of war) then the company shall also be treated as enemy only. Here the identity of company and those who run the company is being mixed up so a case of lifting of corporate veil (as was established in Daimler Co. Ltd. v. Continental Rubber Tyre Co.).
5. In order to ascertain the true nature of transaction: A property of M/s. Nichitpur Coal Pvt. Ltd. got vested in the Central Government as a result of the Coal Mines Nationalisation Act, 1973. The company refused to hand over the possession of the property and claimed that property had already been sold. It was argued that wives of the directors (who were brothers) could buy the property as the company was a different person. Here the Apex Court held that the transaction of sale was not bona fide and genuine as
   1. resolution passed for sale dated 21.09.1970 was ante dated document;
   2. wives did not have any independent source of income;
   3. even the agreement and sale deed were not in terms of the resolution;
   4. purchaser did not exercise any rights as owners since purchase.