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Lifting Of Corporate Veil in Execution Proceedings

April 22, 2022
corporate

By Nihit Nagpal and Devika Mehra

Our legal structure regards company as a legal person having its own unique personality. This simply means that it can exercise its own legal rights and can incur legal duties. Despite the existence of a separate legal personality, a Company acts through its human agents (i.e directors, promoters and members) who are responsible for managing the affairs of the company. Although, agents of a Company are its essence through which it acts but its personality is different from them.

 

Peculiarity of a Company lies in the fact that it has a legal personality of its own, separate from its human agents. One concept which separates the liabilities of the Company from its human agents is a Corporate Veil. A veil exists that separates the Company’s rights, duties and liabilities from that of its human agents. The humans work on behalf of the company behind this imaginary curtain which plays an additional role in concealing the faces of its members, the benefit of which is sometimes taken by them to commit illegal activities. When this human agency is driven by the ill intention to dupe the company or its investors and affiliated persons, the concept of lifting of corporate veil arises.

Doctrine of lifting of Corporate Veil

Stemming from Salomon[1] principle, the Corporate Veil is a metaphoric curtain that divides the company’s personality from those who own it and who work under its name. On paper, the personality of the corporation is a Fictio Juris, but when it comes down to reality, the business of this artificial entity is always dealt by natural beings, who are also the recipients of the corporate advantages.

 

This corporate veil bears various perks which cannot be overlooked, it shields the members and the shareholders from the deleterious effects of the ill-will act done in the name of Corporation. The doctrine of corporate veil implies that if any debt is sustained by the Company or if it violates any provision of law, the human agents will not be held responsible for the same.

 

The people in charge or the members perform the work and transactions on behalf of the Company behind this veil but when they acts beyond the scope of memorandum and articles of association or get involved in illegal activities like fraud, this veil is finally lifted in order to determine and punish the wrongdoer of such activity and not let the actual wrongdoer get away under the garb of the veil.

 

When can Corporate Veil be lifted?

It is given that being an artificial person, a Company is incapable of committing any fraudulent act but if the corporate structure is being misused to dodge obligations or to give rise to any criminal activities, then the Courts would be forced to ignore the masquerade of corporate personality and to take a look behind this veil to find the real guilty.[2]

 

The Companies act, 2013 indirectly deals with this doctrine through sections like 251 or 339 which holds shareholders liable for their wrongful acts. Section 216 of the Act gives power to the Central government to appoint the inspectors to investigate the members or owners of the company under shady and suspicious situations. Thereby, implicitly giving them power to make use of the doctrine.

The Judiciary uses this doctrine as a tool to bring down the offender who they feel is using the Company as a shield for his illegal actions and hold him responsible for such an act instead of holding the whole company responsible for the same.

The law around lifting of corporate veil has been crystallised around six principles formulated by Munby, J. in Ben Hashem v. Ali Shayif[3]. The six principles, as found at paras 159-64 of the case are as follows[4]:

  1. Ownership and control of a company were not enough to justify piercing the corporate veil;
  2. The court cannot pierce the corporate veil, even in the absence of third-party interests in the company, merely because it is thought to be necessary in the interests of justice;
  3. The corporate veil can be pierced only if there is some impropriety;
  4. The impropriety in question must be linked to the use of the company structure to avoid or conceal liability;
  5. To justify piercing the corporate veil, there must be both control of the company by the wrongdoer(s) and impropriety, that is use or misuse of the company by them as a device or facade to conceal their wrongdoing; and
  6. The company may be a “façade” even though it was not originally incorporated with any deceptive intent, provided that it is being used for the purpose of deception at the time of the relevant transactions. The court would, however, pierce the corporate veil only so far as it was necessary in order to provide a remedy for the particular wrong which those controlling the company had done.

In further landmark judgments[5] [6] it was held that there must be cogent evidence of the fact that the Directors are guilty of fraud by alleged siphoning off of funds to frustrate execution of decree.

The Courts time and again have been lifting this veil based on the circumstances and facts of each case. In the case of Farmosa Plastic Corporation Ltd. V. Ashok Chauhan[7] a foreign decree was passed to be implemented in India. The Delhi High Court held that the Courts are at discretion to apply the power of lifting of veil in execution proceeding. The Hon’ble Delhi Court added that the Courts are at liberty to lift the cloaks of the Corporations where they are involved in defrauding others. The decision has been reaffirmed in Sai Sounds Private limited V Kiran Contractors PVT. LTD[8].

 

In Bhatia Industries V. Asian Natural Resources & Anr[9], an arbitral award was decided in favor of a foreign entity and against the Indian entity in an international arbitration proceeding. The award holder i.e. the foreign entity instituted execution proceeding before the Bombay High Court challenging that the Indian entity i.e. judgement debtor belongs to the larger conglomerate of companies incorporated in India and  is involved in fraudulently siphoning off its funds to prevent the execution of the foreign award. In view thereof, the foreign entity (award holder) pleaded to the Court to lift the corporate cloak of the Judgement debtor.

 

The Court in the instant case stated that the corporate veil in the execution proceeding could be lifted when it is proved that the companies are in fact a single economic entity and thus, by referring to the facts of the case held that the judgment debtor and its Indian group are single economic entity who are trying to defeat the execution of the award.

 

A different stance was taken by The Bombay High Court in Mitsui OSK Lines vs Orient Ship agency[10]. In this case a foreign award was passed in 2009 which was also recognized as a decree by the Bombay High Court in 2014. However, in 2019 the award holder sought permission of the court to amend execution proceeding to hold certain associate companies of the judgement debtor personally liable. The Hon’ble Bombay High Court in this case abstained from using this doctrine on the ground that the third party entities were not the part of the original suit and thus, can only be held liable through a separate substantial suit. The Court distinguished the present case from Bhatia Industries V. Asian Natural Resources & Anr. by pointing that the award holder in Bhatia case was implicating the companies who were associated to each other and were a part of a single entity whereas in the instant case of Mitushi, the award holder was seeking the leave of the Court to hold third parties personally liable who were originally not the part of the suit.

Conclusion:

The Courts ad-nauseam have stated that the doctrine of corporate veil will only apply when it is visible that the company is a smokescreen intentionally established for commission of offences and for escaping the liability of such acts under the disguise of the ‘company’. Through the application of this doctrine in a cautious manner, the Courts are lifting the veil to put an end to the shams committed behind the cloak of ‘corporate personality.’ Different cases introduce new set of opinions of different judges which more than often expand the horizon of the doctrine of lifting of corporate veil.

With the increase in scams by the Corporations the Courts with a view to cease them lift the corporate purdah during the execution proceeding in order to ensure that the faith of the business communities do not destabilize from the judiciary. However, yet a new set of law is required to deal with offences committed under the shield of corporate personality.

[1] Salomon v A Salomon and Co Ltd [1897] AC 22

[2]  Delhi Development Authority v Skipper Construction (1996) 4 SCC 622

[3] Ben Hashem v. Ali Shayif, 2008 EWHC 2380 (Fam)

[4] Rakesh Mahajan vs. State of U.P. & Ors. [December 04, 2019]

[5] Shri Ambica Mills Ltd. Re [1986] 59 Compcas 368 (Guj.)

[6] VTB Capital vs Nutritek

[7] Review Petition No. 506/2011 in Execution Petition No. 38/1998

[8] CR No. 3991 of 2013

[9] [2017] 201 CompCas 46 (Bom)

[10] 2020 SCC OnLine Bom 217.

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