The doctrine of “piercing the corporate veil” is a well settled exception to the principle that a company is a separate legal entity which is distinct from its owners and management and has its own legal rights and obligations. Taking advantage of this exception, a curious case of a lender has arised alleging directors of a company for non-repayment of loan which was taken by the company. Upon being decided by the trial court that directors are liable for the repayment of loan, the directors appealed against such judgement resting their fate with the Hon’ble Delhi High Court to decide the case. This interesting question of whether corporate veil should be lifted or disregarded was unfolded in the matter of Sanuj Bathla & Anr vs Manu Maheshwari & Anr on 12 April, 2021.
In this write-up, the author has discussed the facts of the case, alongwith the arguments of both parties, landmark judgements on the issue and final judgement of the Court.
Facts of the case
- The Respondent (Manu Maheshwari/ Lender) gave a loan of Rs. 52 Lakh to M/s. Independent Disk Mastering Private Limited (company/ borrower) on continuous request and persuasion of the Petitioners who are the directors of the company for smooth functioning of the company.
- The lender instituted a suit for recovery of loan upon non repayment of the said loan by the company. The suit was filed against the Company also making its Directors parties to the matter.
- The directors later filed an application seeking deletion of their names from the array of parties on the ground that they were merely Directors in the Company and the Company had taken loan as a separate legal entity.
- Vide impugned order dated 27.07.2018, Trial Court dismissed the application filed by directors of the company.
- Thereafter, aggrieved by order of Trial Court, the directors filed a revision petition seeking deletion of petitioner’s name from array of parties.
Arguments by Petitioners (Directors of the borrower company)
It was argued that there was no contract between the Lender and directors of the borrower company because the alleged loan was given by an Account Payee cheque in favour of the company.
That the directors of the company cannot be made personally liable for the outstanding dues and liabilities of the Company, unless they have given a guarantee, indemnity etc. or there are allegations of fraud etc.
The Trial Court failed to appreciate that liability of a Director of a Company, under law, is confined in case of malfeasance and misfeasance and/or the actions of the Directors amount to an act under the law of tort towards those whom they owe a duty to care i.e. discharge fiduciary obligations. Therefore, it is only under the law of tort that Directors can be made personally liable qua third parties. In the entire plaint, there are no allegations of tort against the directors or that they stood as guarantors or indemnified the Plaintiff, towards the alleged loan.
Arguments by Respondent (Lender)
The Petitioners were the directors and principal officers of the Company and in-charge and responsible for its day-to-day affairs and thus jointly and severally liable and responsible for the acts done on behalf of the Company.
The directors are friends of the Lender who jointly as well as personally requested and persuaded the Lender for financial assistance for smooth functioning of the business of the Company.
Respondents were the directors of the Company when the suit was filed against the Company. However they resigned subsequently and appointed their employees as Additional Directors of the Company. This was a deliberate act to avoid the liability of payment to the Lender.
The directors have been diverting funds of the Company for their personal use and have withdrawn huge cash amounts.
The Company has been ‘struck off’ from the MCA. Summary of accumulated losses shows that the Company has been incurring losses only. In these circumstances, if the directors are deleted from the array of parties and even if the decree is passed in favour of the Lender, it will become in-executable because the Lender will not be able to recover money..
Analysis
While considering the issue, reliance was placed upon numerous landmark judgements which have been discussed below:
In the judgment titled as M/s. Red Zebra Gift Promotion P. Ltd & Anr Vs. Purnavi Events P. Ltd‘. It has been held by the Hon’ble High Court of Delhi that there is no doubt about the fact that a company is a separate legal entity and has a distinct identity from Directors, but, this protection afforded to the Directors of the company is not ironclad or impenetrable. In reality, individuals/persons are the ones who run the company in the hope of reaping benefits out of it. In a case where a court determines that a company’s business was not conducted in accordance with the provisions of corporate legislation, it can pull up the “corporate veil” and discover the true culprit. This lifting of the corporate veil is essential for the purpose of determining the persons who are liable for any fraudulent or unlawful practices done in the garb of running a corporate body.
The doctrine of piercing of corporate veil owes its origin to the landmark case of Salomon vs. A. Salomon and Co. Ltd. (1987) AC 22, where the House of Lords observed as under :-
“to be essential to the artificial creation that the law should recognise only that artificial existence-quite apart from the motives or conduct of individual corporators. In saying this, I do not at all mean to suggest that if it could be established that this provision of the statute to which I am adverting had not been complied with, you could not go behind the certificate of incorporation to shew that a fraud had been committed upon the officer entrusted with the duty of giving the certificate, and that by some proceeding in the nature of scire facias you could not prove the fact that the company had no real legal existence. But short of such proof it seems to me impossible to dispute that once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself, and that the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are.“
The doctrine is an exception to the principle that a Company is a legal entity, separate and distinct from its shareholders, with its own legal rights and obligations. It discards the separate entity of the Company and attributes the acts of the Company to those who are in direct control of its operations. In Ben Hashem vs Ali Shayif (2008) EWHC 2380 (Fam), six principles were crystallized for applying the said doctrine, which are as follows:-
(i) ownership and control of a company were not enough to justify piercing the corporate veil;
(ii) the Court cannot pierce the corporate veil, even in the absence of third-party interests in the company, merely because it is thought to be necessary in the interests of justice;
(iii) the corporate veil can be pierced only if there is some impropriety;
(iv) the impropriety in question must be linked to the use of the company structure to avoid or conceal liability;
(v) to justify piercing the corporate veil, there must be both control of the company by the wrongdoer(s) and impropriety, that is use or misuse of the company by them as a device or facade to conceal their wrongdoing; and
(vi) the company may be a ‘facade’ even though it was not originally incorporated with any deceptive intent, provided that it is being used for the purpose of deception at the time of the relevant transactions.
The position in India with regard to the lifting of corporate veil is found in several decisions. In Life Insurance Corporation vs. Escorts Ltd. & Ors. (1986) 1 SCC 264, a Constitution Bench of the Supreme Court held as follows :-
“90…. Generally and broadly speaking, we may say that the corporate veil may be lifted where a statute itself contemplates lifting the veil, or fraud or improper conduct is intended to be prevented, or a taxing statute or a beneficent statute is sought to be evaded or where associated companies are inextricably connected as to be, in reality, part of one concern. It is neither necessary nor desirable to enumerate the classes of cases where lifting the veil is permissible, since that must necessarily depend on the relevant statutory or other provisions, the object sought to be achieved, the impugned conduct, the involvement of the element of the public interest, the effect on parties who may be affected etc.“
In Balwant Rai Saluja vs Air India Ltd. (2014) 9 SCC 407, the Supreme Court held as under :-
“71. Thus, on relying upon the aforesaid decisions, the doctrine of piercing the veil allows the Court to disregard the separate legal personality of a company and impose liability upon the persons exercising real control over the said company. However, this principle has been and should be applied in a restrictive manner, that is, only in scenarios wherein it is evident that the company was a mere camouflage or sham deliberately created by the persons exercising control over the said company for the purpose of avoiding liability. The intent of piercing the veil must be such that it would seek to remedy a wrong done by the persons controlling the company. The application would thus depend upon the peculiar facts and circumstances of each case.”
However, it has to be borne in mind that the doctrine is not available in every case of alleged liability against a Company. It is only available in restricted cases and limited circumstances, where it is permissible to so do under a Statute or where the corporate structure has been instituted to perpetuate a fraud or is a camouflage, facade or sham to avoid liability or in a case where effect has to be given to a beneficial Legislation. These can be broadly outlined as instances where the corporate veil can be lifted, though it cannot be said that this is an exhaustive list.
One may also refer to observations of the Supreme Court in Arcelormittal India Pvt. Ltd. vs Satish Kumar Gupta & Ors. (2019) 2 SCC 1, as follows :-
“37. It is thus clear that, where a statute itself lifts the corporate veil, or where protection of public interest is of paramount importance, or where a company has been formed to evade obligations imposed by the law, the court will disregard the corporate veil. Further, this principle is applied even to group companies, so that one is able to look at the economic entity of the group as a whole.”
Petitioner also relied upon the judgment of the Co-ordinate Bench in Mukesh Hans & Anr. vs Smt. Usha Bhasin & Ors. 2010 SCC OnLine Del 2776, which squarely covers the present case and fortifies the view taken by this Court. Relevant passages from the judgment are as follows :-
“10. The short question which arises for consideration in the present appeal is as to whether the appellants as erstwhile Directors of the Company, M/s. Dawson Leasing Limited (In Liquidation) can be made liable in a suit for recovery of money when the Directors have not made themselves personally liable by extending any guarantee, indemnity, etc.
11. Indubitably, a company incorporated under the Companies Act, whether as a private limited company or a public limited company, is a juristic entity. The decisions of the Company are taken by the Board of Directors of a Company. The Company acts through its Board of Directors, and an individual Director cannot don the mantle of the Company by acting on its behalf, unless he is so authorized to act by a special resolution passed by the Board or unless the Articles of Association so warrant. It is equally well settled that a Director of a Company though he owes a fiduciary duty to the Company, he owes no contractual duty qua third parties. There are, however, two exceptions to this rule. The first is where the Director or Directors make themselves personally liable, i.e., by execution of personal guarantees, indemnities, etc. The second is where a Director induces a third party to act to his detriment by advancing a loan or money to the Company. On the third party proving such fraudulent misrepresentation, a Director may be held personally liable to the said third party. It is, however, well settled that this liability would not flow from a contract, but would flow in an action at tort, the tort being of misrepresentation and of inducing the third party to act to his detriment and to part with money.
12. This is the settled position ever since 1897 when the House of Lords decided the case of Salomon vs. Salomon & Co. Ltd. 1897 AC 22, and Lord Macnaghten, observed as under: –
“the company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation the business is precisely the same as it was before, the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by that Act.”
13. However, with the passage of time inroads have been made into the aforesaid legal principle that the company is a legal entity distinct from its shareholders and directors and certain exceptions have been carved out. One such inroad is commonly described as lifting or piercing of the corporate veil. This has been succinctly put by the Supreme Court in Tata Engineering and Locomotive Co. Ltd. v. State of Bihar [1964]6SCR885 as follows:
“24. The true legal position in regard to the character of a corporation or a company which owes its incorporation to a statutory authority, is not in doubt or dispute. The Corporation in law is equal to a natural person and has a legal entity of its own. The entity of the Corporation is entirely separate from that of its shareholders; it bears its own name and has a seal of its own; its assets are separate and distinct from those of its members; it can sue and be sued exclusively for its own purpose; its creditors cannot obtain satisfaction from the assets of its members; the liability of the members or shareholders is limited to the capital invested by them; similarly, the creditors of the members have no right to the assets of the Corporation. This position has been well established ever since the decision in the case of Salomon v. Salomon and Co. was pronounced in 1897; and indeed, it has always been the well-recognised principle of common law. However, in the course of time, the doctrine that the Corporation or a Company has a legal and separate entity of its own has been subjected to certain exceptions by the application of the fiction that the veil of the Corporation can be lifted and its face examined in substance. The doctrine of the lifting of the veil thus marks a change in the attitude that law had originally adopted towards the concept of the separate entity or personality of the Corporation. As a result of the impact of the complexity of economic factors, judicial decisions have sometimes recognised exceptions to the rule about the juristic personality of the corporation. It may be that in course of time these exceptions may grow in number and to meet the requirements of different economic problems, the theory about the personality of the corporation may be confined more and more.”
Judgement
In order to pierce the corporate veil there must be allegations of fraud or unlawful practices against the Directors in the garb of a Corporate structure. The Court as a matter of fact found in the facts of the said case that the Directors were responsible in the day-to-day affairs of the Company as well as actively involved in the communications made before and after the placing of the supply orders and were therefore a necessary party. In the present case, the only averment in the plaint as mentioned above is that the directors had along with their friend requested the Lender and persuaded him to advance loan to the Company. The facts of this case do not inspire piercing the corporate veil so as to continue the Directors as parties in the suit.
Allegations in the plaint do not refer to any transaction with the directors of the company in their personal capacity apart from stating that they were known to the Lender in a friendly capacity. Although it is claimed that the money was advanced as loan due to personal relation with the directors, it is undisputed that the transaction was directly with the Company and loan was advanced in the name of the Company by a cheque. Instalments were being paid to the Plaintiff from the account of the Company. There is no allegation of fraud levelled against the directors nor is there any averment that the Corporate structure was created as a mere facade or camouflage to avoid liabilities.
In the absence of any allegations of fraud or misrepresentation, Directors cannot be held personally liable. It is also not the case where the Directors were personal guarantors to the loan transaction or had assured to indemnify the amount. It is a settled law that the doctrine of lifting the corporate veil is available to the Lender where it is permitted by the Statute or Corporate structure is instituted to perpetuate a fraud. The averments made in the plaint do not justify the lifting of the corporate veil to make the Directors personally liable. The cryptic observation of the Trial Court, that the facts and circumstances of the case attract the principle of lifting the corporate veil, is not supported by the pleadings and the order does not even give any reasons for having so held.
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