An Artificial Person behind the Bars

An Artificial Person behind the Bars

This Article is written by Pushti Dublish, pursuing B.A. LL.B. (Hons.) from Galgotias University.

INTRODUCTION

Have you heard this well-known quote “Don’t judge a book by its cover”? In this corporate legal world, whenever a company is incorporated it is considered as a separate legal entity that it is different from the persons who manage its affairs. It is the fundamental principle on which a company is established which distinguishes it from its members, shareholders, promoters, directors, etc. This characteristic of the legal entity gives rise to the concept of lifting the corporate veil. A company is an artificial person i.e. created by law and like a natural person; a company can purchase or sell property in its name and can enter into a contract. Due to its corporate personality, it requires the human agency to act on its behalf.
Now, this concept of lifting the corporate veil emerged because the human agency is committing some fraudulent activities under its name. In this doctrine of lifting the corporate veil, what law does is it goes behind the veil that who is the main offender or the person behind the company. This article will give you insight about the separate legal entity and its exception subsequently the main part i.e. the Doctrine of Lifting the Corporate veil. It further deals with what approach the courts adopt while dealing with such cases and how the corporate can be held criminally liable.

CORPORATE PERSONALITY – SEPARATE LEGAL ENTITY

This attribute of a legal personality i.e. an artificial person defines that in the eyes of law, the company enjoys the certain rights and duties which are different from rights of the natural person who are performing the affairs of the company. This lays down the principle of a separate legal entity.

Relevant Case Laws:

  • This doctrine was then supported in Lee v. Lee’s Air Farming,[2] where the Privy Council held that the Lee though owned the company but he could be an employee of the company and his wife’s claim for the workmen compensation is valid on the ground that he was a distinct entity from the company.
  • The principle of separate legal entity was established in the landmark case of Salomon v. Salomon & Co. Ltd., [1] in this case, Aron Salomon, a sole proprietor, sold his business to the company he incorporated in the name of Salomon & Co. Ltd. in consideration for all but six shares in the company and received debentures worth 10,000 pounds. The six shares were being given to his wife and five children. Unfortunately, the business gets collapsed. Salomon claimed the debentures held as a secured creditor. On realizing the assets and liabilities of the Company, the liquidator comes to the figures that the liabilities of the company were 16,000 pounds and the assets were 6,000 pounds. Salomon took the assets and paid himself first. The other creditors and the liquidator argued that he couldn’t rank himself ahead of the other creditors on the ground that the company & Mr. Salomon were one and same and he is liable to pay the other creditors. HELD: The matter went on appeal to the House of Lords and held that it was not a sham; the debts of the corporation are not the debts of Mr. Salomon because they are two different legal entities and once the artificial person has been created, it must be treated as an independent person with its appropriated rights and obligations.
  • Likewise, in Tata Engineering Locomotive Co. Ltd v. State of Bihar & Ors.,[3] the Supreme Court stated that like a natural person, a corporation has a separate entity from its shareholders. A company have its common seal and name under which it can buy or sell the property. The liability of members and shareholders are limited up to the extent of their share in the company. This rule is also equivalent to the creditors that they don’t have the authority over the assets of the corporation.

According to Gower, the Courts have only interpreted the statutes as “cracking open the corporate shell” when compelled to do so by the clear words of the statute. Therefore, Indian Courts are extra cautious while lifting the corporate veil.[4]

EXCEPTIONS

The exception to this principle has been established by the judgments. Lord Halsbury recognized the concept of a separate entity and provided that there was “no fraud and no agency and if the company was a real one and not a fiction or myth.”

There are two reasons why the exception to this principle exists:-

  1. A corporation cannot be treated as a natural person because the courts would be unable to find the mens rea of the company as it is not capable to commit a crime,only the intention of the real person like directors, members, etc can be determined.
  2. The stringent recognition of the rule will also fail or mislead the outcome if the interested parties can hide under the limited liability attribute.[5]

LIFTING THE CORPORATE VEIL

The lifting the corporate veil means that neglecting the corporate personality, and looking behind the cover that who is the actual offender who is performing the fraudulent acts under the shade of the company name and deceitfully taking benefit of the legal personality. And if this happens, then the corporate veil is lifted by the courts.
As per Black’s Law Dictionary, piercing of corporate veil means a judicial act of imposing liabilities on the directors, corporate officers and the shareholders. [6]
The entire company law is based on the fundamental principle of a separate legal entity. This corporate personality is prima facie significant and needs to be respected. But there are a plethora of cases where this personality is misused and the human agency has deliberately misused this attribute and performs a variety of fraudulent activities and subsequently the court has to raise the veil to determine who is taking the benefit from this principle conferred by the law.
Therefore, this lifting the corporate veil is as important as this attribute as it plays a role of checks on the separate entity and the investors are not held liable beyond their investment in the corporation. It is equally essential to both the corporation and the shareholders.

COURTS APPROACH IN LIFTING THE VEIL

The word ‘veil’ is used as a metaphor by the court but its application depends upon the case. The court uses four altitudes while deciding the cases of lifting the corporate veil.[7] They are:-

  1. Peeping behind the veil
  2. Penetrating the veil
  3. Extending the veil
  4. Ignoring the veil

Peeping behind the veil:

This approach is adopted when the court deals with the certain information like who are the investors or shareholders, how much shares they hold, who controls the company, their inter-relationship with regards to the control of the company. After the court identifies the information, it pulls down the veil and the company attain its natural character.

This approach was adopted in Daimler case [8] where the question raised was whether the defendant (a British company) should pay the plaintiff (a British registered company) even if all the directors and the shareholders were all Germans. The decision by the lower court stood in favour of the plaintiff as the declaration against Trading with the Enemy Act, 1914 states that the enemy character is attached to only those companies which are incorporated in the enemy country. The House of Lords accepted the appeal on the ground i.e. to identify the character of the company.

Penetrating the veil:

The courts adopt this approach when they need to personally get hold of the controlling shareholders. The whole objective is to inflict responsibility on the shareholders for the company’s acts and to establish the direct interest of shareholders in the company’s assets. The veil is penetrated when there is a tendency of war. Taxation is one of the examples of shareholders’ direct interest.

Extending the veil:

This technique is done by its extension so that it holds a collection of companies. When a common activity is conducted by a group of companies then they are regarded as a small entity instead of referring them separately under this type of veil.

This was observed in DHN Food Distributors Ltd. v. London Borough of Tower Hamlets,[9] where the plaintiff claimed compensation for the disturbance caused in confiscating the land belonged to another company but the shareholders of the two other companies were identical.
It was held that the companies on a whole are entitled to compensation both for the value of the land and the disturbance caused.

Ignoring the veil:

This approach is adopted when the companies are incorporated no for performing commercial purpose but to defeat or defraud its investors, creditors, or to avoid laws. Hence, this is not only against the existing legal system but also make the court powerless to issue any order against them.
Sometimes the court’s step in ignoring the company when the other party is affected would lead to injustice. Therefore court should opt for a remedy which would nullify the action.

CRIMINAL LIABILITY OF CORPORATIONS IN INDIA

Pre-Standard Chartered Bank Case Law

Previously, the Indian courts assumed that the corporation cannot be held criminally liable for a most of the offences as the important element of a crime i.e. mens rea cannot be determined in case of a corporation and also it is impossible to put a company behind the bars.

This was first observed in M V Javali v. Mahajan Borewell & Co. & Ors.[10] where the Apex Court held that mandatory fine and imprisonment must be imposed where it can be imposed but in case it can’t be imposed then fine will be the only punishment.

Standard Bank Case Law
In this landmark case, all the previously established principles with regards to the criminal liability of the corporation were overruled. The Standard Chartered Bank was being charged for the violation of the Foreign Exchange Regulation Act, 1973. It was held that the company could be punished with fine irrespective of the mandatory imprisonment given under the respective statute.[11]
The court didn’t go by the plain meaning of the statute but try to deliver justice with the imposition of fines on the companies.
The Supreme Court pointed out in Tolaram Relumal and Anr. v. The State of Bombay [12] that FERA statute does not make any difference between a natural person and the corporation. According to FERA, the corporations are defenseless to criminal prosecution and the difficulty in sentencing the corporations would help them escape the liability and hence leads to grave injustice to the statute. Even the Code Of Criminal Procedure doesn’t make any provision which would exempt the corporations from the prosecution based on the complexity in sentencing the companies. The court defined that the corporation can be held criminally liable and be punished for fines at least but also stated that as there are some offences which have mens rea as a prerequisite element, therefore, the mens rea of corporation existed in that offence is to be assumed.
Post-Standard Chartered Bank Case Law
In Iridium India Telecom Ltd. V. Motorola incorporated and Ors.,[13] The Supreme Court held that a company can be held liable under common law as well as for mens rea. Based on the standard chartered bank case, the court held that criminal liability can arise for a company when the offence is committed in the aspect of the business.
In C.B.I v. Blue Sky Tie Up Ltd. & Ors.,[14] the court held that the company can be held criminally liable.

CONCLUSION

This doctrine of lifting the corporate veil is necessary for protecting the corporate personality. It protects the corporation from the sham and works for the best interest of the shareholders. Court has followed different approaches in a different case. They have also settled the controversial issue by Standard Chartered Bank Case law and can determine the criminal liability of the corporation. Lifting the corporate veil should not be applied rigidly otherwise it would defeat its objective.

References

  1. Solomon v. Solomon & Co. Ltd (1897) A.C. 22.
  2. Lee v. Lee’s Air Farming (1961) A.C. 12.
  3. Tata Engineering Locomotive Co. Ltd v. State of Bihar & Ors. AIR 1965 SC 40.
  4. Gower and Davies, Principles of Modern Company Law, 8th ed. Sweet and Maxwell,
    London, 2008.
  5. An investigation of cases where this exception has been relied upon indicates that the
    decisions made are consistent with the courts’ desire to ensure that no injustice results
    from the existence of the corporate form. H.L. Bolton (Engineering) v. T.J. Graham &
    Sons Ltd. [1956] 3 All E.R. 624, Whitford Beach Pty. Ltd. v. FCT (1982) 150 C.L.R.
    355, Re Chisum Services Pty. Ltd. (1982) 1 A.C.L.C. 292 and Daimler Company Ltd. v.
    Continental Rubber and Tyre Co. (Great Britain) Ltd. [1916] 2 A.C. 307.
  6. Black’s Law Dictionary 1168 (7th ed. 1999).
  7. Daimler company ltd. v Continental Tyre and Rubber Company (Great Britain), [1916]
    2 AC 307.
  8. DHN Food Distributors Ltd. v London Borough of Tower Hamlets [1976] 1 WLR 852.
  9. MV Javali v. Mahajan Borewell & Co and Ors., AIR 1997 SC 3964.
  10. Standard Chartered Bank and Ors. v. Directorate of Enforcement, (2005) 4 SCC 530.
  11. Tolaram Relumal and Anr. v. The State of Bombay, 1955 (1) SCR 158.
  12. Iridium India Telecom Ltd. v. Motorola Incorporated and Ors, AIR 2011 SC 20.
  13. CBI v. M/s Blue-Sky Tie-up Ltd and Ors., (2011) 15 SCC 144.
  14. DEVANSHI BRAHMBHATT, THE DOCTRINE OF LIFTING THE CORPORATE VEIL AND THE JUDICIAL
    TREND IN DETERMINING THE CRIMINAL LIABILITY OF
    CORPORATIONS,http://jcil.lsyndicate.com/wp-content/uploads/2017/06/Trisha-Devanshi-
    corporate-veil.pdf.
  15. Image Credits: https://www.google.com/thefactfactor.com