Beyond The Veil

Updated: Apr 23 2002, 05:30am hrs
The concept of a limited company came into effect with the historic judgment of Salomon vs Salomon, which gave judicial recognition to a company as a juristic entity distinct from its shareholders. Unlike a partnership firm or a Hindu Undivided Family, a company is a mere aggregate of its constituents. This distinct juristic character confers upon a company special rights and privileges such as capacity of ownership and carrying on business. A company can sue and be sued in its own entity. However, being a legal person and not a natural one, a company cannot claim fundamental rights or bring action for wrongs and torts which can be brought against a living person. Given this principle, the benefits of a corporate structure require certain self discipline and compliances to prevent its abuse.

The recognised exception to this basic rule is that of lifting of the corporate veil, a situation in which the court or any investigating authority has to delve beyond the limited liability structure, to ascertain whether the directors and management of a company have misused the structure to defraud persons dealing with them. In other words, where the sham device of incorporation is used for some illegal or improper purpose, a court is justified in lifting the corporate veil and holding a separate legal entity so created, responsible for the acts committed by another company. The court should not adhere to the Salomon principle blindly to create a situation where it would arise in an unjust result. According to the Supreme Court in the case of DDA vs Skipper Construction Co Pvt Ltd, the corporate veil can be lifted in a situation to expose the actual persons who committed a fraud upon the public from their legal shelter, to fix the liability on the persons actually guilty. Judicial view worldwide is that this practice should be resorted to in matters such as taxation, merger controls, group approach etc.

The Companies Act itself recommends certain situations when the corporate veil can be lifted. Section 45 of the Act provides that if the number of members of the company is reduced below the statutory minimum, then the members become severally liable for the debts of the company contracted during that time. Section 147 (4) makes officers signing any negotiable instrument, where the name of the company is not mentioned in the required manner, personally liable to the holder of such instrument. Section 552 provides for unlimited personal liability of members if in the case of winding up, it appears that the business of the company has been carried out for fraudulent purposes.

Ultimately, the principle of lifting of the veil is justified in the context of the conduct of the parties, the purpose sought to be achieved, and of course the touchstone of public interest. All of which makes it clear that it is the misuse of the concept structure which calls for this action. Recent judgments of the Company Law Board however, has sought to give a totally different interpretation to this concept, which may have the effect of excluding private companies from the regimen of the applicability of the Act. The Act lays down certain requirements of conduct and compliances by companies, public as well as private. These include functions and operations of the board of directors and the shareholders and the manner in which decisions may be passed by the board or the general body for giving effect of the policies and decisions of the company. To quote the most common example: conduct of businesses and transactions have to be approved by shareholders by way of special resolution or general resolution as the case may be.

There is a recent trend in family companies to override these statutory provisions by establishing an independent voting pattern such as concept of affirmative or unanimous voting at different levels. These are provided in the shareholders agreements, which further provide that, as these companies are quasi partnerships in case of contradiction, the provisions of such agreement shall override the articles or any other provision to the contrary.

In the recently decided cases of Nupur Mitra vs Basubani Pvt Ltd and J S Chawla vs Tirathram, the Company Law Board has upheld this proposition that where a company is in the nature of a partnership, then although a private agreement and understanding between the shareholders cannot bind the company, yet in a family arrangement it is possible to pierce the corporate veil to establish that the company is nothing but a family business structured in the form of a company to be owned in managed by all the members, regardless of shareholding pattern. The Board has held in such cases, any action of noncompliance of the provisions of the Act is not an actual violation thereof and can be legally validated.

With due respect, such a view imparts an incorrect interpretation to the concept of piercing the corporate veil which does not contemplate giving protection to noncompliance with the Act. If a group of people have chosen a corporate structure over that of a partnership or a HUF, then the ground rules of the opted for structure have to apply. The exception from complying with statutory obligations of account of being a family business is a cause for alarm as it runs counter to the concept of a corporate structure. Hopefully the Supreme Court will reverse this trend.

Kumkum Sen is a corporate lawyer and a partner in Khaitan & Khaitan, a Delhi law firm