By Vasundhara Majithia, Yamini Rajora, National Law University Jodhpur
Editor’s Note: The fundamental attribute of corporate personality, from which all other consequences flow if that the corporation is a legal entity distinct from its members.This doctrine has been established for business efficacy, necessity and convenience. In the doctrine of ‘Lifting the Corporate Veil’, the law goes behind the mask or veil of incorporation in order to determine the real person behind the mask of a company. It is one of the most widely used doctrines to decide when a shareholder or shareholders will be held liable for obligations of the corporation and continues to be the most litigated and most discussed doctrines in all of corporate law. Therefore, a study of the same through the lens of leading case laws and judgements as done by the authors would be highly beneficial.
Corporate personality has been described as the ‘most pervading of the fundamental principles of company law”. It constitutes the bedrock principle upon which company is regarded as an entity distinct from the shareholders constituting it. When a company is incorporated, it is treated as a separate legal entity distinct from its promoters, directors, members, and employees; and hence the concept of the corporate veil, separating those parties from the corporate body, has arisen. The issue of “lifting the corporate veil” has been considered by courts and commentators for many years and there are instances in which the courts have deviated from the strict application of this doctrine. This doctrine has been established for business efficacy, necessity and convenience. In the doctrine of ‘Lifting the Corporate Veil’, the law goes behind the mask or veil of incorporation in order to determine the real person behind the mask of a company. One of the main motivations for forming a corporation or company is the limited liability it offers its shareholders. By this doctrine of limited liability, a shareholder can only lose only what he or she has contributed as shares to the corporate entity and nothing more.
But for clarity as to ‘Lifting of the Corporate Veil’, an understanding of the corporate personality of a company is required, along with study of the provisions of Indian law that pave the way for courts to pierce the corporate veil. In this project, we have attempted to study and analyze the concept of separate legal entity, the various grounds for piercing of the corporate veil and elements of lifting of corporate veil analyzed through the lens of leading case laws and judgements.
The fundamental attribute of corporate personality, from which all other consequences flow if that the corporation is a legal entity distinct from its members. Hence, it is capable of enjoying rights and of being subjects to duties which are not the same as those enjoyed or borne by its members. In other words, it has a “legal personality” and is often described as an artificial person in contrast with a human being, a natural person.[i] For centuries, there was a heated controversy over the applicability of the doctrine of separate legal entity and further to limit the theory of limited liability which is often metaphorically termed as “lifting the corporate veil”.[ii] It has also been defined as “piercing the corporate veil: the judicial act of imposing liability on otherwise immune corporate officers, directors, and shareholders for the corporation’s wrongful acts.”[iii]
Corporate personality became an attribute of the normal joint stock company only at a comparatively late stage in its development, and it was not until Solomon v. Solomon & Co.[iv] at the end of the nineteenth century that its implications were fully grasped even by the courts. Solomon had for many years carried on a sole trader a prosperous business as a leather merchant. In 1892, he decided to convert it into a limited company and for this purpose Solomon & Co. Ltd. was formed by Solomon, his wife and five of his children as members and Solomon as managing director. The company purchased the business as a going concern for £39,000 which was a sum which represented the expectations of a fond owner rather than anything that can be called businesslike or a reasonable estimate of value. The price was satisfied by £10,000 in debentures, conferring a charge over all the company’s assets, £20,000 in fully paid £1shares and the balance in cash. The result was that Solomon held 20,001 of the 20,007 shares issued and each of the remaining six shares was held by a member of his family each, apparently as a nominee for him. The company almost immediately ran into difficulties and only a year later the then holder of debentures appointed a receiver and the company went into liquidation. Its assets were sufficient to discharge the debenture but nothing was left for the unsecured creditors. In these circumstances, Vaughan Williams J. and a strong Court of Appeal held that the whole transaction was contrary to the true intent of the Companies Act and that the company was a mere sham, and an alias, trustee or nominee for Solomon who remained the real proprietor of the business. As such, he was liable to indemnify the company against its trading debts. But the House of Lords unanimously reversed this decision. They held that the company has been validly formed since the Act merely required seven members holding at least one share each. It said nothing about their independent, or that they should take a substantial interest in the undertaking, or that they should have a mind and will of their own, or that there should be anything like a a balance of power in the constitution of the company. Hence, the business belonged to the company and not to Solomon and Solomon was its agent. Thus, this case established that provided the formalities of the Act are complied with, a company will be validly incorporated, even if it is a “one person company” and the courts will be reluctant to treat a shareholder as personally liable for the debts of the company by piercing the corporate veil. Thus, the court held that there was no fraud since the shareholders were fully conversant with what was being done.
As most of the provisions of Indian Law were borrowed from the English Law, it more or less resembles the English Law. Solomon’s case has been the authority ever since in the decisions of the doctrine in Indian company cases.
Likewise, in Macaura v. Northern Assurance Co. Ltd.[v] the House of Lords decided that insurers were not liable under a contract of insurance on property that was insured by the plaintiff but owned by a company in which the plaintiff held all the fully-paid shares. The House of Lords held that only the company as the separate legal owner of the property, and not the plaintiff, had the required insurable interest. The plaintiff, being a shareholder, did not have any legal or beneficial interest in that property merely because of his shareholding. Support for the doctrine has been exhibited more recently in Lee v. Lee’s Air Farming[vi]. The Privy Council held that Lee, as a separate and distinct entity from the company which he controlled, could be an employee of that company so that Lee’s wife could claim workers’ compensation following her husband’s death.
The Supreme Court in Tata Engineering Locomotive Co. Ltd v. State of Bihar & Ors.[vii] stated: “the corporation in law is equal to a natural person and has a legal entity of its own. The entity of corporation is entirely separate from that of its shareholders; it bears its own names and has seal of its own; its assets are separate and distinct from those of its members; the liability of the members of the shareholders is limited to the capital invested by them; similarly, the creditors of the members have no right to the assets of the corporation.” In some of the cases, judicial decisions have no doubt lifted the veil. Gower has summarized the position with the observation that in a number of cases the legislature has rented in many respects, the veil woven by Solomon’s case. According to Gower, the courts have only construed the statutes as “cracking open the corporate shell” when compelled to do so by the clear words of the statute. Thus, even in India it can be seen that at present, the consensus is that cracking open the veil is somewhat cautious and circumspect.
Piercing or lifting the veil is corporate law’s most widely used doctrine to decide when a shareholder or shareholders will be held liable for obligations of the corporation. It continues to be one of the most litigated and most discussed doctrines in all of corporate law.[viii]
The term “piercing the corporate veil” has also been described as, “the Court’s unwillingness to permit corporate presence and action to divert judicial course of applying law to ascertain facts”.[ix] When this principle is invoked, it is permissible to show that the individual hiding behind the corporation is liable to discharge the obligations ignoring the concept of corporation as a separate entity. Generally, an incorporated company is liable as a juristic person. It is different from its shareholders and Board of directors of Company. The acts of malfeasance and misfeasance and acts of misdemeanor by the shareholders and directors of a corporation (company), do not always bind the company as such. However so as to apply law to ascertained facts, judicial process can ignore juristic personality of the company and haul-up the directors and in certain cases even shareholders to discharge the legal obligations. When the corporate veil is lifted/pierced, it only means that the Court is assuming that the corporate entity of a concern is a sham to perpetuate the fraud, to avoid liability, to avoid effect of statute and to avoid obligations under a contract.[x]
In Skipper Construction Company (Private) Ltd.[xi], the Supreme Court referred to the principle of lifting corporate veil. After referring Palmer’s Company Law as well as Modern Company Law by Gower, it was observed as under:-
The concept of corporate entity was evolved to encourage and promote trade and commerce but not to commit illegalities or to defraud people. The corporate veil indisputably can be pierced when the corporate personality is found to be opposed to justice, convenience and interest of the revenue or workman or against public interest.
In LIC of India v. Escorts Ltd.[xii], Justice O.Chinnapa Reddy had stressed that the corporate veil should be lifted where the associated companies are inextricably connected as to be in reality, part of one concern. After the Bhopal Gas leak disaster case, the lifting of corporate veil has been escalated. Furthermore in State of UP v. Renusagar Power Company[xiii], the Supreme court lifted the veil and held that Hindalco, the holding company and its subsidiary, Renusagar company should be treated as one concern and that the Power Plant of Renusagar must be treated as the own source of generation of Hindalco and on that basis, Hindalco would be liable to pay the electric duty. After the decision in Renusagar case, the doctrine has been considered in several other cases.
In Trustor AB v. Smallbone (No.2)(2001)[xiv], the Vice-Chancellor concluded; “Companies are often involved in improprieties. Indeed there was some suggestion to that effect in Solomon. But it would make undue roads into the principle of Solomon if an impropriety not linked to the use of the company structure to avoid or conceal the liability of it if the company was used as a device or facade to conceal the true facts thereby avoiding or concealing any liability of those individuals.”
Just as in the case of Jones v. Lipman[xv] the corporation must be the device through which the impropriety is conducted, impropriety alone will not suffice.
As early as Solomon, judgments have indicated possible exceptions to the separate entity concept. Lord Halsbury recognised the separate entity providing there was “no fraud and no agency and if the company was a real one and not a fiction or myth.” As noted by Lord Denning in Littlewoods Mail Order Stores Ltd. v. IRC,[xvi] “cast a veil over the personality of a limited company through which the courts cannot see. The courts can, and often do, pull off the mask. They look to see what really lies behind.”
The circumstances under which the Courts may lift the corporate veil may broadly be grouped under the following two heads:
- When membership is reduced
Under section 45 of the Companies Act, when the number of members of a company are reduced below 7 in case of a public company and below 2 in case of a private company and the company continues to carry on its business for more than 6 months while the number is so reduced, every person who is a member of such company, knows this fact, is severally liable for the debts of the company contracted during that time.
- Improper use of Name
Section 147(4) provides that an officer of a company who signs any Bill of Exchange, Hundi, Promissory note, cheque, wherein the name of the company is not mentioned in the prescribed manner, such officer shall be held personally liable to the holder of such Bill of exchange, hundi, promissory note or cheque as the case may be; unless it is duly paid by the company.
- Fraudulent conduct
If in the course of winding up of a company, it appears that any business of the company has been carried on with the intent to defraud the creditors of the company or any other person or for any other fraudulent purpose, the persons who were knowingly parties to the carrying on of the business, in the manner aforesaid, shall be personally liable for all or any of the debts or other liabilities of the company, as the court may direct.[xvii]
- Failure to refund application money
The directors of a company are jointly and severally liable to repay the application money with interest, if the company fails to refund the application money of those applicants who have not been allotted shares within 130 days from the date of issue of the prospectus.[xviii] However, this does not in any way affect the very existence of the company or indeed its subsequent independent personality and other features.
- Misrepresentation in prospectus
In case of misrepresentation in a prospectus, every director, promoter and every other person, who authorizes such issue of prospectus incurs liability towards those who subscribed for shares on the faith of untrue statement.[xix] Besides, these persons may be charged criminally and fined upto Rs. 50,000 or imprisoned upto two years or may be fined as well as imprisoned.[xx]
- Holding Subsidiary companies
A holding company is required to disclose to its members the accounts of the subsidiaries. Every holding company is supposed to attach to its balance sheet, copies of the balance sheet, profit and loss account, directors report and auditors’ report etc. in respect of each subsidiary company.[xxi] It amounts to lifting of the corporate veil because in the eyes of law a subsidiary company is a separate legal entity and through this mechanism their identity is known.
- For facilitating the task of an inspector to investigate the affairs of the company
If it is necessary for the satisfactory completion of the task of an inspector appointed to investigate the affairs of a company for alleged mismanagement, or oppressive policy towards its members, he may investigate into the affairs of another related company in the same management or group.[xxii]
- For investigation of ownership
The Central Government may appoint one or more inspectors to investigate and report on the membership of any company for the purpose of determining the true persons who are financially interested in the company and who control its policy or materially influence it.
- Liability for ultra vires acts
Directors and other officers of a company will be personally liable for all those acts which they have done on behalf of a company if the same are ultra vires the company.
- Protection of revenue
In Sir Dinsaw Maneckjee Petit, the assessee was a millionaire earning a huge income by way of dividend and interest. He formed four private companies and transferred his investments to each of these companies in exchange for their shares. The dividends and interest income received by the company was handed back to Sir Dinshaw as a pretend loan. It was held that the company was formed by the assessee purely as a means of avoiding tax and companies thus formed were nothing more than the assesee himself. It did no business and was created as a legal entity simply to extend pretend loans to Sir Dinshaw. In the case of CIT v. Sri Meenakshi Mills Ltd.,[xxiii] where the veil had been used as means of tax evasion, the court upheld the piercing of the veil to look at the real transaction.
- Prevention of fraud or improper conduct
Where the medium of a company has been used for committing fraud or improper conduct, courts have lifted the veil and looked at the reality of the situation. The two classic cases of the fraud exception are Gilford Motor Company Ltd v. Horne[xxiv] and Jones v. Lipman. In the first case, Mr. Horne was an ex-employee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company. In order to defeat this he incorporated a limited company in his wife’s name and solicited the customers of the company. The company brought an action against him. The Court of appeal was of the view that “the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne. “In this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud.” Thus the court of appeal regarded it as a mere sham to cloak his wrongdoings. In the second case of Jones v. Lipman a man contracted to sell his land and thereafter changed his mind in order to avoid an order of specific performance he transferred his property to a company. Russel J specifically referred to the judgments in Gilford v. Horne and held that the company here was “a mask which (Mr. Lipman) holds before his face in an attempt to avoid recognition by the eye of equity” he awarded specific performance both against Mr. Lipman and the company.
- Determination of the enemy character of a company
In times of war the court is prepared to lift the corporate veil and determine the nature of shareholding as it did in the Daimler Co. Ltd. v. Continental Tyre and Rubber Co.,[xxv] where a company was incorporated in London for the purpose of selling German tyres manufactured by a German company. Its majority shareholders and all its directors were German. The English Courts held it to be an enemy company on lifting the veil and trading with this company was held to amount to trading with the enemy.
- Group enterprises
Sometimes in the case of group of enterprises the Solomon principal may not be adhered to and the court may lift the veil in order to look at the economic realities of the group itself. In the case of D.H.N. Food products Ltd. v. Tower Hamlets London Borough Council[xxvi] it has been said that the courts may disregard Solomon’s case whenever it is just and equitable to do so. The court of appeal thought that the present case where it was one suitable for lifting the corporate veil. Here the three subsidiary companies were treated as a part of the same economic entity or group and were entitled to compensation. Lord Denning has remarked that we know that in “many respects a group of companies are treated together for the purpose of accounts, balance sheet, and profit and loss accounts”. The nature of shareholding and control would be indicators whether the court would pierce the corporate veil. The House of Lords in the above mentioned case had remarked “properly applied the principle that it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere facade concealing the true facts” In the figurative sense facade denotes outward appearance especially one that is false or deceptive and imports pretence and concealment. That the corporator has complete control of the company is not enough to constitute the company as a mere facade rather that term suggests in the context the deliberate concealment of the identity and activities of the corporator. The separate legal personality of the company, although a “technical point” is not a matter of form it is a matter of substance and reality and the corporator ought not, on every occasion, to be relieved of the disadvantageous consequences of an arrangement voluntarily entered into by the corporator for reasons considered by the corporator to be of advantage to him. In particular “the group enterprise” concept must obviously be carefully limited so that companies who seek the advantages of separate corporate personality must generally accept the corresponding burdens and limitations.
- Where a company acts as an agent for its shareholders
Where a company is acting as agent for its shareholder, the shareholders will be liable for the acts of the company. It is a question of fact in each case whether the company is acting as an agent for its shareholders. There may be an Express agreement to this effect or an agreement may be implied from the circumstances of each particular case. In the case of R.G. Films Ltd.[xxvii], an American company financed the production of a film in India in the name of a British company. The president of the American company held 90 per cent of the capital of the British company. The Board of trade of Great Britain refused to register the film as a British film. Held, the decision was valid in view of the fact that British company acted merely as he nominee of the American Company.
- In case of economic offences
In Santanu Ray v. Union of India,[xxviii]it was held that in case of economic offences, a court is entitled to lift the veil and pay regard to the economic realities behind the legal façade.
- Where Company is a sham or cloak
When the court finds that company is a mere cloak or sham and is used for some illegal or improper purpose, it may lift veil. In the leading case of P.N.B. Finance v. Shital Prasad[xxix], where a person borrowed money from a company and invested it into three different companies, the lending company was advised to bring together the assets of all the three companies, as they were created to do fraud with the lending company. The meaning of a “sham‟ was defined by Diplock LJ in Snook v London and West Riding Investments Ltd.[xxx], thus: “it means acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligation (if any) which the parties intend to create….but…for acts or documents to be a „sham‟, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating…‟
- Control and domination
Control and determination part of the test determines the relationship between the shareholder and the corporation. Generally, mere majority stock ownership will be insufficient to satisfy this element. Instead, one must show “complete domination, not only of finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction has no separate mind, will or existence of its own.” To determine the existence of “complete domination”, courts usually require the plaintiff to produce evidence of inadequate capitalization or undercapitalization, failure to follow corporate formalities, commingling of funds, diversion of funds or assets for non-corporate purposes.[xxxi]
- Improper purpose or use
This test requires the plaintiff to show that the control exercised by the parent company or dominant stockholder was “used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or dishonest and unjust act in contravention of plaintiff’s legal right.” This inquiry focuses on the relationship between the plaintiff and the corporation. It is an explicit recognition that some improper conduct must have occurred, establishing that the corporation was controlled and dominated.[xxxii]
- Resulting damage or harm
In this test the plaintiff must show that the defendant’s control, exerted in a fraudulent, illegal or otherwise unfair manner toward it, caused the harm suffered. In other words, the plaintiff must prove that, unless the corporate veil is pierced, it will have been treated unjustly by the defendant’s exercise of control and improper use of the corporate form and, thereby, suffer damages.[xxxiii]
Corporations play a significant role not only in creating and managing business but also in common lives of most people. That is why most modern criminal law systems foresee the possibility to hold the corporation criminally liable for the perpetration of a criminal offence. The doctrine of corporate criminal liability turned from its infancy to almost a prevailing rule.[xxxiv]
In India, the need for industrial development has led to the establishment of a number of plants and factories by the domestic companies and under-takings as well as by Transnational Corporations. Many of these industries are engaged in hazardous or inherently dangerous activities which pose potential threat to life, health and safety of persons working in the factory, or residing in the surrounding areas. Though working of such factories and plants is regulated by a 614 number of laws of our country, there is no special legislation providing for compensation and damages to outsiders who may suffer on account of any industrial accident.[xxxv]
Criminal Liability of Corporations: Pre-Standard Chartered Bank Case Law
Earlier, Indian courts were of the opinion that corporations could not be criminally prosecuted for offenses requiring mens rea as they could not possess the requisite mens rea. Mens rea is an essential element for majority, if not all, of offenses that would entail imprisonment or other penalty for its violation. Indian courts held that corporations could not be prosecuted for offenses requiring a mandatory punishment of imprisonment, as they could not be imprisoned.
In A. K. Khosla v. S. Venkatesan[xxxvi], two corporations were charged with having committed fraud under the IPC. The Magistrate issued process against the corporations. The Court in this case pointed out that there were two pre-requisites for the prosecution of corporate bodies, the first being that of mens rea and the other being the ability to impose the mandatory sentence of imprisonment. A corporate body could not be said to have the necessary mens rea , nor can it be sentenced to imprisonment as it has no physical body.
In Kalpanath Rai v State (Through CBI)[xxxvii], a company accused and arraigned under the Terrorists and Disruptive Activities Prevention (TADA) Act, was alleged to have harbored terrorists. The trial court convicted the company of the offense punishable under section 3(4) of the TADA Act. On appeal, the Indian Supreme Court referred to the definition of the word “harbor” as provided in Section 52A of the IPC and pointed out that there was nothing in TADA, either express or implied, to indicate that the mens rea element had been excluded from the offense under Section 3(4) of TADA Act.
There is uncertainty over whether a company can be convicted for an offence where the punishment prescribed by the statute is imprisonment and fine. This controversy was first addressed in MV Javali v. Mahajan Borewell & Co and Ors[xxxviii] where the Supreme Court held that mandatory sentence of imprisonment and fine is to be imposed where it can be imposed, but where it cannot be imposed ,namely on a company then fine will be the only punishment.
In Zee Tele films Ltd. v. Sahara India Co. Corp. Ltd[xxxix], the court dismissed a complaint filed against Zee under Section 500 of the IPC. The complaint alleged that Zee had telecasted a program based on falsehood and thereby defamed Sahara India. The court held that mens rea was one of the essential elements of the offense of criminal defamation and that a company could not have the requisite mens rea. In another case, Motorola Inc. v. Union of India[xl], the Bombay High Court quashed a proceeding against a corporation for alleged cheating, as it came to the conclusion that it was impossible for a corporation to form the requisite mens rea, which was the essential ingredient of the offense. Thus, the corporation could not be prosecuted under section 420 of the IPC.
Standard Chartered Bank Case Law
This is the landmark case in which the apex court overruled the all other laid down principles. In this case, Standard Chartered Bank was being prosecuted for violation of certain provisions of the Foreign Exchange Regulation Act, 1973. Ultimately, the Supreme Court held that the corporation could be prosecuted and punished, with fines, regardless of the mandatory punishment required under the respective statute.
The Court did not go by the literal and strict interpretation rule required to be done for the penal statutes and went on to provide complete justice thereby imposing fine on the corporate. The Court looked into the interpretation rule that that all penal statutes are to be strictly construed in the sense that the Court must see that the thing charged as an offence is within the plain meaning of the words used and must not strain the words on any notion that there has been a slip that the thing is so clearly within the mischief that it must have been intended to be included and would have included if thought of.[xli]
Justice Paranjape had stated[xlii]:
“the question whether a corporate body should or should not be liable for criminal action resulting from the acts of some individual must depend on the nature of the offence disclosed by the allegations in the complaint or in the charge-sheet, the relative position of the officer or agent, vis-a-vis, the corporate body and the other relevant facts and circumstances which could show that the corporate body, as such, meant or intended to commit that act…”
The Supreme Court also pointed out that, as to criminal liability, the FERA statute does not make any distinction between a natural person and corporations. Further, the Indian Criminal Procedure Code, dealing with trial of offenses, contains no provision for the exemption of corporations from prosecution when it is difficult to sentence them according to a statute. The court held that the FERA statute was clear: corporations are vulnerable to criminal prosecution, and allowing corporations to escape liability based on the difficulty in sentencing would do violence to the statute. The Court did not develop its reasoning far enough so as to specifically hold that a corporation is capable of forming mens rea and acting pursuant to it. However, the Court held that corporations are liable for criminal offenses and can be prosecuted and punished, at least with fines. Many of the offenses, punishable by fines, however do have mens rea as a necessary element of the offense. By implication, it can be said that post Standard Chartered decision, corporations are capable of possessing the requisite mens rea. As in prosecution of other economic crimes, intention could very well be imputed to a corporation and may be gathered from the acts and/or omissions of a corporation.
Criminal Liability of Corporations: Post-Standard Chartered Bank Case Law
There is no immunity to companies from prosecution merely because the prosecution is in respect of offences for which punishment prescribed is mandatory imprisonment. In Iridium India Telecom Ltd. v. Motorola Incorporated and Ors.[xliii], the apex court held that a corporation is virtually in the same position as any individual and may be convicted under common law as well as statutory offences including those requiring mens rea. The criminal liability of a corporation would arise when an offence is committed in relation to the business of the corporation by a person or body of persons in control of its affairs and relied on the ratio in Standard Chartered Bank Case.
The apex court held that corporations can no longer claim immunity from criminal prosecution on the grounds that they are incapable of possessing the necessary mens rea for the commission of criminal offences. The notion that a corporation cannot be held liable for the commission of a crime had been rejected by adopting the doctrine of attribution and imputation[xliv].
In another judgment in July 2011 of CBI v. M/s Blue-Sky Tie-up Ltd and Ors[xlv], the apex court reiterated the position of law held that companies are liable to be prosecuted for criminal offences and fines may be imposed on the companies.
A basic principle of German law is societas delinquere non potest, which means that a corporate body cannot be liable for a criminal offence. The argument is that the human element is missing and that the creation and operation of slush funds, as well as giving bribes, are all human acts and not the acts of the company itself.[xlvi] But Germany has developed an elaborate structure of administrative sanctions, which includes provisions on corporate criminal liability. These so-called Ordnungswidrigkeiten are handed down by administrative bodies. The key provision for sanctioning the corporation is Section 30 Ordnungswidrigkeitengesetz, which calls for the imposition of fines on corporate entities.[xlvii]
The criminal sanctions are quite high and criminal liability of a company is recognized by the Australian Legislation[xlviii]. Moreover, the Australian legislature has introduced criminal liability of directors.
- United States and United Kingdom
For more than fifty years, most criminal law and corporate scholars in the United States have been opposed to corporate criminal liability, arguing that it should be eliminated or at least strictly limited[xlix]. In the US and the UK, it has been a settled principle that corporates can be held criminally liable.
France had also not recognized corporate criminal liability since the French Revolution, the new Code Pénal of 1992 makes specific mention of this concept in section 121(2). The resistance to not including corporate criminal liability in the criminal code had increased over the years, and in 1982 the “Conseil Constitutionnel” had made it clear that the French Constitution did not prohibit the imposition of fines on a corporation.[l]
- International Conferences
The Concept of Criminal liability of Corporation is also mentioned under various International documents. A number of conferences have dealt with the same issues since the end of World War II. Among them are the 8th International Conference of the Society for the Reform of Criminal Law in 1994 in Hong Kong and the International Meeting of Experts on the Use of Criminal Sanctions in the Protection of the Environment in Portland, in 1994.[li]
The Seventh United Nations Congress on the Prevention of Crime and the Treatment of Offenders of 1985 in Milan mentioned that “due consideration should be given by Member States to making criminally responsible not only those persons who have acted on behalf of an institution, corporation or enterprise, or who are in a policy-making or executive capacity, but also the institution, corporation or enterprise itself, by devising appropriate measures that could prevent or sanction the furtherance of criminal activities.[lii]”
In 1998, the Council of Europe passed the Convention on the Protection of the Environment through Criminal Law, which stipulated in Article 9 that either “criminal or administrative, sanctions or measures” could be taken in order to hold corporate entities accountable.[liii]
The doctrine of piercing or lifting of the veil of a Corporate Personality makes a change in the attitude of law as originally adopted towards the concept of separate legal personality or entity of the corporation. In Ansuman Singh v. State of U.P.[liv], the court held that in suitable cases, the court will lift the corporate veil.
It may happen that the corporate personality of the company is used to commit frauds or improper or illegal acts like tax evasion. Thus, the concept of piercing or lifting the corporate veil holds significance. A corporate veil may be pierced either through statutory provisions or by judicial interpretation. Piercing the corporate veil in taxation matters is an outcome of judicial decisions. The court has the power to disregard the corporate entity if used for tax evasion or to circumvent tax obligation.[lv]
The veil has also been lifted after finding that a corporation is merely an adjunct, business conduit or alter ego of another corporation or person. When the veil is pierced, the other entity, or the directors, officers, stockholders or members of the corporation, could be held solitarily and personally liable for corporate obligations.[lvi]
Piercing the Veil: Indian Context
When any private company is wound up any tax assessed on the company whether before or in course of liquidation, in respect of any previous year cannot be recovered, every person who was director of that company at any time during the relevant previous year shall be jointly and severally be liable for payment of tax.
A company transferred its business to another company which was not taxable, but the company was carrying on some other business which was taxable. The company remained liable to pay the tax applicable to such business and lifting of Corporate Veil was permitted even in the absence of any statutory provision in this regard.[lvii]
In the case of Richer Holding Ltd. (RHL)[lviii], the issue before the High Court was whether RHL was obliged to withhold tax on the consideration paid for acquisition of 60% of the shares in a UK company that held a majority stake in an Indian Company. The High Court rejected the petition filed by RHL against the show cause notice by the Tax Authority since it was premature it was premature at this stage to arrive at a conclusion that there is no avoidance of tax obligations and RHL was not liable to tax on capital gains. The High Court also observed that it may be necessary for the Tax Authority to lift the Corporate Veil as well as examine the extent of powers the majority shareholder had in the interest/assets of the Indian Company to look into the real nature of the transaction.
In Vodafone International Holdings BV v. UOI[lix] Hutchinson International (non-resident company) held 100% shares of CGP Investments Holdings Ltd. (non-resident company) which in turn held 67% shares in the Indian company Hutchinson-Essar. The question which arose was, whether the income accruing to Hutchinson as a result of the transaction could be deemed to accrue or arise in India by virtue of Sec. 9 of the Income Tax Act. In Vodafone, the High Court answered all issues against Vodafone. However, final and concrete conclusions cannot be drawn as the judgment was not dealing with the taxability of the transaction.
In Santanu Ray v. UOI[lx], it was held that in case of economic offences the court is entitled to lift the corporate veil and pay regard to the economic realities behind the legal façade. The court held that the veil of corporate entity could be lifted by the adjudicating authorities so as to determine as to which of the directors were concerned with the evasion of excise duty by reason of fraud, concealment or wilful misstatement or contravention of the provisions of the Act.
Piercing the Veil: International Context
A corporation is a separate entity from its shareholders and is subject to taxation separate and apart from its shareholders.[lxi] Similarly, separate corporations are generally treated as separate entities for tax purposes, no matter how closely they may be affiliated, as in the case of a parent and wholly owned subsidiary.[lxii] Only in exceptional circumstances will courts ignore the separate existence of Corporations.[lxiii]
If a corporation was formed for a valid business reason or conducted substantial business activities after its formation, it will be recognized for tax purposes.[lxiv] While the Supreme Court has intimated that and otherwise separate taxable corporate entity may, in some circumstances, qualify as a non taxable agent of a principal,[lxv] two perquisites must be satisfied: relations with the corporation`s principal must not be dependent on the fact that it is owned by the principal, and its business purpose must be carried on of normal duties of an agent.[lxvi] Where a corporation qualifies as a non-taxable agent, shareholders may be entitled to deduct loses sustained in transaction engaged in through the agent.[lxvii]
In the Menguito[lxviii] case, the Supreme Court stated that it considers the following as substantial evidence that two entities are actually one juridical taxable person:
- When the owner of one directs and controls the operations of the other, and the payments effected or received by one are for the accounts due from or payable to the other; or
- When the properties or products of one are all sold to the other, which, in turn, immediately sells them to the public.
In this case, the sole proprietor was held liable for tax liabilities of the corporation after finding overwhelming evidence supporting the piercing of the corporate veil. Such evidence consists of several admissions by the sole proprietor and his wife, and documents presented in evidence showing that the identities of the sole proprietorship and the corporation are interchangeable.
It is also worth noting that corporate fiction is pierced not only on the basis of fraud but also in alter-ego cases where a dummy corporation serves no business purpose other than as a blind. In at least two cases, the Supreme Court disregarded the veils of corporate fiction after finding that while the organization of a separate corporation was not to perpetuate fraud, the clear intention was to minimize taxes.
Whether or not a corporation a separate entity form the individual who created the corporation is not the same question as whether it was an alter ego for the purpose of piercing the corporate veil and holding the individual liable for its taxes; and a finding of separate taxable entity does not preclude personal assessment against the individual.[lxix]
A corporation is subject to federal corporate income tax liability as long as it continues to do business in the corporate manner, despite the fact that its recognized legal status under state law is voluntarily or involuntarily terminated;[lxx] and a valid corporation will be disregarded for federal tax purposes only after the state has revoked its charter.[lxxi] A liquidating corporation continues its federal tax existence so long as it retains valuable assets.
Piercing of Corporate Veil under Direct Tax Code
The new Direct Tax Code (hereafter DTC) replaced the Income Tax Act, 1961 with effect from 1st April, 2012, the basic objective behind its enactment being simplification of the language so as to enable better comprehension thereby reducing the number of law suits. Significant among the provisions that it introduced, are the provisions aimed at tackling the problem of tax avoidance since this has been resulting in a major loss of revenue for the government. Certain legislative amendments had been made earlier to counter this particular problem but did not prove very effective since the tax payers found sophisticated methods to get passed them thereby necessitating further changes.
The current Income Tax Act 1961 marks a difference between ‘Tax avoidance’ and ‘tax evasion’. Tax evasion refers to a situation where a person tries to reduce his tax liability by deliberately suppressing the income or by inflating the expenditure. An assessee guilty of tax evasion is punishable under the relevant laws. On the other hand tax avoidance refers to any planning, though done strictly according to legal requirements but destroys the basic intention of the statute; the assessee will be punishable under such circumstances only in the event of colourable device.[lxxii]
The doctrine of piercing the corporate veil is not subject to any bright line tests. Courts have struggled for years to develop and refine their analysis of these claims. However, each new action brings a different set of facts and circumstances into the equation and a separate determination must be made as to whether the plaintiff has adduced sufficient evidence of control and domination, improper purpose, or use and resulting damage. The decision whether to pierce the corporate veil may be assisted, at least in part, upon the opinion of qualified experts. In particular, expert testimony would be helpful to the trier of fact in determining whether the corporation has been adequately capitalized for its intended purpose. Ultimately, however, the judgment whether to disregard the corporate entity will be based upon a balancing of various factors all or some of which are necessary but may not be sufficient to pierce the veil.
The act of piercing the corporate veil until now remains one of the most controversial subjects in corporate law. There are categories such as fraud, agency, sham or facade, unfairness and group enterprises, which are believed to be the most peculiar basis under which the Law Courts would pierce the corporate veil. But these categories are just guidelines and by no means far from being exhaustive.
Edited by Kanchi Kaushik
[i] Gower and Davies, Principles of Modern Company Law, 8th ed. Sweet and Maxwell, London, 2008.
[iii] Black’s Law Dictionary 1168 (7th ed. 1999)
[iv] Solomon v. Solomon & Co.  A.C. 22, HL
[v] Macaura v. Northern Assurance Co. Ltd  A.C. 619
[vi] Lee v. Lee’s Air Farming  A.C. 12
[vii] Tata Engineering Locomotive Co. Ltd v. State of Bihar & Ors. AIR 1965 SC 40
[viii] Harshit Saxena, “Lifting of Corporate veil” available at www.ssrsn.com
[ix] Volume 32A of Words and Phrases (West Publishing Company – third reprint 1989 p.84)
[x] Supra note 2
[xi] Skipper Construction Company (Private) Ltd. (1997) 89 Comp Cas 362 (SC)
[xii] LIC of India v. Escorts Ltd. AIR 1986 SC 1370
[xiii] State of UP v. Renusagar Power Company AIR 1988 SC 1737
[xiv] Trustor AB v. Smallbone (No.2)(2001)
[xv] Jones v. Lipman  l WLR 832
[xvi] Littlewoods Mail Order Stores Ltd. v. IRC  1 W.L.R. 1241, 1254
[xvii] Section 542
[xviii] Section 69(5)
[xix] Section 62
[xx] Section 63
[xxi] Section 212
[xxii] Section 239
[xxiii] CIT v. Sri Meenakshi Mills Ltd AIR 1967 SC 819
[xxiv] Gilford Motor Company Ltd v. Horne (1933) Ch. 935 (CA)
[xxv] Daimler Co. Ltd. v. Continental Tyre and Rubber Co.  2 A.C. 307
[xxvi] D.H.N. Food products Ltd. v. Tower Hamlets London Borough Council  1 WLR 852
[xxvii] R.G. Films Ltd. (1953) 1 All ER 615.
[xxviii]Santanu Ray v. Union of India (1989) 65 Comp. Cas. 196 (Delhi)
[xxix] P.N.B. Finance v. Shital Prasad 54 Comp. Cas. 66 (Delhi)
[xxx] Snook v London and West Riding Investments Ltd. (1967) 2 QB 786
[xxxi] Shagun Singh, Lifting the Corporate Veil with reference to leading cases, available at http://artismc.com/index.php/blogs/view/55/221/ Last visited 20th September 2014.
[xxxiv] Thiyagarajan, T. Sivanathan; Corporate Criminal-concept, available at http://www.manupatra.com/Articles /artlist.asp?s=Corporate/Commercial accessed on 27th September, 2014
[xxxv] Charan Lal Sahu v. Union of India, AIR 1990 SC 1480
[xxxvi] A. K. Khosla v. S. Venkatesan, (1992) Cr.L.J. 1448
[xxxvii] Kalpanath Rai v. State (Through CBI), (1997) 8 SCC 732
[xxxviii] MV Javali v. Mahajan Borewell & Co and Ors., AIR 1997 SC 3964
[xxxix] Zee Telefilms Ltd. v. Sahara India Co. Corp. Ltd., (2001) 3 Recent Criminal Reports 292
[xl] Motorola Inc. v. Union of India, (2004) Cri.L.J. 1576
[xli] Tolaram Relumal and Anr. v. The State of Bombay, 1955 (1) SCR 158
[xlii] Standard Chartered Bank and Ors. v. Directorate of Enforcement, (2005) 4 SCC 530
[xliii] Iridium India Telecom Ltd. v. Motorola Incorporated and Ors , AIR 2011 SC 20
[xliv] Angira Singhvi ,”Corporate Crime and Sentencing in India: Required Amendments in Law”, International Journal of Criminal Justice Sciences ,Vol. 1 Issue.2 July 2006 ISSN:0973 available at http://www.sascv.org/ijcjs/angira.html; accessed on 26th September, 2014
[xlv] CBI v. M/s Blue-Sky Tie-up Ltd and Ors., (2011) 15 SCC 144
[xlvi] Konstantin Zens, Susan Watson, “Enforcement Instruments In Transnational Corporate Bribery: An Overview”, 2012 International Company and Competition Law Review 271 available at www.westlaw.com , accessed on 27th September, 2014
[xlvii] Markus Wagner, “Corporate Criminal Liability National and International Responses”, Background Paper for the International Society for the Reform of Criminal Law 13th International Conference Commercial and Financial Fraud: A Comparative Perspective Malta, 8-12 July 1999 available at http://www.icclr.law.ubc.ca/publications /reports/corporatecriminal.pdf accessed on 29th September, 2014
[xlviii] Supra note 46
[xlix] Sara Sun Beale, “A Response To The Critics Of Corporate Criminal Liability”, 46 AM. CRIM. L. REV. 1481 available at http://www.law.yale.edu/documents/pdf/cbl/Beale_paper.pdf accessed on 27th September, 2014
[l] Stessens, Guy. “Corporate Criminal Liability: A Comparative Perspective” International and Comparative Law Quarterly, v. 43, July 1994, p.501
[li] Supra note 47
[lii] Guiding Principles for Crime Prevention and Criminal Justice in the Context of Development and a New International Economic Order. 29 November 1985 http://www.un.org/documents/ga/res/40/a40r032.htm accessed on 29th September, 2014
[liii] Convention on the Protection of the Environment through Criminal Law. 4 November 1998. available at http://conventions.coe.int/Treaty/en/Treaties/Html/172.htm accessed on 29th September, 2014
[liv] Ansuman Singh v. State of U.P., AIR 2004 All. 260
[lv] Deputy Commissioner v. Chetan Transport Corp. Ltd., (1992) 74 Comp.Cas. 563 (Mad.)(DB)
[lvi] Supra note 13
[lvii] India Waste Energy Development Ltd v. Government NCT of Delhi (2003) 114 Comp Cases 82 (Del)
[lviii] Richter Holding v. The Assistant Director of Income Tax, (2011) 243 CTR (Kar) 149
[lix] Vodafone International Holdings BV v. UOI, Ministry of Finance and Asst. Director of Income Tax (International Taxation), (2009) 311 ITR 46 (Bom.)
[lx] Supra note 28
[lxi] Ganter v. C.I.R., 90-2 U.S. Tax Cas. (CCH) P 50335
[lxii] King v. C.I.R., 72-1 U.S. Tax Cas. (CCH) P 9341
[lxiii] Britt v. US, 70-1 U.S. Tax Cas. (CCH) P 9400
[lxiv] Evans v. C.I.R., 77-2 U.S. Tax Cas. (CCH) P 9596
[lxv] National Carbide Corp. v. C.I.R, 49-1 U.S. Tax Cas. (CCH) P 9223
[lxvi] Vaughn v. U.S., 84-2 U.S. Tax Cas. (CCH) P 9706
[lxvii] C.I.R. v. Bollinger, 88-1 U.S. Tax Cas. (CCH) P 9233
[lxviii] Commissioner of Internal Revenue v. Menguito, 565 SCRA 461, 468-575 (2008)
[lxix] Harris v. U.S., 85-2 U.S. Tax. Cas. (CCH) P 9511
[lxx] Messer v. C.I.R., 71-1 U.S. Tax Cas. (CCH) P 9214
[lxxi] U.S. v. Young, 85-2 U.S. Tax Cas. (CCH) P 9643
[lxxii] Supra note 58