What do you mean by Separate Legal Entity Concept? State the exceptions to Separate Legal Entity Concept.

Concept of Separate Legal Entity.

Lifting of Corporate Veil The term ‘Corporate Veil’ means that in the eyes of law, company is a separate legal entity distinct from its members. ‘Veil’ means a line of demarcation existing between the two i.e., one the company and the other its members.

Sometimes, the necessity of the situation may compel the authorities to disregard the corporate legal entity and look to individual members who are in fact the real beneficial owners of all corporate property, and this is what is known as Lifting of or Piercing of the Corporate Veil. When this veil is used as a means to commit fraud or wrong conduct, then it becomes necessary for even courts to lift or pierce this veil and look at the members who are behind the company and hold them liable for the wrongful acts of the company. The exceptions to’ the doctrine of Separate Legal Entity can be studied under the following heads :

  • Under statutory provisions.
  • Under judicial interpretation.

Exceptions under Statutory Provisions.

For establishing the relationship of holding and subsidiary companies: 

Where one company controls the management of the other company, the former is called the holding company and the latter subsidiary As per Section 129 (3), every holding company is required to prepare, in addition to its own financial statements (Balance Sheet, Statement of Profit & Loss etc.) a consolidated financial statement of the company and of all the subsidiaries

For facilitating the task of an inspector appointed under Section 210 or Section 212 or Section 213 to investigate the affairs of a company: 

If it is necessary for the satisfactory completion of the task of an inspector appointed to investigate the affairs of a company for alleged mismanagement, fraudulent purpose or oppressive policies towards its members, he can investigate the affairs of other related companies under the same management or group.

For investigation of ownership of company: 

Under Section 216, the Central Government may appoint one or more inspectors to investigate and report on the membership of any company for the purpose of determining the true persons who are financially interested in the company and who control its policy or materially influence it.

Misrepresentation in prospectus: 

Every director/promoter or authorized person, is liable for imprisonment for a term ranging from six months to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, and it may extend to three times the amount involved in the fraud.

Failure to return application money:

If minimum subscription is not received within a period of 30 days from the date of issue of the prospectus, the application money should be returned within a period of 15 days from the closure of such issue. In case of default, the directors and other officers responsible for default shall be jointly and severally liable to repay that money with interest @ 15% p.a.

Mis description of name: 

Directors and other officers of the company will be personally liable for all the contracts made by them on behalf of the company in their personal. names, e.g., acceptance of a Bill of Exchange drawn upon a company by a director in his personal name or omitting to use the name of the company in the prescribed manner (for example, not using the word ‘Ltd.’ as a part of the company’s name).

Fraudulent conduct of business: 

If in the course of the winding up of company, it appears that any business of the company has been carried on with the intention to defraud creditors of the company or any other person, the Tribunal, on the application of the Official Liquidator or the Company Liquidator or on an application of any other creditor or contributory of the company may, if it thinks it proper to do so, declare that persons who were knowingly parties to the carrying on of the business in the manner aforesaid, shall be personally responsible without any limitation of liability for all or any of the debts or other liabilities of the company as the Tribunal may direct. (Section 339).

Directors with unlimited liability: 

Sometimes, when the directors, through a written agreement, agree to have their liability Made unlimited, they become personally liable for all the debts of the company.

Liability of promoters for pre-incorporation contracts: 

Promoters remain liable on those contracts which are not adopted by the company after its incorporation. They become personally liable for contracts entered into on behalf of the company.

Exceptions under judicial Interpretation

Protection of revenue: 

The court has powers in connection with income tax assessment to go behind the corporate entity and to inquire about the real owners of the company. In Re Dinshaw Maneckjee Petit, Dinshaw had huge income in the form of dividend and interest. He floated four Private companies and transferred the investment in part to each of these companies in exchange of their shares. Thus, all the income in the form of dividend and interest was received by these four private companies. These four private companies handed back the amount to Dinshaw Maneckjee Petit in the form of pretended loan. The objective of floating these companies was tax evasion i.e., avoidance of tax intentionally. In this case, it was decided that these four private companies and Dinshaw Maneckjee Petit were one and the same.

Prevention of fraud or improper conduct: 

The court has also the power to lift the veil of corporate personality where there are reasons to doubt that the machinery of incorporation has been used for some fraudulent purpose as to defraud creditors or to avoid legal obligations.

In the case of Gifford Motors Company vs. Horne, Mr. Home was an ex-employee of the company. He was under an agreement with the company not to solicit its customers. He fraudulently formed a company to carry on ‘similar business which he was not allowed to do in his personal capacity as per his agreement with the company. His company was held to be a mere sham or hoax formed for the sole purpose of allowing him to commit a breach of the agreement which he had entered into with his former employer.

In the case of Jones vs Lipman, Mr. Lipman contracted with Jones to sell his land. Offer was accepted by Jones. Later on, Lipman changed his mind and requested Jones to be released from the contract. Jones did not agree. Lipman floated a company and the only members of the company were Lipman and a clerk of his solicitor. He transferred the piece of land to the company. The objective of transferring the land was to prevent the specific performance of the contract. Jones filed a suit against Lipman and the company for the specific performance of the contract. It was decided that the company was not a distinct entity from Lipman since the company was floated with the objective of avoiding legal obligation.

Determination of the enemy character of the company: 

The court has also lifted the corporate veil in order to determine the enemy character of the company. In the case of Daimler Co. Ltd. vs. Continental Tyre and Rubber Company . (Great Britain) Ltd., Daimler Co. Ltd. was incorporated in England for the purpose of selling there tyres manufactured in Germany by a German Company. Its majority shareholders and all the Directors were Germans, resident in Germany. When the war broke out between England and Germany in 1914, the company was declared to be an enemy company. During the war period, the company filed a suit to recover a trade debt. The court dismissed the suit on the plea that such payment -would be a trading with the enemy company.

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