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1. What is the concept of corporate veil?

A shield that protects the members from the action of the company. i.e. Members cannot be held liable for the actions/liability of the Company. A protective cover in the form of a separate entity provided by the corporate Law.

2. What is the Concept of a separate legal entity?

Established by the landmark judgment in Solomon vs Solomon & Co. Ltd. It also established the concept of limited legal liability in case of limited companies. 

3. What is the concept of piercing/lifting of a corporate veil?

This is an exception to the concept of separate entities. It refers to a situation wherein the courts look behind the protective shield to find the wrong doers if the same protective shield has been abused, to hold them personally responsible. The basic reason being that a corporate entity is an artificial person so if there have been any fraudulent/illegal activities, they are actually being committed by people acting on its behalf. Here mens rea is considered absent in the case of the corporate body but present in Directors.

4. What are the Circumstances under which the corporate veil can be pierced ?

Some of the circumstances in which corporate veil is pierced

• Fraud or improper conduct ( promoter agreed to sell land and before completing the formalities transferred the land to company to avoid specific performance )- Jones V. Lipman (1962) 

• Corporate façade only an agency instrumentality (American company produced film in India claiming it to be British while 90% of capital was held by the president of the American Company. The Board of Trade refused to register it as a British film – an English company acted merely as the nominee of the American corporation) – Re. R.G. Films Ltd. (1953)

• Conduct against public policy (the de facto control lied with Germany which was at war with England. Giving money to the Company would have meant giving money to an enemy) – Connors Bros. v. Connors (1940)

• Enemy character – Daimler Co. Ltd. V. Continental tyre & Rubber Co. (1916)

• Evasion of Taxes (Re. Sir Dinshaw Maneckjee Petit, A.I.R. 1927 Bombay 371)

• Avoidance of welfare legislation (a new company was formed by the principal company which had no business of its own or even assets. Was formed so that profits could be split so that payment of bonus could be avoided) – Workmen Employed in Associated Rubber Industries Ltd., Bhavnagar V. The Associated Rubber Industries Ltd., Bhavnagar and another, A.I.R. 1986 SC

• Abuse of the corporate personality for unjust and inequitable purposes.

• Criminal Activities  

5. What is Reverse piercing of the corporate veil?

Is a concept where the corporate entity is held responsible for the actions of the Shareholders. Usually, in case of debts. That is a corporate body made responsible for shareholders liability. Charging the corporate assets to satisfy the debts of third parties for resulting from wrongful deeds of the shareholder.

6. What is the Concept/idea behind reverse piercing of the corporate veil?

The concept is used when the actions of the controller/promoter is assumed to be done by the corporate body. Even the assets held by the corporate are considered to be actually belonging to the shareholder. Becomes more conspicuous when the promoter/director/shareholder is not able to pay his debts and hence the assets of the corporate body are attached and considered to be belonging to the shareholder for recovery. Here, the separate entity concept is completely ignored. There is no separation between the assets of the corporate and that of the shareholder.

7. When does the concept come into picture?

No widely accepted test/conditions arrived upon till now. Depending upon who makes the claim, it can be divided into two subcategories – inside reverse piercing – where the insider/shareholder tells the court to ignore the separate entity concept and outside Reverse piercing – where an outsider/ third party asks the court to disregard the  separate entity concept.

8. Has the concept been widely accepted ?

There are many cases in the US where the doctrine has been applied to a smaller or greater extent. There are many sub categories of the doctrine as well. But it is difficult to apply.

The doctrine has not found complete support from any country till now though the American judiciary/courts has applied it in very few cases.

It is more of an academic concept and difficult to apply.

US

In the US there are three tests to be undergone before applying the doctrine based on the case - FMC Finance Corp V. Murphee:

1. Degree of control

2. Acts whether for fraudulent or irregular purpose

3. Damage to the aggrieved  

However, in Manichean V. Exela however, the judiciary took a step back. When it is the question of a third party getting affected, the effect on the interests of innocent shareholders are also to be taken into consideration. Balance of interest between the two sides must be taken into consideration.

UK 

The situation in the UK is not much different from India. The UK courts also are apprehensive about moving away from the separate entity concept established by Solomon V. Solomon & Co. Accordingly, the piercing of the veil is to be considered as a last resort that too in exceptional cases where no other remedy is available. 

In Prest V. Petrodel Resources Ltd. Wife Ms. Yasmin Prest claimed maintenance from her husband Michael Prest. Here, there were properties owned by the companies solely owned by Mr. Micheal Prest. Mrs. Prest claimed the properties in question therefore, were in fact owned by Mr. Prest. The Supreme court held that Mr. Prest was entitled to the assets as he had contributed to their purchase and held them in trust for the Company as a result. There was no need for piercing the veil here as there is no abuse of the corporate legal personality. Also, there was nothing to establish any kind of  “evasion” or even “Fraud” as in the case of the exceptions to the Solomon V. Solomon & Co.   

9. Difference between traditional corporate veil piercing and reverse piercing

Both the concepts are opposite of each other. While the traditional version respects the separate entity concept and believes in peeking behind the veil only when the doctrine of separate entity is abused. It starts with enquiring into the corporate and later catches hold of the actual wrong doer hiding behind the veil.

The reverse piercing is opposite of it. Here the enquiry starts with the shareholder and when found he is the dominating force in a corporate, the corporate is also brought into picture and is made accountable for the doings of the shareholder thereby completely ignoring the separate entity concept. 

Some important points – main principles to be understood in the context

1. Mens-rea – Mens- rea applicable only in case of natural persons and not juristic persons/legal fiction. When any illegal act is indulged into it is actually being done by the agents and not the corporate itself. And hence the following comes into play.

2. Alter -ego – second personality – corporate manifestation of the wrongdoer. The corporation is so dominated or controlled by the shareholder that the primary purpose of its existence is the shareholder’s objective rather than its own. Say for instance the corporate body is also held responsible even though the authorized signatory was the actual culprit – i.e. though the entities were separate the corporate was held responsible for the agent’s act – cheque dishonor case - Aneeta Hada & Ors. V. Godfather Travels – vicarious liability 

3. Vicarious Liability - 

Principal(corporate) held liable for agent’s (Director’s) doing. No separate doctrine required. Same as reverse piercing of the corporate veil. Widely accepted principle in India. But too much of emphasis on this can also undermine the separate entity concept more so when the stakeholders are large in no. In State Bank of India V. Kingfisher Airlines the courts did recognize the doctrine and Vijay Mallya was made liable as he was the chief promoter and controller. But the principle was accepted in the form of vicarious liability rather than applying it straight away. That is the business unit was considered the principal while the promoter its agent and hence BU held accountable.

4. Reverse piercing directly affects the limited liability concept and makes the corporate entity also accountable for the actions of the shareholder

Difficulties in applying the concept

5. Some kind of controller test should be in place to establish that the interests of the Directors and corporate are intertwined and not separate for reverse piercing which again goes against the concept of separate entity as in most cases in the beginning the promoters only nourish the corporate to life. While reverse piercing is to be applied in case of wrong doings and not otherwise. Proper test to be established. Conditions/guidelines to be properly laid down. In India, difficult to establish control as shareholding may or may not determine the control. The actual control may be in someone else’s hand. It is a big challenge to practically determine it. 

6. Stakeholders interest 

Innocent shareholders- shareholders invest in the company for returns and their interests are badly affected for no fault of theirs because of wrongdoing by one of them or Director(s). This is not a fair practice.

Third parties – including business entities including ancillary/supplementary industries/ consumers, employees etc. interacting with the business unit get affected. Most of these forces rely heavily on the separate entity concept and depend heavily on its undeterred continuity.  

Creditors – Creditors give credit with a view of getting returns from such lending. They do so by assessing the credit standing of the corporate body with almost no knowledge about the doings of the individual shareholders. And when the assets of the corporate body get attached because of the doctrine, it is not only the credit worthiness of the corporate getting affected but the creditors faith is also badly affected which in turn may discourage them from lending in future as well.  Particularly, when one creditor tries  to get priority over the others by relying on the doctrine, also, as in case of outside reverse piercing, it can again go against the spirit of IBC.

Harmful to the Indian economy which consists mainly of closely held companies. The Indian economy gathers tremendous support from the fact that the liability of the promoters is limited, there is separation of identity. It is one of the main constituents for attracting investors also. The doctrine may end up closing the economy which has just started opening up well.   

Indian Precedent:  

Premlata Bhatia V. Union of India (2004) 

License was granted to the individual which was later transferred by her to Company without Govt. consent. She argued that she and the company were virtually the same. It was held that shareholders cannot ask for the lifting of the veil for their own purpose. 

This reestablished the Solomon V. Solomon & Co. principle again in a new light.