Under What Circumstances the Court May Disregard the Separate Legal Entity of a Company?

2. Holding and Subsidiary Company Relationship:

A company is termed as a holding company when it has the power to control the composition of the board of directors of another company or holds a majority of its share in another Company.

The other company called a subsidiary of the former company has a separate legal entity. The principle of lifting the corporate veil is applicable in holding-subsidiary company relationship in two cases:

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(i) Section 212 of the Companies Act requires a holding company to attach to its Balance-Sheet, copies of the Balance Sheet, Profit & Loss Account, Director’s Report and Auditors Report of each of its subsidiaries.

Further, listed companies are required, as per the Accounting Standards, to prepare Consolidated Balance Sheet to give better information of the financial position of the group as a whole to the creditors, shareholders and public.

(ii) Where in spite of subsidiary companies being separate legal entities, the facts and circumstances show that they are in reality parts of one concern owned by a parent company or a group as a whole.

3. Investigation in the Affairs of a Company:

If an inspector is appointed under section 235 or 237 of the Companies Act to investigate the affairs of the company, he has the power to investigate also the affairs of any other related company in the same management or group (section 239). This is in complete disregard to the separate entities of the companies.

4. Investigation of Ownership of a Company:

Where it appears to the Central Government that there is good reason to do so, it may appoint one or more inspectors to investigate and report on the membership of any company and other matters relating to the company, for the purpose of determining the true persons:

(a) Who are or have been financially interested in the success or failure, whether real or apparent, of the company; or

(b) Who are or have been able to control or materially influence the policy of the company. (Section 247)

Thus, it involves piercing the corporate veil.

5. Directors with Unlimited Liability:

Ordinarily, the liability of a director in a limited company is the same as that of the members of the company. There is nothing in the Act, however, to prevent their liability being made unlimited by memorandum of the company or if limited by memorandum, being converted into an unlimited liability in pursuance of authority given by the articles. The same principle applies also in the case of a manager of a limited company. (Sec. 322)

6. Fraudulent Conduct of Business:

If in the course of the winding up of a 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 persons, the court, on the application of the official Liquidator or the liquidator or on application of any other creditor or contributory of the company may, if it thinks it proper so to do, declare that any persons who were knowingly parties to the carrying on of the business in the manner above said, shall be personally responsible without any limitation of liability for all or any of the debts or other liabilities of the company as the court may direct. (Sec. 542)

7. Failure to Return Application Money:

If the application money of those applicants whom no share has been allotted is not repaid up to the 130th day of the issue of the prospectus, then the directors of the company shall be jointly and severally liable to repay that money with interest @ 6% p.a. from the expiry of 130th day. [Sec. 69(5)]

8. Misrepresentation in the Prospectus:

In the case of misrepresentation in a prospectus, every director, promoter and every other person who authorizes the issue of such a prospectus incurs liability towards those who subscribe for shares on the faith of untrue statements contained therein (Sec. 62). Further, they may be held criminally liable also (Sec. 63).

9. Misdescription 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). (Sec. 147)

10. Non-payment of Tax:

When any private company is wound up and any tax assessed on the company whether before or in the course of or after liquidation in respect of any income of any previous year cannot be recovered, then every person who was a director of that company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax.

He may, however, be exempted from this liability in case he proves that the non-payment of tax was not due to any gross negligence, misfeasance or breach of duty on his part. (Sec. 179 of the Income-tax Act)

11. Liability of Promoters for pre-incorporation contracts:

Promoters will be personally liable for all those pre-incorporation contracts which are not adopted by the company after incorporation.

12. Ultravires Acts:

The directors of the company are personally liable for all those acts which they have done on behalf of the company, which are:

(i) ultra-vires the company, or

(ii) ultra-vires the directors if the company does not adopt those acts.

13. Liability under other Statutes:

There are many other provisions of the company law where director(s) of a company are personally liable for the default in complying with those provisions. Some of these are: non-maintenance of proper books of accounts; default in holding of annual general meetings; default in filing the annual returns; default in paying dividends after declaration; false declaration of solvency; non- cooperation with the company auditors or with the liquidators (in the event of winding up of the company); non-compliance with the regulations of the Securities and Exchange Board of India (SEBI).

Besides these, directors may be held liable under pollution laws, social security laws (e.g. Minimum Wages Act, ESI, EPF, and Gratuity), and Competition Act, Foreign Exchange Management Act (FEMA), and taxation laws.

In all the above cases, the corporate veil shall be broken through and the company shall not be allowed to use its legal entity to give shelter to the fraudulent or otherwise guilty persons.