The chief advantage of incorporation from which all others follow is the separate legal entity of the company. In reality, however, the business of the legal person is always carried on by, and for the benefit of, some individuals. In the ultimate analysis, some human beings are the real beneficiaries of the corporate advantages, “for a while, by fiction of law, a corporation is a distinct entity, yet in reality it is an association of persons who are in fact the beneficial owners of all the corporate property” And what the Salomon case decides is that “in questions of property and capacity, of acts done and rights acquired or, liabilities assumed thereby … the personalities of the natural persons who are the company’s corporators is to be ignored”
This theory of corporate entity is indeed the basic principle on which the whole law of corporations is based. Instances are not few in which the courts have successfully resisted the temptation to break through the corporate veil. A landlady’s bid to regain tenanted premises for self-business could not succeed as the business was in the name of her company. The Supreme Court did not allow a shareholder to sue for the violation of the fundamental rights of his company. Where a company acquires a majority of the shares and also the assets of another company, that does not extinguish the debt of one to the other. The shareholders and creditors of a dissolved company cannot maintain an action for the recovery of its leftover assets. A managing director cannot be compelled in his personal capacity to produce books of which he has custody in official capacity.
In Lee v Lee’s Air Farming Ltd, Lee incorporated a company of which he was the managing director. In that capacity he appointed himself as a pilot of the company. While on the business of the company he was lost in a flying accident. His widow recovered compensation under the Workmen’s Compensation Act. “In effect the magic of corporate personality enabled him to be master and servant at the same time.”66 Where the total number of directors and shareholders consent to the misuse of the company’s money, they can be prosecuted for theft because the consent of the whole number may not be the consent of the company.
But the theory cannot be pushed to unnatural limits. Circumstances must occur which compel the courts to identify a company with its members. “There are situations where the court will lift the veil of incorporation in order to examine the ‘realities’ which lay behind. Sometimes this is expressly authorised by statute … and sometimes the court will lift of its own volition.
In State of Karnataka v Selvi J. Jayalalitha, the Supreme Court emphasised that company is a separate entity from the members subject to the exception when corporate entity is a mere cloak or sham used to misdirect shareholders and authorities. A company cannot, for example, be convicted of conspiring with its sole director. In the circumstances, the court said: “where the sole responsible person in the company is the defendant himself, it would not be right to say that there were two persons or two minds.”
The corporate veil is said to be lifted when the court ignores the company and concerns itself directly with the members or managers. “It is impossible to ascertain the factors which operate to break down the corporate insulation.” The matter is largely in the discretion of the courts and will depend upon “the underlying social, economic and moral factors as they operate in and through the corporation”?? All that can be said is “that adherence to the Salomon principle will not be doggedly followed where this would cause an unjust result” Corporate veil can be lifted, not only in the case of holding-subsidiary company or in cases of tax evasion, but also for execution proceedings. The other instances where the doctrine is to be applied are as follows:
- Partnership of two separate corporate entities with one acting as alter ego.
- Where actual control in the subsidiary company lies with the parent company.
- Where the name of the company is just a sham.
- Where two companies are interlinked.
The following grounds have become well-established where the doctrine is to be applied.
- Determination of character– Occasionally it becomes necessary to A ermine the character of a company, for example, to see whether to determine in such a case, the courts may in their discretion examine the character of persons in real control of the corporate affairs.
Daimler Co Li v Continental Tyre & Rubber Co Ltd’ is illustrative:
A company was incorporated in England for the purpose of selling tyres manufactured in Germany by a German company. The German company held the bulk of the shares in the English company. The holders of the remaining shares (except one) and all the directors were Germans, resident in Germany. Thus the real control of the English company was in German hands. During the World War I the English company commenced an action to recover a trade debt. And the question was whether the company had become an enemy company and should, therefore, be barred from maintaining the action.
The House of Lords laid down that a company incorporated in the UK is a legal entity, a creation of law with the status and capacity which the law confers. It is not a natural person with mind or conscience. It can be neither loyal nor disloyal. It can be neither friend nor enemy. But it may assume an enemy character when persons in de facto control of its affairs are residents in any enemy country or, wherever resident, are acting under the control of enemies. Accordingly, the company was not allowed to proceed with the action. If the action had been allowed the company would have been used as a machinery by which the purpose of giving money to the enemy would be accomplished. That would be monstrous and against public policy. But where there is no such danger to public interest, the courts may refuse to tear open the corporate veil.
2. For benefit of revenue – “The court has the power to disregard corporate entity if it is used for tax evasion or to circumvent tax obligation. “A clear illustration is in the case of Dinshaw Maneckjee Petit, re 1927-
The assessee was a wealthy man enjoying huge dividend and interest income. He formed four private companies and agreed with each to hold a block of investment as an agent for it. Income received was credited in the accounts of the company but the company handed back the amount to him as a pretended loan. This way he divided his income into four parts in a bid to reduce his tax liability.
But it was held that “the company was formed by the assessee purely and simply as a means of avoiding super-tax and the company was nothing more than the assessee himself. It did no business, but was created simply as a legal entity to ostensibly receive the dividends and interests and to hand them over to the assessee as pretended loans”.
3. Fraud or improper conduct.-The corporate entity is wholly incapable of being strained to an illegal or fraudulent purpose. The courts will refuse to uphold the separate existence of the company where it is formed to defeat or circumvent law, to defraud creditors or to avoid legal obligations. Corporate veil can be lifted in cases of fraud, misrepresentation, diversion of funds.?
One clear illustration is Gilford Motor Co Ltd v Horne.
Horne was appointed as a managing director of the plaintiff company on the condition that “he shall not at any time while he shall hold the office of a managing director or afterwards, solicit or entice away the customers of the company”. His employment was determined under an agreement. Shortly afterwards he opened a business in the name of a company which solicited the plaintiff’s customers. It was held that “the company was a mere cloak or sham for the purpose of enabling the defendant to commit a breach of his covenant against solicitation. Evidence as to the formation of the company and as to the position of its shareholders and directors leads to that inference. The defendant company was a mere channel used by the defendant Horne for the purpose of enabling him, for his own benefit, to obtain the advantage of the customers of the plaintiff company, and that the defendant company ought to be restrained as well as the defendant Horne”
Where a person borrowed money from a company and invested it in shares of three different companies in all of which he and his son were the only members, the lending company was permitted to attach the assets of such companies as they were created only to hoodwink the lending company as was held in the case of PNB Finance Ltd vs Shital Prasad Jain 1981.
4. Government companies-A company may sometimes be regarded as an agent or trustee of its members or of another company and may, there-fore, be deemed to have lost its individuality in favour of its principal. In India this question has frequently arisen in connection with Government companies. A large number of private companies for commercial purposes have been registered under the Companies Act with the President and a few other officers as the shareholders. The obvious advantage of forming a government company is that it gives the activities of the State “a little of the freedom which was enjoyed by private corporations and [the Government] escaped the rules and principles which hampered action when it was done by a government department instead of a government corporation. In other words, it gave the Government some of the robes of the individual” And in order to assure this freedom the Supreme Court has reiterated in a number of cases that a government company is not a department or an extension of the State. It is not an agent of the State. Accordingly, its employees are not civil servants and prerogative writs cannot issue against it. In one of these cases, the court remarked.