The most fundamental Principle of Company Law is corporate personality. It is on this quintessential and elemental principle that makes a company an entity that is entirely distinct from its shareholders, promoters, directors etc. Thus, when a company is incorporated, a legal entity gets created, which is separate from its members, employees, shareholders, directors, promoters etc., which has led to the concept of ‘corporate veil’. The purpose of establishing this Doctrine was to provide business efficacy and convenience. The main stimulation behind the formation of a corporation or a company is the limited liability which is offered to its shareholders and because of this limited liability, the liability of each shareholder is limited to only what he or she has contributed as shares to the company.
In the Doctrine of ‘Lifting the Corporate Veil’, the law goes behind the mask or veil of incorporation to determine the real person or group of people behind the company. The Courts and Jurists have regarded the concept of ‘lifting the corporate veil’. The Courts according to Gower’s common dictum would lift the veil when the corporate personality of the company is being blatantly being used as a means to commit fraud, improper conduct or where the protection of public interest is of paramount concern or where the sole purpose of forming the company was to evade taxes. The corporation shall be regarded as an association of persons rather than a legal entity when the very same legal entity is used to defeat public convenience, justify wrong or to defend crime. To have clarity in the concept of ‘lifting of corporate veil’, corporate personality of a company is required to be understood. The courts before did not affix any criminal liability of the corporate on the ground that being an artificial personality, they are completely incapable of having any mensrea, but later the courts took an altogether different approach wherein, through judicial pronouncements they held that the corporate segment can be criminally prosecuted.
Separate legal personality of a company
The consequence of attributing a legal personality to a corporation is that it is distinct entity from its members and this 'egal personality' is often described as an artificial person in contrast with a human being, a natural person. This clearly indicates that a corporation is completely capable of enjoying rights and of being subject to certain duties that are not same as borne by its members.
The principle of a corporation having a separate legal entity was firmly established in the landmark cases of Salomon v. Salomon& Co. Ltd. In this case, Salomon was a sole trader, had a flourishing business as a leather merchant, sold his manufacturing business to Salomon& Co. Ltd., a company which he himself had incorporated) in consideration for all but six shares in the company. He received debentures worth 10 thousand pounds. The other subscribers to the memorandum were his wife and five children who each took up one share. The business subsequently collapsed and Salomon made a claim on the basis of the debentures held as a secured creditor. The liquidator on the other hand argued that Salomon could not rank ahead of other creditors on the ground that both the company and Mr. Salomon were one and the same, in other words that the company carried on business on behalf of Salomon.
The House of Lords on appeal subsequently held that Salomon& Co. Ltd. was not a sham, further the debts of the corporation were not the debts of Mr. Salomon because they were two separate legal entities, and that once the artificial person has been created, "it must be treated like any other independent person with its own rights and liabilities appropriate to itself." Since, most of the provisions of Indian Law were borrowed from the English Law, it mostly resembles the English Law. Salomon’s case has been the authority ever since in the decisions of the Doctrine in Indian company cases. The Privy Council in a more recent case of Lee v. Lee’s Air Farming, the Doctrine of separate legal entity of a corporation was further supported wherein it held that Lee, could be an employee of the company as a separate and distinct entity from the company which he controlled, so that Lee’s wife could claim workers’ compensation following her husband’s death. Similarly, the Supreme Court in the case of Tata Engineering Locomotive Co. Ltd v. State of Bihar &Ors.stated that a corporation in law is equivalent to a natural person having a legal entity of its own, which is completely separate from its shareholders. The corporation has its own name and seal, separate assets from its members. The liability of its members extend to only the share capital invested by them, similarly, the creditors of the members would also not have no authority over the assets of the corporation. Gower has summarized the position, and according to him, 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, in India it can be observed that at present, that the courts are somewhat cautious and circumspect in cracking open the veil.
History of the Doctrine of corporate veil
The Doctrine of corporate veil was originated in 1897 with the Salomon case. Since then it is being followed, but during the years, the way the Doctrine of corporate veil is followed has taken different approaches. From 1897to 1966, it was called the period of early experimentation where the courts experimented with different approaches of the Doctrine. The different approaches were tried keeping in view the decision of the House of Lords in Salomon’s case. From 1966 to 1989 was the period where the Rules of the House of Lords in Salomon’s case were changed and the lifting of veil was encouraged. Lord Denning in Littlewoods Mailstores v IRC stated that, "the Doctrine laid down in Salomon’s case has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see, but that is not true. The courts can, and often do, pull off the mask." From 1989 to the present date, the Doctrine of corporate veil lifting began to be disfavored by the courts. The classic case, which started the trend of disapproving the Doctrine is Woolfsan v. Stratheclye Regional Council in which Lord Keith stated that the only situation where a corporate veil could be lifted was, where there are special circumstances indicating that the company is a 'mere facade concealing the true facts.' Thus the English court started to take a very narrow view of the Doctrine and the Judgment of the court of appeal in Adams v Cape Industries Plc. There were only three circumstances in which the corporate veil could be pierced. They were:
- If the court is interpreting a statute or document and the statute itself is ambiguous.This would allow the court to treat a group as a single entity.
- If special circumstance indicate, that it is a mere facade concealing the true facts, the court may lift the veil.
- It is an application of the agency principle. Parent companies and subsidiaries are unlikely to have express agency agreements and it is even difficult to prove an implied agency. Evidence is required that,day to day control was being exercised by the parent company over its subsidiaries.
Approaches adopted by the courts to lift the CORPORATE veil
The courts use the word 'veil' as a metaphor, but it approaches the practice of lifting the veil differently in different cases. There are threea different attitudes which court takes while deciding different cases
PIERCING THE VEIL:
This approach is used by the court to deal with the information, as to who are the shareholders, what is the proportion of their holdings, who are the controllers, and what is their inter-relationship with regard to the control of the company. After getting the information, the veil is pulled down and the company again becomes separate legal entity. The most important case in this regard is the 'Daimler case'.
PENETRATING THE VEIL:
In second category the courts reach through the veil and get hold over the controlling shareholders personally. The purpose of penetrating the veil is to impose responsibility upon the shareholders for the company's acts, and to establish their direct interest in the company's assets. One example of the shareholder’s direct interest is taxation. Other example when veil is penetrated is when there is tendency of a war. In R. v London County Councilwhereby, a local authority refused to renew a cinematography license held by a company incorporated in England, because a substantial majority of its shares were held by German nationals and three out of its six directors were German. The court upheld the refusal, holding that the control or at least the influence which the enemy nationals might exert over the activities of the company, in exhibiting the film was a relevant matter during wartime.
EXTENDING THE VEIL:
A third technique of lifting the veil is by its extension, so that it embraces a bundle of companies. When a group of legal entities is conducting a common activity, so that instead of referring to each one separately, one can regard them all as a single entity, under one extended veil of incorporation. An example of this would be DHN Food Distributors Ltd. v London Borough of Tower Hamlets. In this case, a company claimed compensation for disturbance owing to the expropriation of land, though the land belonged to another company, the shareholders of which were identical to those of the two others. Lord Denning emphasized that: 'This is especially the case when a parent company owns all the shares of the subsidiaries ... these subsidiaries are bound hand and foot to the parent company and must do just what the parent company says ... The three companies should, for present purposes, be treated as one.' It is important to note the different approaches taken by the court as explained above. Its first step was piercing the veil to see the shareholdings of the three companies at stake. It revealed that the shareholders (and directors) of all three were identical.
This is actually a penetration of the veil that leads to the second step by recognizing the direct interest of each of the components in the assets of the enterprise. The third step is the extension of the veil to cover the entire group, seeing it as one comprehensive entity. It was finally held that the companies as a group are entitled to compensation not only for the value of the land but also compensation for disturbance.
Grounds of lifting the corporate veil
As early as Salomon, judgments have shown possible inclinations to exceptions to the separate entity concept. The circumstances under which the Courts may lift the corporate veil may broadly be grouped under the following two heads:
Under Statutory Provision:
When the membership is reduced (Under section 45 of the Companies Act)
- Improper use of Name (Section 147(4))
- Fraudulent conduct (Section 542)
- Failure to refund application money (Section 69(5))
- Misrepresentation in prospectus (Section 62)
- Holding Subsidiary companies (Section 212)
- For facilitating the task of an inspector to investigate the affairs of the company (Section 239)
- Liability for ultra vires acts
- Under judicial interpretations
- Protection of revenue
- Prevention of fraud or improper conduct
- Determination of the enemy character of a company
- Where a company acts as an agent for its shareholders
- In case of economic offences
- Where Company is a sham or cloak
Criminal liability of corporations in india
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 mensrea as they were absolutely incapable of possessing it, which is an essential element for majority of offenses that would result in imprisonment or other penalty. Indian courts held that corporations could not be prosecuted for offenses requiring a mandatory punishment of imprisonment for the simple reason that they could not be imprisoned.
Whether a company could be convicted for an offence where the punishment prescribed by the statute is imprisonment, and fine was still uncertain. This controversy was first addressed in MV Javali v. MahajanBorewell& Co and Ors., 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.
Standard chartered bank case law
This was the landmark case in which the Apex court overruled all other principles that had yet been laid down wherein the company could not be criminally liable for offences. In this case, Standard Chartered Bank was being prosecuted for violation of certain provisions of the Foreign Exchange Regulation Act, 1973. 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 for the penal statutes and went on to deliver complete justice by imposing fine on the corporate establishment. It held that the courts in case of penal statutes must only 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.
The Supreme Court also pointed out that, with regards to criminal liability, the FERA statute does not make any distinction between a natural person and corporations and that according to FERA, corporations are vulnerable to criminal prosecution, and allowing corporations to escape liability based on the difficulty in sentencing would result in grave injustice to the statute. Further, the Code of Criminal Procedure does not encompass any provision for the exemption of corporations from prosecution on the ground that it would be difficult to sentence them in accordance with the statute. The Court however, did not develop its reasoning far enough so as to specifically hold that a corporation is capable of forming mensrea and acting pursuant to it. Nevertheless, the Court held that corporations would be criminally liable for offenses and thus, could be prosecuted and punished, at least with fines.88 Since, many of the offenses, punishable by fines, have mensrea as a prerequisite element of the offense, thus, it can be implied that post Standard Chartered decision, corporations are capable of possessing the requisite mensrea.
Till date, the demonstration of puncturing the corporate shroud stays a standout amongst the most questionable subjects in corporate law. In spite of the fact that specific classifications, for example, extortion, organization, trick or exterior, shamefulness and gathering ventures have been distinguished for being the premise under which the Courts would puncture the corporate cover yet it is of most extreme significance to take note of that these classes are simply rules and in no way, shape or form a long way from being comprehensive
In spite of the fact that the courts have punctured the corporate cover to decide the character of the people behind the commission of offenses, for example, fakes and so on., the courts through legal translation have additionally held that the corporate ought not be dealt with uniquely in contrast to an individual and ought to be kept on a similar balance while settling criminal obligation and henceforth they can be criminally indicted.
By: Navin Kumar Jaggi & Mritunjay Sengar