THE CONCEPT OF REVERSE PEIRCING OF CORPORATE VEIL

Background

 

The doctrine of piercing of the corporate veil has a much long dated history and was begun not in the industrial sector but with religious institutions and churches who held properties separate from individuals or their legal heirs who were in control of these institutions which later was expanded to other institutions such as hospitals, universities or colleges by 16th century. Furthermore, it is notable to say that 17th century brought an increase in trading and formation of trading corporations which completely got in line with this doctrine. The theories of corporate personality were the subject matter of jurists who tried to define legal persons and separated the concept of legal persons (juristic persons) from natural persons. The jurisprudential aspect describes Legal persons as real or imaginary beings to whom personality is attributed by law by way of fiction where it doesn’t exist in fact. There are two essentials of legal persons – corpus and animus ,the former is the attribute for the body into which law infuses the animus while the animus represents the will or intention of the fictitious personality.

Doctrine of the Corporate Veil 

 

In literal sense, a corporation is an artificial or fictitious person constituted by the personification of a group or a series of individuals. A corporation has in law a different existence and personality from that of its members or shareholders. The foundation of corporate governance rests on this principle that a company is a separate legal entity , distinct from its members and shareholders providing them financial protection. Thus, the company is neither an agent nor a trustee of its members and hence ,they are not liable for each other’s acts except as provided in any law governing them. In simple words, the company after incorporation is not liable for any act or omission of the members or shareholders and vice versa. This protection or shell between the members/shareholders company is known as its ‘corporate veil’ in legal context.

This principle was surfaced and gained recognition in the case of Saloman V/s A. Saloman & Company Limited decided by the House of Lords in 1897, wherein the legal fiction of the company as a juristic person was separated from the actions, rights and liabilities of the company from its shareholders or officers, by refusing to permit the primary shareholder to be made liable for the debts of the insolvent company, and hence, overturning the decision passed by the Court of Appeals. It gave judicial recognition to the contention that after incorporation, the company has a separate personality independent of its shareholders, which cannot be considered as acting as an agent for them. The Salomon principle has been given due recognition as a basic canon of company law in India, both by the judiciary as well as legislators, with the doctrine of the corporate veil enshrined in the Companies Act, 2013 act as well.

In ReKondoli Tea Co. Ltd. The Calcutta High Court rejecting the plea of the shareholders for exemption from the ad valorem duty , observed that the Company was a separate body from its shareholders and hence, held that the transfer of tea estate to shareholders had been as if they were totally different persons. Therefore, although a shareholder owns all the shares of the company, the business of the company is not his until the company is treated as an agent of that sole shareholder. The shareholder must be differentiated from the company. Such was also held in the famous case of Macaura v. Northern Assurance Co. Ltd.

Doctrine of Piercing of Corporate Veil 

 

Gradually, the repercussions of  this doctrine were revealed and far reaching due to this  a need was felt to curb its scope. Various complex structures of the company to avail  benefits added to this misery. For instance, hypothetically if the recognition of a separate corporate personality was absolute,the obligation placed on an individual could be overcomed by the incorporation of a company having such a person as the majority shareholder. Moreover, with this conjecture the companies could then restrict their liability to a bare minimum by forming a series of shell companies having little or no assets or using subsidiaries to indulge in illegal or prohibited activity. So this corporate veil was sought to be maintained but it is pertinent to note that fraud and misconduct started in some exceptional circumstances due to this principle. Therefore, the courts across the globe sought to ‘lift the corporate veil’ for achieving the ends of justice.Thus, in simpler words, piercing of corporate veil refers to the liability imposed by the Courts on those persons who are actually guilty of the wrongful act or omission under the garb of corporation.  The reasons which supported the contentions of the court include :

• As the Company is an artificial person, it is numb and  powerless without its members and can’t do anything on its own. For instance, a company cannot have a mens rea , separated from its officers to constitute an offence.
• It is further important to note that in the interest of justice ,it is necessary to adopt flexible and liberal approach to resolve the disputes encircling the company and its liabilities.

 

There are various theories governing the doctrine of piercing of corporate veil determining its far reaching ends but they do work on a generally accepted basic rules and the party seeking to pierce the corporate veil has to pass through the two prong test :

There should be presence of  unity of interest and ownership that the separate personalities of the company’s members/shareholders do not exist, and

 That if the alleged acts are treated by the corporation alone, then an inequitable result shall follow.

Case 1: Gilford Motor Company v. Horne

 

In this case, the ex-employee of Gilford Co. contractualized that he could not solicit the customers of the company but in order to defeat this provision, he then incorporated a company in the name of his wife and started soliciting the customers of that company. The Court of Appeal contended that the second company in Mr. Horne’s wife’s name was a mere device as the main purpose of incorporating the company was to perpetuate fraud. Therefore, the Court was in favour of lifting the corporate veil. 

Case 2: Ben Hashem v. Ali Shayif

 

This case was a matrimonial dispute before the England and Wales High Court where emerged six famous tests regarding any piercing (traditional or reverse) of the corporate veil which have now crystallized themselves in English and Indian law, which are as follows :

Ownership and control are not solely sufficient for the court’s satisfaction to pierce the corporate veil.

Even Though there is absence of unconnected third party interest, piercing may only take place because it is necessary in the interests of justice.

The court felt that the veil can only be pierced if impropriety in usage is proved.

That impropriety must be in the usage of corporate entity.

Control by the wrongdoer together with impropriety is important to be proved.

The corporate form has to prove their point beyond doubt in the cases of fraudulent intent.

A recent instance of lifting back the corporate veil in the context of tax assessment was Vodafone International Holdings B.V. V/s Union of India where the company challenged a show cause notice issued by the revenue authorities  claiming that the indirect transfer of 67% of shares of Indian entity Hutchison-Essar caused by purchase of 100% shares of another offshore company would attract payment of capital gains tax in India to the tune of rupees twelve thousand. A three judge bench of the Supreme Court held out in favour of the company, thereby overturning the decision of the Bombay High Court whose decision pierced the corporate veil by arriving at the conclusion that the transaction of acquisition of shares of the offshore target company amounted to transfer of controlling stake of the Indian entity of Hutchison-Essar.

 

Apart from the judicial authenticities ,there are various provisions in the Companies Act 2013 which are in consonance of lifting the corporate veil , they include Sections – 34,35, 45,147(2) ,542 .

 

Doctrine of Reverse Piercing of Corporate Veil

 

This doctrine is just an antithesis to the traditional doctrine of piercing of the corporate veil which incorporates that the individual liability of the shareholders and members of the company could be reversed . In other words, the reversal of the doctrine of piercing of the corporate veil is reverse piercing since in this case, the shareholders and members of the Company make it liable for its own debts in contradiction to the traditional doctrine. It is a concept of American origin rather than English Common law as in 1992 , New York it was first noted that the reverse piercing of a corporate veil is permissible . In the United States ,it was argued that its importance arises in varied complex situations, wherein for instance, if the creditor of the shareholder is not allowed to reverse pierce then his claim would only depend on the personal ability of the person to pay back coupled with the amount received by him from the company. However, the reverse piercing is still a controversial theory in situations either where there are multiple shareholders of the company or when the creditors are given the higher pedestal, like that of corporation’s creditors ( but it is rare) . As a result, the reverse piercing is less universally accepted than the traditional veil piercing.

The doctrine of ‘reverse’ piercing was  unheard of in India as well as in the UK. The Indian courts initially were reluctant in bluntly accepting this jurisprudence, especially before 2005.

But, finally, in the landmark decision of  Standard Chartered Bank v. Directorate of Enforcement (“Standard Chartered Bank”) , SC held that a corporation can be prosecuted and punished for an offence with fines, regardless of the mandatory punishment required under respective statutes. In this present case,the Bank was being prosecuted for violation of certain provisions of FERA. The SC digressed from the literal and strict rule of interpretation, as is required for penal statutes, and sought to deliver complete justice by imposing fine on the corporate. This marked the incorporation of the ‘reverse’ piercing doctrine into the jurisprudence of Indian courts.

Conclusion

 

The doctrine of ‘reverse’ piercing, although not properly enunciated,percolated into the jurisprudence in India. But the trouble is not yet solved as no corporate criminal liability can be fixed on a company unless there is a statutory provision mandating the same, and it continues to this day. Consequently, ‘reverse’ piercing has a limited scope. But, it should not be forgotten that public policy coupled with justice and stability with time cannot be forsaken. The courts must more actively allow the ‘reverse’ piercing concept, even if not as the first resort but definitely in circumstances that allow for it.