Lifting Or Piercing The Corporate Veil: Clarifying The Two-Step Examination

[By Arunoday Rai]

The author is a student of National Law School of India University.

 

Introduction

The doctrine of lifting or piercing the corporate veil is fundamental to the company law. This doctrine acts as an exception to the concept of a company being a separate juristic entity. It allows the court to treat the rights and liabilities of the corporation as the rights and liabilities of its shareholders. The courts in India have recently tried to expand the horizon of this doctrine to pay regard to the new economic realities behind the evolving corporate structure in the modern era. 

This article contends that such an expansion of this doctrine has been on a misplaced understanding of Supreme Court (SC) precedents. The courts in India have failed to provide a sound legal basis to expand the contours of this doctrine and have failed to differentiate between various attitudes with which SC has lifted the veil in different cases. It argues that SC has used this doctrine in two types of situations: the first type involves peeping behind/lifting the veil, whereas the second type of cases involves penetrating/piercing the veil. The author sheds light on the confusion caused by the interpretation of the doctrine by the courts due to their lack of understanding of the above-mentioned two-step examination. 

The Two-Prong Test  

It is essential to understand what is meant when the courts lift the veil of the company. The doctrine is generally been used to impose liability on the shareholders or alter ego of the company by lifting the veil. However, the two-stage analysis in this post highlights that such a view of the doctrine is incomplete. The act of lifting the veil is not always detrimental to the shareholders/alter ego of the company but can be beneficial at times.  

Peeping Behind/Lifting the Veil 

The first stage in the analysis involves the least discussed act taken by the court, where it merely lifts the veil of the company. At this stage, the court lifts the veil of the company to gather information such as shareholding patterns, shareholders, control, etc. It pulls down the veil once such information is gathered and the company is treated as per the information gathered during the inquiry done by the court at this stage. For instance, the statutory lifting of the veil provided in Sections 2(46) and 2(87) of the Companies Act, 2013 is a classic example of this stage.  

The SC in the case of Renusagar had to adjudicate on the issue whether Renusagar was a power plant owned by Hindalco. If both these entities were considered to have no separate existence, then Hindalco would be entitled to certain exemptions on electricity duty by the State government. The SC lifted the veil to hold that both industries had no independent existence and were inextricably linked up together. The judgment by the SC eventually benefitted the Petitioner’s company as the veil was lifted only to investigate the relationship between both entities involved in this petition. 

SC has also provided certain prerequisites that need to be fulfilled before the veil is lifted or peeped into. The apex court in LIC v. Escorts had held that a veil can be lifted in various situations such as fraud or improper conduct, evasion of taxing or a beneficent statute, public interest, effect on parties, etc. It did not provide a straight jacket formula but listed broad illustrative situations where the veil could be lifted. However, it went ahead to say that in the present case, no such lifting of the veil is necessitated beyond the governing statutes involved as it is not necessary to the case. 

Therefore, it should be noted that this stage only involves the court lifting the veil and is a condition precedent to the next stage of penetrating the veil where a court after gathering information may make an order against the company imposing liability on them or refrain from imposing any liability.  

Penetrating/Piercing the Veil 

This stage involves the imposition of liability upon the shareholders for the company’s acts through the piercing of the veil. Such liability can be seen through Section 36 of the Companies Act, 2013 where a person who knowingly or recklessly induces persons to invest money can be held liable for action under Section 447 of the Act. This provision is an example of the statutory piercing of the corporate veil where liability is imposed on a person for committing a prohibitive act. 

The standard for piercing the corporate veil has been subject to contradictory judgments in India. While some courts have held that fraud is a sine qua non for piercing the veil, other courts have held to the contrary. This article supports the former view by underscoring the importance of demonstrating impropriety or evasion of legal obligations as a prerequisite for piercing the veil.  It has upheld such a view by recognizing that the law does not allow for imposing liability on mere commonality or interlocking shareholding or common directorships. The requirement of fraud or evasion of a legal obligation is essential to protect the fundamental precept that every company is a distinct legal entity. However, various courts have agreed to the latter view as they have conflated the standards to be used during the two-stage analysis while applying this doctrine. 

The Confusion 

Several courts in India have held that the contours of this doctrine cannot be restricted to the requirement of fraud/sham/façade and could be extended to situations where justice, equity, public interest, and convenience so required. The courts that have taken this view have tended to rely on judgments of the SC in LIC v. Escorts and Renusagar which has been interpreted to enlarge the standard of piercing the corporate veil.  

For instance, the Bombay High Court in Bhatia International has held that the doctrine is no longer restricted to the cases of tax evasion but also pertains to cases that are opposed to justice and convenience. It goes ahead to state that once the court has concluded that two companies are single entities then the general rule of limited liability and separate entity of companies would not apply. Essentially, this judgment holds that once the court has peeped behind the veil and come to a certain conclusion, there is no requirement for the court to even enter into the analysis of the second stage.  

Various High Courts who have reasoned along similar lines to Bhatia International have conflated the two-stage analysis presented in the doctrine.1 They have missed the fact that while the first stage is merely about gathering information, the second stage deals with the imposition of liability. Therefore, since both stages have different implications for the company involved, the standard present at one stage cannot be imported to the other.  

The reliance of these judgments on LIC and Renusagar is misplaced as both of these judgments do not delve into the second stage (liability) analysis at all. Both these judgments pertain to the lifting and not piercing the veil. Therefore, when these judgments mention that the scope of lifting the veil is unlimited, they are in effect talking about such standards being present while lifting and not piercing the veil. The judgments that have been relied on by the SC in these cases themselves have pierced the corporate veil in cases of circumvention of law or fraud. 

In the cases where the corporate veil was required to be pierced, such as Skipper Construction, TELCO, and Vodafone International the SC held that the corporate veil can only be pierced in cases of fraud/wrongful purposes, sham/façade entity, and evasion of statutory obligation. The SC in Balwant Rai Saluja discusses this jurisprudence and relies on Prest to hold that the principle of piercing the veil needs to be applied in a restrictive manner where a subsidiary company is being formed as a mere camouflage to avoid liability.  

The Bombay HC also relies on the SC’s judgment in Gotan Lime where it pierced the corporate veil on the grounds of public interest. However, the said judgment is per incuriam as it ignores various SC’s precedents such as Skipper Construction and Vodafone International to create a new category termed as ‘public interest’. It fails to discuss LIC v. Escorts and selectively quotes the precedents such as Renusagar and Skipper Construction without contextualizing the entire judgment. As stated above, Renusagar does not deal with liability whereas Skipper Construction categorically holds that fraud is a mandatory pre-condition before imposing liability on a company. It fails to even mention SC’s judgment on Balwant Saluja which had a higher judge bench and was decided two years earlier. 

Conclusion 

The courts, like in Bhatia International, have failed to understand the difference between lifting and piercing the veil and conflates the standard used in the former to be used in the latter scenario. This article demonstrates that courts have failed to provide a sound legal basis to import the standard of ‘lifting’ the veil into ‘piercing’ the veil. The article also traced the SC judgments to flesh out the two-prong test and the respective standards used for them. After analysing the precedents, it becomes clear that the SC has tended to distinguish between the two stages involved in this doctrine and has categorically held the requirement of fraud or impropriety to be present while piercing the veil. 

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