TAMIL NADU NATIONAL LAW SCHOOL

A PROJECT SUBMITTED ON;

A STUDY ON LIFTING OF CORPORATE VEIL IN CASE OF ONE PERSON

COMPANY

IN COMPLIANCE TO PARTIAL FULFILLMENT OF THE MARKING SCHEME, FOR

TRIMESTER VII OF 2017, IN THE SUBJECT OF CORPORATE LAW

SUBMITTED TO FACULTY:

Mr. M.S. KAARMUKILAN

FOR EVALUATION

SUBMITTED BY:

MOHAMED FARVACE

B.A L.L.B (HONS.)

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 INDEX

INTRODUCTION

MEANING

STATUTORY PROVISIONS

JUDICIAL GROUNDS

ONE PERSON COMPANY AND LIFTING OF CORPORATE VEIL

CASE LAW RELATED TO ONE PERSON COMPANY AND LIFTING OF

CORPORATE VEIL

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 STUDY OF LIFTING OF CORPORATE VEIL IN CASE OF ONE PERSON
COMPANY

INTRODUCTION

The landmark judgment of Salomon v. Salomon and Co. Ltd. recognised the principle
of separate legal entity of company which says that a company has a separate existence from
its members. This concept thus protects the shareholders from being personally liable for the
companys wrong and its obligations. In other words, unlike a partnership, the liability of
members of the company is limited to the extent of capital contributed by them. This means
that whenever any wrong is committed by the company, then its members cannot be held
liable for those wrongs. The Supreme Court in the case of Tata Engineering Locomotive Co.
Ltd. v. State of Bihar and others held that the corporation is a natural person and has its own
existence. The entity of member is entirely distinct from its members; has its own name and
seal; It assets are separate from its members, and similarly the liability of its shareholders is
limited to the amount of capital invested by them. However, the truth is that that being an
artificial person, the company is not capable of doing any act itself. The business is always
carried on by individuals. In such cases, the courts lift this corporate veil of the company to
identify the individuals who are actually guilty. The reason behind it is that no individual can
misuse the veil of the company to hide his own wrongs. This is known as the lifting of the
corporate veil or piercing the corporate veil.1

MEANING OF LIFTING OF CORPORATE VEIL

Piercing the corporate veil is one of the most widely used concepts to determine when can the
shareholders of the company be liable for the obligations of the corporations. This concept
operates as a check on the principle where shareholders can be held liable only to the extent
of capital contributed by them. Piercing the corporate veil means disregarding the corporate
personality and looking for the real person who is in the control of the company. 2 In other
words, where the shareholders take the corporate personality of the company as a means to
commit fraudulent acts, then the court will break through the corporate shell and apply the

1
Guide to Companies Act, 17th edn 2010, part 1, A. Ramaiya
2
Gower and Davies, Principles of Modern Company Law, 8th ed. Sweet and Maxwell, London, 2008.

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principle of lifting or piercing through the corporate veil. In United States V. Milwaukee
Refrigerator Co., it was observed that-

A corporation is considered to have a separate legal entity as a general rulebut when the
notion of legal entity is used to defeat public convenience, justify wrong, protect fraud or
defend crime, the law will regard the corporation as an association of persons.

In Life Insurance Corporation of India v. Escorts Limited and Others[1], the Supreme Court
laid down two major instances when the corporate veil is lifted. These are

1. Statutory provisions
2. Judicial grounds3

STATUTORY PROVISIONS

Officer in Default (Section 5 of the Act) This Section talks about the liability of officer in
default that is those individuals who are involved in wrongful or illegal acts are liable in
respect of the offences committed by them. Thus, this section talks about the joint and several
liability of the members. The term officer in default includes a managing director or a
whole-time director.4

Reduction of Membership (Section 45 of the Act) A public company requires at least 7

members for its formation and a private company requires at least two members (Section 3 of
the Act). However when a company has been formed without complying with this minimum
requirement and continues to carry on its business, then each member who knows such fact is
individually liable for any debts contracted by the company during that time.

Improper use of Name (Section 147 of the Act) Sub-section 4 of Section 147 of the Act
provides the liability of the officer who signs Bill of Exchange, Hundi, Promissory note,
cheque under the improper name of the company. Such officer shall be to the holder of such

3
Solomon v. Solomon & Co. [1897] A.C. 22, HL
4
Macaura v. Northern Assurance Co. Ltd [1925] A.C. 619

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Bill of Exchange, hundi, promissory note or cheque as the case may be; unless it is duly paid
by the company.5

Fraudulent conduct (Section 542 of the Act) If at the time of termination of the
corporation, it is found that the activities of the company were carried to deceive the investors
of the company then the individuals who had knowledge of such business would be
personally liable for any loss caused to such investors as the court may direct.

Failure to refund application money (Section 69 of the Act) If the company fails to repay
the application money to the applicants who were not allotted the shares within 130 days
from the date of issue of the prospectus, then the directors of a company are jointly and
severally liable to repay the application money with interest. However, this wont in
any effect the continuance of the company and its separate existence.

JUDICIAL GROUNDS

Apart from the statutory provisions, the courts in India on its own discretion also lift the
corporate veil on certain grounds. Some of the cases in respect of this are-

FRAUD OR IMPROPER CONDUCT the most common ground when the courts lift the
corporate veil is when the members of the company are indulged in fraudulent acts. The
intention behind it is to find the real interests of the members. In such cases, the members
cannot use Salomon principle to escape from the liability. In one of the leading cases of Shri
Ambica Mills Ltd., Re, [2] the court held that the corporate veil of the company can be lifted in
cases of criminal acts of fraud by officers of a company. Similarly, the court pierced the
corporate veil in the case of VTB Capital v. Nutritek and held the directors personally liable
for obtaining loan fraudulently.6

Tax Evasion Sometimes, the corporate veil is used for the purpose of tax evasion or in order
to avoid any kind of tax obligation. It is not possible for the legislature to fill all the gaps in
the law and thus it is important for the judiciary to interfere. In such cases, the courts lift the
veil of the company to find out the real state of affairs of the company. The leading case

5
Shagun Singh, Lifting the Corporate Veil with reference to leading cases, available at
http://artismc.com/index.php/blogs/view/55/221/
6
Ibid

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of Vodafone[4] was an example of the corporate structure formed to evade the taxes. The apex
court in this case observed that Once the transaction is shown to be fraudulent, sham,
circuitous or a device designed to defeat the interests of the shareholders, investors, parties to
the contract and also for tax evasion, the Court can always lift the corporate veil and examine
the substance of the transaction. The Court, in this case, entitled the Income Tax Office to
pierce the corporate veil of the company.

Company as an Agent In every case where a company is acting as an agent for its
shareholders, in such cases the principle of vicarious liability is applied, and the shareholders
will be responsible for the acts of the company. The court in such cases would look at the
facts of the cases to determine whether the company is acting an agent for its members or not.
This can be inferred either from the agreement where it has been expressly mentioned or can
be implied from the circumstances of each case.7

ONE PERSON COMPANY AND LIFTING OF CORPORATE VEIL

One Person Company (OPC) came up in the Companies Act, 2013. Section 2(62) of the Act
defines One Person Company as a company which has only one person as a member. This
implies the entire share capital is held by one person, and he is the only director of the
company. The question that persists w.r.t. such a company is that whether an OPC is same as
a sole proprietorship concern and whether the principle of separate corporate personality is
applicable on such a company.8

When the Court of Law is of the view that the company is just a bubble or has been created to
evade the revenue department or otherwise to create fraud, the court may disregard the
separate corporate personality principle of the company and lift the corporate veil flowing
between the company and its owners. So does that imply that the corporate veil would get
automatically lifted when a question of liability arises despite that the OPC is a limited
liability company. It appears that the answer to this question must be in negative. 9 The
corporate veil is lifted by courts where there is evidence showing the company was used to

7
Supra 1
8
Supra 2
9
Thiyagarajan, T. Sivanathan; Corporate Criminal-concept, available at http://www.manupatra.com/Articles
/artlist.asp?s=Corporate/Commercial

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commit fraud or wrong that injured the party seeking to pierce the veil, or to prevent fraud
or improper conduct. Corporate veil is also lifted where the company is used as a device or
faade to conceal the true facts, thereby avoiding or concealing any liability of individual in
control of the company.10

To conclude there is a limited principle of English Law which applies when a person is under
an existing legal obligation or liability or subject to an existing legal restriction which he
deliberately evades or whose enforcement he deliberately frustrates by interposing a company
under his control. The court may then pierce the corporate veil for the purpose, and only for
the purpose, of depriving the company or its controller of the advantage that they would
otherwise have obtained by the companys separate legal personality.

And as far as the property of the OPC is concerned, i.e. whether the OPCs property is Sole
shareholders property it has been generally opined that although a sole shareholders
shareholding might provide the key whereby to unlock the companys assets, the principle of
corporate personality precluded treating those assets as substantially the same as the
shareholding. Further, even if the Court is persuaded to lift the corporate veil, it is not the
negation of the Separate Corporate Personality principle, it is a limited jurisdiction, very
uncommonly exercised; and even if the court is persuaded to treat the assets of the company
for some default or breach of its owner those assets remain in the separate beneficial
ownership of the company.11

Thus an OPC is a company incorporated under the Companies Act; and although it is entire
share capital is held by one person, that does not detract from the legal status of the OPC as
an incorporated body having a distinct corporate entity and corporate personality. It is a body
corporate by the name contained in the memorandum, capable of exercising all the functions
of an incorporated company under this Act and having perpetual succession with power to
acquire, hold and dispose of property, both movable and immovable, tangible and intangible,
to contract and to sue and be sued, by the said name. Accordingly, the companys assets are

10
Supra 1
11
ibid

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the companys assets and not the assets of the person who owns all the shares of the
company.12

THE ASSESSMENT OF THE LIMITED LIABILITY DOCTRINE

Historically, before recognising the limited liability, merchants sought methods of

minimising their risk. One of the ways adopted was to share the risk between
partners, another was to offer creditors a high return in case the company flourishes and
prospers and not to recompense creditors in the situation that the company fails, also insuring
against the risk in case of loss.The Limited Liability Act 1855 introduced the limited liability
to become a legitimate feature of companies as far as English Law is concerned. But what do
we mean by limited liability? What does this concept offer to the business world?

Limited liability is said to be a distinction feature of corporate law. It means that in the
situation that the company is unable to pay its debts, members of the company will not have
to contribute towards paying the company debts out of their own private funds, they are only
liable to contribute to the amount they have paid or promised to pay for their shares. This
concept is important to public companies entrepreneurs who needed to raise capital for large
scale enterprises when limited liability was used for public companies.14 Also another
importance lies in the fact that the business man who knows that his maximum liability to his
creditors is the amount he has agreed to invest by a way of capital is more likely to take the
risk. That is what the legislator originally wanted to encourage passive investors to contribute
by a clear distinction between personal and business assets.13 The limitation of the liability of
investors to the amount they put in their business is a privilege which can be abused at the
expense of the creditors, especially unsecured ones, who will bear the risk of the business
failure. As a result, they may lose their money in the situation that the company is declared
bankrupt and no longer able to pay its debts. Critics of the limited liability doctrine criticise
the limited liability doctrine in the sense that shareholders will reap all the benefits of risky

12
ngira Singhvi ,Corporate Crime and Sentencing in India: Required Amendments in Law, International
Journal of Criminal Justice Sciences ,Vol. 1 Issue.2 July 2006 ISSN:0973 available at
http://www.sascv.org/ijcjs/angira.html;
13
Konstantin Zens, Susan Watson, Enforcement Instruments In Transnational Corporate Bribery: An
Overview, 2012 International Company and Competition Law Review 271 available at www.westlaw.com

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activities, but do not bear all the costs which are borne by creditors, but is it more appropriate
to shift the risk of business failure and let it be borne by one group rather than letting it rest as
it falls? First of all, there is no business not associated with risk, every business man must
take into consideration the failure of his business and someone must shoulder the risk under
any rule. It is said that one entrepreneur cannot bear a large amount of loss and shifting the
loss from him to a wealthy group like large institutional investors will let the risk of the
business failure spread out amongst all creditors rather than one person. Abusing the limited
liability on the account of creditors lead some commentators to suggest that abolishing the
limited liability doctrine will put a limit to these forms of abuses in terms of protecting
creditors, but what will be the result on the commercial world? Whatever hard things may be
said about the limited liability, it has conferred very great benefit to the community, it has
provided large sums of money for useful industrial undertakings and advanced the progress
of industry and commerce. It is even said that the limited liability has been co-extensive and
inextricably linked with success of Western Capitalism.14 Let us assume that the limited
liability is abolished. I think we will be back to the beginning again. Traders will create other
methods to minimise their liability by agreement, contract and relying on insurance. Also,
these forms of abuses which are taking place in relation to the limited liability are not the rule
but exceptions; many businesses are prospering and flourishing without any difficulty. If
there were some form of abuses taking place, can we say that the limited liability is no good
to the world of commerce? In my opinion I think not, nothing is absolute although there are
disadvantages associated with the limited liability, the advantages outweigh the
disadvantages. Instead of abolishing the limited liability doctrine, we should strengthen our
laws in terms of protecting creditors.15

CASE ON ONE MAN COMPANY AND LIFTING OF VEIL

The Court of Appeal in Broderip v Salomon declared that Mr Salomon when he had
incorporated the company with six dummies, was abusing the Companies Act. All
shareholders must be honourable men, bona fide traders, none of them dummies. The
decision of the House of Lords reversed the finding at the Court of Appeal and established
the legality of the one-man companies. Limited liability was also available to sole traders
who can limit their liability to the amount they put in their business. Soon after recognising
the one man companies, many abuses of the corporate form took place. Limited liability was

14
Supra 13
15
ibid

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one way of defrauding creditors. This gap in the law started to induce commentators to
address the problem.16 Kahn Freund thought that the best way to get out of this problem was
to abolish the private companies and to lift the corporate entity in extreme cases for the
benefit of the creditors. The Jenkins Committee mentioned the fact that the increase in
registration fees might also solve the problem. While some of the suggestions were
implemented, others were not.It is now possible to establish a private company with one
member as a result of the Companies Courts will not let the corporate form be used for the
purposes of fraud or as a device to evade legal obligation. If the court is convinced that this is
done the corporate veil will be lifted. Two cases illustrate this proposition. In Gilford Motor
Company Ltd vHorne an agreement was made between the plaintiff and the defendant which
prevented the latter from setting up a business competing with his employer. The defendant
thought he was clever enough when he set up a new limited company to evade his obligation.
The Court of Appeal were clear the company was formed as a device and accordingly
ignored the separate legal personality and granted the plaintiff an injunction against the
defendant and his company. Also in Jones v Lipman24 the court awarded specific
performance against both the company and the defendant who had agreed to sell his property
to the plaintiff in order to avoid that he set up his own business.

Finally we can say that in cases of the abuse of the corporate personality, the court will not
hesitate in lifting the veil between the company and its members. Also under the wrongful
trading provision, a parent company might be held liable to pay the debts of its subsidiary.17

CONCLUSION

The House of Lords found that honesty and good faith on Salomons part prevented him from
indemnifying the company creditors as they knew they were dealing with a legal person
totally different from his incorporators. Limited liability at that time was also available to
sole traders and large investors who wanted some form of limit on their undertakings.

The abuses which took place afterwards led some commentators to suggest abolishing the
limited liability at all or at least to abolish the private companies, but what would be the

16
Vodafone International Holdings BV v. UOI, Ministry of Finance and Asst. Director of Income Tax
(International Taxation), (2009) 311 ITR 46 (Bom.)
17
ibid

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effect of that on the commercial world? and are these abuses the exception or the rule? It is
submitted that industry and trade will suffer as a result of many investors not contributing
more than the amount they wish to invest, and we will be back at the beginning again.
Traders will find a way to limit their liability under contract or insurance as they have done
before.
Alteration of risk from shareholders to creditors and the abuse of the corporate
personality and the limited liability associated to it does not mean that the limited liability is
of no good; many companies are prospering and flourishing without any problem and these
abuses are not the rule but the exception to it. The law started recognising the problem and
formed methods of protecting creditors, either preventive or compensatory, preventive
measures requiring directors to take care of creditors interests and compensatory measures
relating to fraudulent and wrongful trading. But are these measures of protection adequate? In
my opinion I do not think so, since they only enforced other provisions by a liquidator when
the company was in liquidation and this does not address the problem either.The judges also
are not sure when to lift the veil between the parent company and its subsidiary only in
exceptional circumstances will declare shareholders liable to pay the debts when they use the
company in case of fraud or to evade legal obligation, but its a matter of the circumstances
and there is no basic rule. It is hoped that parliament will develop a coherent effective
systematic way of evading the adverse effect which limited liability can have on creditors. As
a result this will give limited liability its proper function and will avoid severe criticism of it.

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BIBLIOGRAPHY
PRIMARY SOURCES
Solomon v. Solomon & Co. [1897] A.C. 22, HL
Macaura v. Northern Assurance Co. Ltd [1925] A.C. 619
Vodafone International Holdings BV v. UOI, Ministry of Finance and Asst. Director
of Income Tax (International Taxation), (2009) 311 ITR 46 (Bom.)

SECONDARY SOURCES

BOOKS

Guide to Companies Act, 17th edn 2010, part 1, A. Ramaiya

Gower and Davies, Principles of Modern Company Law, 8th ed. Sweet and Maxwell,
London, 2008.
ARTICLES
Angira Singhvi ,Corporate Crime and Sentencing in India: Required Amendments in
Law, International Journal of Criminal Justice Sciences ,Vol. 1 Issue.2 July 2006
ISSN:0973 available at http://www.sascv.org/ijcjs/angira.html;
Konstantin Zens, Susan Watson, Enforcement Instruments In Transnational
Corporate Bribery: An Overview, 2012 International Company and Competition
Law Review 271 available at www.westlaw.com
Shagun Singh, Lifting the Corporate Veil with reference to leading cases, available at
http://artismc.com/index.php/blogs/view/55/221/

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