Concept of Corporate Personality
A company is a legal person, since in the eyes of law it is capable of having legal rights and obligations just like a natural person. Like any other person it can acquire and own property, transfer property, enter into contracts and sue and be sued in its own name. Being a legal person, a company has a separate legal entity, a personality distinct from its members or shareholders.
The concept of separate entity of a company was established in the celebrated case of Salomon Vs Salomon & Co. Ltd. The facts of the case are that one Salomon, a boot manufacturer, formed a company with himself, his wife, and daughter and four sons as the sole shareholders. Salomon took 20,000 shares of £1 each, debentures worth £10,000 secured by the assets of the company and the balance in cash. His wife, daughter and four sons took the company and the balance in cash. His wife, daughter and four sons took up one £1 share each. The personal business assets of Salomon were taken over by the company for £38,782. The company contracted debts and went into liquidation. The unsecured creditors claimed payment of their dues before the secured debentures held by Salomon on the ground that Salomon and the company were one and same person and the company was a mere ‘alias’ or agent for Salomon. It was held by the House of Lords that the company, being a legal person and having existence quite distinct from its members, could not be regarded as an agent or ‘alias’ for Salomon. As such, Salomon being a secured creditor of the company is entitled to payment out of the assets of the company in priority to the unsecured creditors.
In the words of McNaghten, L.J:
“The Company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustees for them. Nor are the subscribers, as members, liable, in any shape or form, except to the extent and in the manner provided by the Act.”
Lifting or Piercing the Corporate Veil
Ordinarily, the Courts recognise the separate legal entity of the company and consider themselves bound by the principle laid down in the case of Salomon Vs Salomon & Co. Ltd. But in reality there is no such separation between the economic interested of the company and its members. In exceptional cases, the Courts may disregard the concept of corporate entity to look at the persons behind the company. They may lift the corporate veil to probe into the economic realities behind the scene. This is known as the ‘lifting or piercing the corporate veil’.
In general the Courts have made a departure from the principle of corporate entity when there was reason to suspect that the veil of corporate personality had been used to conceal fraudulent or improper conduct or for doing things against public policy or public interest. Lifting of the corporate veil may also become necessary in cases where the directors or members of a company are held personally liable for violation of statutory provisions under the Companies Act.
Some of the exceptional cases necessitating the lifting of the corporate veil may briefly be indicated below:
- In the Interest of Revenue: Where it appears that a company has been formed or is being used for the only purpose of evading taxes or for avoiding tax liability, the Courts may ignore the separate entity of the company and lift the veil to look into the persons responsible for tax evasion.
- Avoidance of Welfare Legislation: Where it appears that the company has used the ‘veil of incorporation’ as a means of avoiding social welfare legislation, it is the duty of the Court to lift the corporate veil and discover the true state of affairs.
- For Checking Fraud or Improper Conduct: Where it appears that the company has been formed for some fraudulent purpose or to conceal the real identity of the owners, the Courts will lift the corporate veil to find out the real owners of the company.
- Against Public Policy: Where the principle of separate entity conflicts with public policy the Court may lift the corporate veil in defence of the public policy.
- Avoidance of Legal Obligation: The Court will also disregard the legal personality of a company where the corporate veil is being used to avoid legal obligation.
- Under Companies Act, 1956: The following instances necessitate lifting of corporate veil to identify the persons responsible for such acts:
- Reduction in membership below the statutory minimum.
- Fraudulent conduct of business.
- Failure to refund application money.
- Contracts made in personal names of directors.
- Mis-statements in Prospectus.
- Ultra vires acts.
Credit: Business Law-CU