The Concept of “Corporate Personality” and Its Limits Under Indian Law: A Critical Analysis| Authored By : Aaron George Biju| Volume VI Issue II|

Abstract

The principle of the corporate personality is the foundation of the contemporary corporate law, business enterprise, and the economic systems in the world. It enables a business to be a separate legal person, independent of its founders, shareholders and directors. Although this legal fiction has contributed to the growth of the world economy due to limited liability, perpetual succession, and aggregation of vast amounts of capital, it is not an unconditional right. When the corporate form is used to commit fraud, avoidance of legal duties, evasion of welfare laws, or other detrimental actions to societal interest, the judiciary and the legislature lift this mask – a process called lifting or piercing the corporate veil. The research paper extensively discusses the jurisprudential basis of corporate personality, statutory and constitutional sanction of corporate personality in India, socio-economic justification of corporate veil, and fundamental constraints of corporate veil under Indian jurisprudence, common law precedents and existing legislation such as the Companies Act, 2013 and the Insolvency and Bankruptcy Code, 2016. 

1. Introduction to Corporate Personality and Legal Theory

1.1 The Meaning of “Corporate Personality” as a Legal Construct

 The term person has its origin in the Latin word persona, meaning mask used by actors in Greek and Roman plays, and which is used in jurisprudence. As time passed on, the term was embraced in the law to refer to any entity that is able to bear rights, bear duties and be involved in a legal relationship. Natural persons form such attributes by being born, but in the case of a corporation, it is all a fiction of law. When a company is incorporated, the law gives the company artificial life giving the company a separate persona. This implies that the corporation itself has the power to enter into contracts, to own property, to hire employees, to engage in torts, and to be sued or to sue in its own right, and does not depend in any way upon the persons who are the shareholders of the corporation or who run its day-to-day affairs.

1.2 Jurisprudential Theories of Corporate Personality.

To know what the corporation personality can go, one should know the way the law legitimizes its existence. This is explained by a number of jurisprudential theories:

• The Fiction Theory (Savigny and Salmond): In this theory, it is assumed that the natural persons are only human beings. An incorporation is a legal fiction of the State that makes a person. Its fictional nature means that it lacks an intrinsic will or mind and it must be acted upon by humans.
• The Concession Theory: This is similar to the Fiction Theory but holds that legal personality is a concession or privilege offered by the sovereign State. Because the privilege is conferred by the State, the State (by its courts and statutes) may revoke or disregard it whenever it is abused. Lifting the corporate veil is based on this theory.
• The Realist Theory (Gierke): According to this theory, a corporation is not a mere fiction; it is a real sociological entity, with a collective will distinct from the individual members. Although this is not fully recognized in the common law tradition, it emphasizes how powerful corporations are in the society today.

1.3 The distinction between Natural Person and Artificial (Juridical) Person.

The difference between a natural person and an artificial person is central to the law of corporations. Natural person is a living flesh and blood human being, with a mind and a body, who lives in accordance with natural life cycles. An artificial (or juridical) person is one which exists in the surface of the law. Due to its invisibility and intangibility, it needs to be performed by human agents (directors, officers, and employees). Nevertheless, any action of these agents, acting within the limits of their power and in the name of the company is legally ascribed to the artificial entity, rather than to the humans themselves. 

 1.4 The Significance of Separate Legal Personality.

Corporate personality as a legal construct is not simply an academic theory; it is the driving force behind modern day capitalism. Its value is in a number of benefits:

• Limited Liability: It is the highest economic advantage. Shareholders are limited to the amount of company debts they pay according to their shares. In case the company collapses, their personal property (homes, savings) will be secured.
• Perpetual Succession: The life of the company does not rely on the lives of the members. The legal maxim is true, and it is, as the saying goes, “Members may come and members may go, but the company goes on forever. It outlives the death, insolvency or insanity of its shareholders.
• Transferability of Shares: under Corporate personality, ownership is easily transferred, without disturbing the legal existence of the business.
• Separate Property: The company has title to its assets. A shareholder does not own the assets of the company he/she just owns a package of rights (shares) in the company. Macaura v. Northern Assurance Co. Ltd. clearly outlined the fact that a shareholder lacks any insurable interest in the property of the company.

2. Salomon v. Salomon and Co. Ltd. and Common Law Foundations.

The landmark British case of Salomon v. A. Salomon and Co. Ltd. (1897) that solidified the absolute nature of the separate legal entity principle cannot be discussed without delving deeper into the issue of corporate personality.

2.1 Facts and Issues in the case of Salomon.

Aron Salomon was a merchant and a boot maker of leather in the Victorian England. He wanted to share the business with his family and to have a limited liability but he put his business into a limited liability company. Salomon, his wife, his daughter and his four sons divided one share to satisfy the statutory requirement of seven members at the time. Salomon was on the board with 20,000 shares in it, and he exercised absolute control.

He sold his business to the new company formed at the price of £39,000. The company in exchange paid him fully paid shares, 10000 in secured debentures (which made him a secured creditor) and the rest, in cash. The company was later forced into a liquidation by a strike in the boot trade and loss of government contracts. Its assets were good to meet the payment of Salomon (the secured creditor) but not the unsecured trade creditors. Its liquidator brought a lawsuit against Salomon claiming that the company was just a sham, alias or agent of Salomon and thus he should be personally liable to the company debt.

2.2 Holding of the House of Lords.

The courts of lower instance decided against Salomon, particularly under the notion that a one man-company was a violation of the Companies Act. But these decisions were unanimously overruled by the House of Lords. Lord Macnaghten passed a decision that influenced the corporate law in the world:

• The company is technically, after incorporating the memorandum, a wholly distinct person than the subscribers of the memorandum; and, although it may be the case that once incorporated the business is the business the same as it was prior to incorporation, and that the hands to which the profit accedes are the same hands, the company is not legally a representative of the subscribers, or of them in any capacity.
• The people in charge of the company were called promoters; the House of Lords decided that the intentions of the promoters do not matter provided that the legal formalities of incorporation are followed to the letter. The debentures that Salomon obtained were valid and he had a right to receive payment prior to the unsecured creditors.

2.3 Strengthening of the Principle: Air Farming Ltd of Lee v. Lee.

Salomon principle was extended and confirmed in another case Lee v. Lee Air Farming Ltd. (1961). Mr. Lee created his own company with 2999 of the 3000 shares. He was the only governing director as well as the company having him as the chief pilot. During his work, he died in an air accident. His widow took out worker compensation. The insurer claimed that Lee and the company were inseparable, and no one can hire himself. This was denied by the Privy Council which considered that the company and Mr. Lee were separate entities under the law; thus, the company was free to make a valid employment agreement with their controlling shareholder.

3. Personality of Corporations in Indian Law.

The Salomon principle forms the foundation of Indian company jurisprudence as Indian corporate law is highly influenced by English common law.

3.1 Statutory Foundation Based on the Companies Act, 2013.

Corporate personality is codified in India. The effect of registration is contained in Section 9 of Companies Act, 2013 (similar to Section 34 of the 1956 Act). It says that the subscribers to the memorandum since the date of incorporation become a body corporate who is able to perform all the functions of an incorporated company, who has perpetual succession, and who may acquire, retain and transfer properties.

3.2. Constitutional Rights of a Corporation.

Although a company is considered a legal person, it is not a citizen. This difference is crucial to the constitutional law of India.

• Article 14 (Right to Equality): The Supreme Court has ruled that a company is an entity entitled to equality before the law and equal protection of the laws under Article 14 ( Chiranjit Lal Chowdhuri v. Union of India).
• Article 19 (Fundamental Freedoms): Article 19 rights (such as freedom of speech, freedom to continue trade) can be enjoyed by citizens only. According to the landmark case of State Trading Corporation of India v. CTO (1963), a company is deemed not to be a citizen and thus it cannot invoke Article 19. In addition, in Tata Engineering and Locomotive Co. Ltd. (TELCO) v. State of Bihar, the Court denied the lifting of the corporate veil to have shareholders assert Article 19 rights on behalf of the corporation, saying it would kill the principle of separate legal entity.
• Evolution in Bennett Coleman: But in Bennett Coleman and Co. v. Union of India the Court indicated that although a company cannot claim to have Article 19 rights, the rights of the shareholders under Article 19 are inseparably linked with the rights of the company and, therefore, the shareholders can challenge such a state action that affects the company and, therefore, their own fundamental rights.

3.3 Early Indian Precedents

The separate legal personality was acknowledged by Indian courts prior to the House of Lords decision in Salomon. In Re Kondoli Tea Co. Ltd. (1886) a group of people sold their tea estate, which they collectively owned, to a new company that was composed of them alone. They contended that since they were the sole shareholders, it was a transfer to them per se and should not be liable to ad valorem stamp duty. The Calcutta High Court turned it down, on the basis that the company was an independent entity, quite separate of its shareholders, and the transfer was subject to full stamp duty.

4. Rationality and Significance of the “Corporate Veil.

4.1 The Metaphor of the Veil 

The corporate veil is a metaphor in law signifying the boundary between the corporation and its natural persons who establish and operate it. In dealing with a third party, the business only deals with the party before the veil. They are not able to pierce it so that the individuals behind it would be personally liable to the company.

4.2 Law and Economics: The Rational of Limited Liability.

On the view of law and economics (advocated by scholars such as Easterbrook and Fischel), however, the veil is not a technicality: it is an economic necessity:

• Agency Costs reduction: In a large publicly traded company, shareholders (principals) will delegate management to directors (agents). The absence of limited liability would force shareholders to spy on the managers all the time, fearing to be personally bankrupt and cause increasing transactions and agency costs. Passive investment is permissible by the veil.
• Diversification: Diversification is facilitated by limited liability whereby investors can diversify their capital among several companies. Had they been liable to unlimited liability in all their companies in which they invested, they would have concentrated their fortunes in one, highly surveilled company, and ruined the modern stock market.

• Ideal Risk Sharing: It transfers the risk of corporate failure out of the shareholders and into the creditors. Creditors (such as banks) tend to be in a better position to evaluate corporate risk, observe financial well-being, and require risk-adjusted interest rates or security.

4.3 Vulnerability of the Construct.

The company being a soulless entity cannot commit any crimes, develop malicious intentions or plan fraud against itself. Human agency is needed. Bad players soon discovered that the veil could be used as a weapon. They started employing the corporate form to conceal their identities, to siphon their public funds, to evade taxes and to launder money and avoid statutory obligations, hoping that the legal fiction would provide them with complete immunity.

5. Doctrine of Lifting or Piercing of a Corporate Veil.

In the event that the corporate form is misused, equity requires that the law should not be blind to the matter. An exception to the Salomon principle which is fair is the doctrine of lifting or piercing the corporate veil. It enables courts and regulatory bodies to disregard the distinct legal personhood and peep behind the corporate mask and punish or hold to account the natural persons who are indeed in charge.The veil is not raised by courts easily. The doctrine is a limiting one as it has been determined in the recent Indian Supreme Court decision involving Balwant Rai Saluja v. Air India Ltd. (2014). The Court made it clear that the veil is piercible only when it is demonstrated that:

• The corporation is a simple “alter ego” or mask.
• The corporate form is being abused or avoided to commit impropriety or an evasion of the law.
• The control exerted by the individuals and the impropriety committed are directly related to the injury sustained by the plaintiff.
• The general philosophy is that the corporate veil is a veil of bona fide business and not a veil of fraud.

6. Lifting of the Veil by the Judiciary: Categorization and Indian Jurisprudence.

Judicial piercing most often happens in particular types of misconducts. Indian courts, under heavy English influence, such as Gilford Motor Co v. Horne (where a company was created to avoid a non-compete clause) and Jones v. Lipman (where a company was created to avoid a specific performance of a sale of land) have established a strong body of jurisprudence to lift the veil.

6.1 Fraud and Improper Conduct.

The most prevalent basis of piercing the veil is the formation or utilization of a company as a vehicle of fraud. Delhi Development Authority v. Skipper Construction (P) Ltd.: It is an Indian monumental case. Homebuyers promised commercial spaces made Skipper Construction, which was run by a promoter and his family, amass colossal amounts of money, collected by hundreds of homebuyers. The promoters would funnel the money into the accounts of their family members and shell companies in a systematic way, abandoning the project. The Supreme Court vigorously dismissed the defense of the separate legal personality by the promoters. Basing all on equity, the Court ruled that the corporate character should not be preserved as it is applied to defraud citizens. The Court disregarded the corporate entity and instead regarded the promoters and the shell companies as a single entity and attached their personal properties to compensate the homebuyers.

Subhra Mukherjee v. Bharat Coking Coal Ltd.: A privately owned coal mining firm which was suspecting that the government was about to nationalize coal mines, quickly disposed of the immovable property in the wives of the directors by a sham sale. The veil was pierced, and the Supreme Court realized that the transaction was a sham to deprive the company of its property and bankrupt the nationalization law.

6.2 Evasion of Taxes

The courts are not so tolerant in cases where business setups are formed due to evading taxes, as opposed to genuine business objectives.Sir Dinshaw Maneckjee Petit, Re (1927): This was a rich assessee who established four companies of his own and sold to them his huge dividend-yielding holdings. The companies were merely in receipt of dividends and returned the same to Sir Dinshaw as so-called loans. The Bombay High Court pulled the curtain and stated that the companies were nothing other than a sham, which was made to separate his income and avoid super-tax.

State of UP v. Renusagar Power Co.: Hindalco, a giant manufacturing firm, established a wholly owned subsidiary, Renusagar, with the sole purpose of power generation to supply power to the Hindalco plant. The State tried to impose a duty on electricity that was to be paid to external sources. The veil was lifted by the Supreme Court that acknowledged that Renusagar had no existence of its own and no independent purchasers; it was so closely interwoven with Hindalco. They were considered to be a single economic entity, that is, Hindalco was producing its own power, which altered the tax implications.

Vodafone International Holdings BV v. Union of India: The court did not overturn the decision in favor of Vodafone; however, by acknowledging the validity of complex transnational holding structure and drawing the distinction between an attempt to avoid tax in a legitimate manner and an attempt to evade taxes through tax avoidance, it reaffirmed that where a structure is a colorable device with no commercial substance, the tax authorities may pierce

6.3 Welfare and labour legislations evasion.

Indian courts are vigorous in defending the workers against corporate restructuring that aims at destroying labor rights. Associated Rubber Industry Ltd. v. Workmen of Associated Rubber Industry Ltd.: A corporation established a subsidiary and sold its investment portfolio to the subsidiary which was fully owned by the company. This was purely to minimize the gross profit of parent company, which would lower the statutory bonus to be paid to its workmen under the Payment of Bonus Act. The Supreme Court lifted the veil and ruled that the subsidiary was a sham and the companies be taxed as a single entity in determining the bonus.

6.4 Contempt of Court

In Jyoti Limited v. Kanwaljit Kaur Bhasin, the court ordered a firm to be prohibited to sell a piece of property. To avoid the court order, the partners had floated a private limited company, sold the property to the company and the company sold it. The Delhi High Court unveiled the veil and judged the individuals guilty of disrespect to the court, the corporate person was only a mask to defy the court order.

7. Veil Lifting Based on Statute and Quasi-Statute.

Besides judicial discretion the Indian Parliament has progressively incorporated within several statutes provisions to automatically lift the corporate veil in particular situations.

7.1 Under the Companies Act, 2013.

The 2013 Act put a stranglehold on corporate misconduct, which added harsh statutory veil-piercing clauses:

• Section 7(7) (Incorporation by Fraud): In case a company is incorporated with the production of false information or the concealing of material facts, National Company Law Tribunal (NCLT) may issue orders stating that the members of the company shall have unlimited liability.
• Sections 34 and 35 (Misstatements in Prospectus): In cases where a company issues public money in a prospectus that includes misleading statements, all directors, promoters and experts appointed to authorise an issue will be personally liable to compensate investors.
• Section 251 (Fraudulent Striking Off): In case of an application to strike off the name of the company being made fraudulently to defraud creditors or avoid taxes, the individuals operating the company will be personally liable to losses suffered by the concerned parties.
• Section 339 (Liability of Fraudulent Conduct of Business): An effective clause in winding up. Provided that it may seem that the business was operated to defraud creditors, then the NCLT may declare that any persons who were knowing parties to carrying on the business shall be personally liable, without limit, to all the debts of the company.
• Section 212 (SFIO Investigations): Authorises the Serious Fraud Investigation Office to examine the affairs of a company and its maze of subsidiaries, disregarding the corporate veil to find the ultimate beneficiaries of fraud.

7.2 Insolvency and Bankruptcy Code 2016 (IBC).

The IBC has greatly affected the veil of incorporation, especially in the aspect of the responsibilities of the directors towards insolvency.

Section 66 (Fraudulent and Wrongful Trading): In cases where corporate debtors are subjected to the Corporate Insolvency Resolution Process (CIRP), and the Adjudicating Authority concludes that the company has committed business to defraud its creditors, it can order directors or partners to make personal contributions to the assets of a company. Moreover, in case a director was aware of or should have been aware that insolvency was inevitable and did not take reasonable steps to avert a loss to creditors (wrongful trading) his or her personal property may be attached.

7.3 Tax Law and FEMA.

Income Tax Act, 1961 (Section 179): When a private company is in liquidation and the amount of tax owed cannot be recovered, the amount is jointly and severally liable to the persons who were directors in the previous year in question except when an individual can demonstrate that the failure to recover was not occasioned by his gross neglect, misfeasance or breach of duty.

FEMA and PMLA: The authorities of the enforcement agencies (such as the Enforcement Directorate) under the Foreign Exchange Management Act and the Prevention of Money Laundering Act are given powers in statute to look beyond the corporate structures and to see the Ultimate Beneficial Owner (UBO) to discourage money laundering, round-tripping of funds, and terror financing.

7.4 Administrative/Quasi-Judicial Piercing

The Supreme Court applied the doctrine in the administrative/regulatory setting in the case of State of Rajasthan v. Gotan Limestone Khanji Udyog Pvt. Ltd. One of them was a partnership firm with a mining lease in the state. In order to sell this lease to a giant cement conglomerate (which must be authorized by the government and hefty transfer fees are imposed), the partners transformed their company into a private limited company, and subsequently sold 100 percent shares to the conglomerate. The company did not legally change ownership of the lease. The Supreme Court however, pulled the cover and declared the transaction a sham to transfer a state-owned natural resource illegally. The veil was lifted to safeguard the interest of people and state income.

8. Policy Concerns, Legal Uncertainty, and Criticism.

8.1 The Peril of lawlessness in jurisprudence.

One of the biggest criticisms of the judicial history of veil-lifting in India and elsewhere in the common law world is that it lacks rigor in terms of its doctrine. Veil-piercing jurisprudence is sometimes referred to as a maze or unprincipled by scholars. Instead of using predictable, analytical tests of law, courts often employ extremely subjective, pejorative metaphors to describe a company as a sham, alias, puppet, or cloak.

Such subjectivity is very disturbing in terms of law. A creditor transacting with a subsidiary may rush to the parent company and request it to settle the debts of the subsidiary basing on some vague allegations of being an economic entity. Judges with too broad discretion to apply the veil in the name of “justice” creates systemic risk. Unpredictable veil-piercing interferes with the basic commercial need of investors to price risk correctly by offering legal certainty.

8.2 The Principle of Concealment vs. Evasion (The UK Approach)

The rigorous doctrinal transparency of recent UK jurisprudence has not been embraced by Indian courts. By distinguishing between concealment and evasion in the UK Supreme Court of the case of Prest v. Petrodel Resources Ltd. (2013), Lord Sumption limited the doctrine substantially.

• Concealment: In this case a company is employed to hide the identity of the real actors. In this case, the court does not even have to lift the veil, it merely applies ordinary legal means (such as the law of agency or trusts) to peep behind the veil.
• Evasion: This is where a person is liable or has an existing legal duty and he avoids the obligation by inserting a company in between. The only circumstances under which the veil is really pierced are those of evasion.

This is one of the analytical frames that Indian jurisprudence ought to embrace to minimize judicial arbitrariness.

8.3 The Issue: Fairness and Legitimate business expectations.

The final quandary is whether to trade equity and economic efficiency. Rude or unpredictable uncovering of the veil is extremely detrimental to the honest business anticipations. In case honest entrepreneurs suspect that their personal resources are going to be targeted because of an honest, but failed, business venture, then the economic advantages of limited liability are eviscerated, fearing innovation and risk-taking.

9. Reform Proposals and the Way Forward.

Indian corporate law needs to be approached with a delicate future-oriented thinking to resolve the tension between curbing abuse of corporations and preserving the sanctity of limited liability. It is impossible to fully forego the Salomon principle, yet the reinforcement of the measures against its abuse is urgently needed in the age of the sophisticated global finance.

9.1 Capturing Tests of Judicial Review of Lifting the Veil.

The legislature ought to look at revising the Companies Act to incorporate a systematic guideline that sets out the precise parameters of judicial veil-piercing. A codified rule, similar to a statutory alter ego rule, that would necessitate evidence of total domination, unity of interest, and the commission of a particular fraud, would restrain the arbitrary discretion in judicial decisions, but still maintain the doctrine as a means against true fraudsters.

9.2 Changing the Emphasis towards the Director Liability and the Wrongful Trading.

Instead of a veil piercing to assault passive shareholders, reforms must pay much attention to the behavior of the board. The increase in the wrongful trading provisions by the IBC is a good move. In case a business goes down in a disaster because of gross negligence or irresponsible risk-taking by the managers, the directors ought to be held liable to demonstrate that they were acting in the best interest of the creditors as the business approached insolvency. This secures creditors without the need to dissolve the corporate entity itself.

9.3 Improved Disclosures, KYC, and UBO Tracking.

It is better to prevent than judge veil-piers post-facto. Regulators can trace the people behind convoluted networks of shell companies by enhancing the strength of Know Your Customer (KYC) norms and enforcing strict and real-time reporting of Ultimate Beneficial Ownership (UBO) before a fraud is completely perpetrated. The projects of the Ministry of Corporate Affairs (MCA) like the ACTIVE (Active Company Tagging Identities and Verification) registry, and the greater merging of information between the MCA and SEBI and the Income tax department are important measures.

9.4 Independent Directors and Auditors Role.

The corporate form can be prevented to be abused by strengthening the independence and accountability of the gatekeepers- auditors and independent directors. Tougher punishment of auditors who do not disclose shams between holding and subsidiary companies can serve as an effective deterrent to the establishment of facade corporate forms.

10. Conclusion

Corporate personality is still one of the most brilliant creations of law jurisprudence that underlies the establishment of the contemporary, industrialized global economy. The principle, which was decided in Salomon v. Salomon–the separation of the company as a legal person independent of its members–is the immovable rock on which company law rests. It has liberalized investment, encouraged unprecedented concentration of capital, and cushioned honest entrepreneurs against ruinous personal liability. But the corporate veil is not a divine, absolute right but a practical legal instrument. It is a State privilege to facilitate legitimate business. The urge to use the corporate form to launder money, evade taxes and commit fraud is growing exponentially as Indian markets become more and more complex, intertwined with the global financial systems. The principle of lifting or piercing the corporate veil is the necessary outlet of the law. Indian law, through a developing body of common law, a series of landmark Supreme Court decisions, and a series of tougher statutory provisions within the Companies Act and the Insolvency and Bankruptcy Code, has made the legal fiction of the corporation to be impregnable to the wrongdoers. To balance between two extremes is the future of Indian corporate jurisprudence. It needs to carefully guard the limited liability of the good investors to generate capital and confidence in the business, and at the same time it has to create clean-cut, predictable and rock-solid legal provisions to quickly tear the veil when the corporate entity is turned into a simple instrument of fraud. It is only by such a cautious tuning that the law can go on to promote economic growth and yet remain faithful to the core principles of equity and justice.