FRAUD
BY DIRECTORS: LIABILITY & CORPORATE VEIL
The Companies Act 1956 have undergone overhaul and
Companies Act 2013 now is a comprehensive Act entailing details about the
incorporation of a company and procedure for corporate governance and intricacies
related to role and liability of Directors, their fiduciary relationship and
the civil and criminal actions as contemplated within the meaning of the Act
are also illustrated. The company is a juristic entity and can sue or be sued
only by natural person. The Directors have the limited liability, often in
respect of the governance of company and in case of fraud by a company, the
Directors or any officials in Managerial or Supervisory position in the
delinquent company shall also be liable.
The issue that is faced oftenly by a claimant against the company is the
impediments as regards lifting of
corporate veil of a company and the Directors of a company extricates
themselves from personal liability on the aforesaid premise. What, if fraud is
committed by a Director? Whether the Directors shall be immune to the fraud
committed? How the issues are to be dealt with are the questions that bothers
many.
LAW & PRECEDENTS
In a case reported as Mukesh
Hans & Anr vs Uma Bhasin & Ors 2010Lawsuit/Del 3237 dealt with
the issue of personal guarantee of a Director in a company. The issue was
whether the Directors could be held personally liable in respect of affairs of
a company , if: (i) There is no personal guarantee executed by him (ii) If
there is averment in plaint that the Directors were personally liable and had
undertaken to pay the liability personally and (iii) If there is no personal
undertaking, whatsoever. Another dimension to the case shall be, what if the
debtor company has gone into liquidation? The hon’ble Delhi High Court in the
above referred case has held in para no.11 as under:
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 decision of the Company are taken by the Board of
Directors of a Company. The Company acts through the Board of Directors, and an
individual Director cannot don the mantle of the Company, by acting on its
behalf, unless he is authorized to act by a special resolution passed by
Board or unless by article of Association so warrants. 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. Secondly, 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
liability would not flow from a contract, but would flow in an action on tort,
the tort being of misrepresentation and of inducing the third party to act to
his detriment and to part with money”.
A celebrated judgment reported as Salmon
Vs Salmon & Co. Ltd 1897 AC 22 may
be referred to, wherein 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 trustees 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.
The hon’ble Supreme Court in a case captioned
as New Horizons Ltd vs Union of India
1995 1 SCC 478 has held in para 27 as under:
27. The conclusion would not be different even if the
matter is approached purely from the legal standpoint. It cannot be disputed
that that in law, a company is a legal entity distinct from its members. It was
so laid down by House of Lords in 1897 in the leading case of Salmon Vs Salmon
& Co. Ever since this decision has been followed by the Courts of England
as well as in this country. But there has been inroads in the doctrine of corporate
personality propounded in the said decision by statutory provisions as well by judicial pronouncements. By the process
commonly described as “lifting the veil” , the
law either goes behind the corporate personality to the individual members or
ignores the separate personality of each company in favour of the economic
entity constituted by a group of
associated companies. . This course is adopted when it is found that the
principles of corporate personality is too flagrantly opposed to justice…..”
In a matter reported as Tristar
Consultants Vs Customer Service India Pvt Ltd & anr 2007 139 DLT
688, the Delhi High Court has held as under in paragraph no.28:
“To
interpret the law as is sought to be projected by the petitioner would mean
negation of the concept of a company being limited by its liability as per the
memorandum and article of association of the Company. Other then where
Directors are have made themselves personally liable i.e by way of guarantee,
indemnity etc. liabilities of directors of a company, under common law are
confined to cases of malfeasance and misfeasance i.e where they have been
guilty of tort towards those to whom they owe a duty of care i.e discharge
fiduciary obligations. Admittedly qua third parties, where Directors have
committed tort. To the third party, they may be personally liable”.
The hon’ble Delhi High Court has
held in Mukesh Hans (Supra) that if
there is assertion in plaint that the Directors had extended any contract of
guarantee or had undertaken to make payment to the respondents of the loan
amount on behalf of the company or owed liability in any manner then only the
Directors could be held to be liable. Moreover, a mere assertion of fraud shall
be meaningless, unless, the same is pleaded meticulously and in detail to the
hilt. As per Order VI Rule 4 of Code of Civil Procedure, the particulars of
fraud should be clearly stated in plaint with particulars.
In the above backdrop, it may be
worthwhile to refer to a judgment rendered by hon’ble Supreme Court in a case
reported as Raj Saluja Vs Air India Ltd (2014) 9 SCC 408:
“ 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 have been and should be applied in a restrictive manner, that is,
only in a 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
of veil must be such that 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”.
The Supreme Court has held in Arcelormittal India Pvt Ltd vs Satish Kumar
Gupta & Ors (2019) 2 SCC 1 has
held as under:
“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 the company has been found to evade obligations imposed by
the law, the court will disregard the corporate veil. Further his principle is
applied even to group companies, so that one is able to look at the economic
entity of the group as a whole”.
CONCLUSION
The aforesaid discussion based on
the judgments rendered by hon’ble Supreme Court and hon’ble Delhi High Court has
laid down that salmon case (Supra) cannot be applied holistically and in all
situations and in all circumstances and that law has evolved ever since. The
Salmon case is a benchmark, alright, and lifting of corporate veil is generally
not recommended , but in the case of public interest, camouflage, deception and
fraud, Salmon (Supra) shall not aid the delinquent. The personal guarantee,
apart, if fraud is inbuilt in a suit or petition and averments with specific particulars
to that effect are found conspicuous in such plaint or petition, then, in such
a situation protective umbrella of Salmon
(Supra) shall not be available to such Directors and the Directors could be
held liable. Moreover, when the plaint with specific lists of the acts
attributed on Directors and his personal liability by virtue of such documents
or undertaking are part of record, the Directors cannot claim immunity. The
situation has changed and quite vastly taking note of overall good and public
interest. The deception and deceit have also acquired new dimension and blanket
ban to prosecution of individual Director on the premise of no individual liability
shall not hold good in every case and if a closely held company is created for an
outlet of sham transaction and the debtor is sought to be defrauded, then, Salmon (Supra) shall not aid such Director.
Moreover, even when lack of contract or lack of privity may help a Director
from evading personal liability, law of tort and malfeasance and misfeasance
may still catches with them if the acts of fraud and deceit are evident.
______
Anil K Khaware
Founder & Senior Associate
Societylawandjustice.com
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