There are some disadvantages of incorporation which are important to be pointed out.
1. Lifting the corporate veil:
The theory of corporate entity is indeed the basic principle on which the whole law of corporation is based. But there are circumstances, which compel the court to identify the company with its members. There are situations where the court will lift the veil of incorporation in order to examine the realities which lay behind. In doing so, The Court may lift the corporate veil to identify the members of the company and thus make the directors personally liable or ignore the separate entity of a company which is a member of a group of companies or a subsidiary to a principal/parent company and declare it identical with that parent company as its agent.
This concept is based principally on discretion of the Court. But in the Companies Act 1994 some provisions are made to hold the directors personally liable despite the fact that Company is a separate legal entity. The case laws and the statutory provisions are discussed below—
In the case of R Vs Mc Donnel –1966, the Managing Director of a Company, being the sole director of the Company committed fraud with another Company. Here the company cannot be convicted of conspiring with its sole director. In the circumstances, the Court said, where the sole responsible person in the company is the defendant himself, it would not be right to say that there were two persons or two minds.
The corporate veil is said to be lifted when the Court ignores the company and concerns itself directly with the members or managers. The circumstances under which, the Courts will lift the corporate veil are as follows—
- Determination of Character:
Occasionally it becomes necessary to determine the character of a Company, for example, to see whether it is enemy. In such a case, the courts may in their discretion examine the character of persons in real control of the corporate affairs.
Case Reference – Daimler Co Vs Continental Tyre & Rubber Co, 1916
A Company was incorporated in England for the purpose of selling tyres manufactured in Germany by a German Company. The German Company held the bulk of shares in the English Company. The holders of the remaining shares (except one) and all the directors were Germans, resident in Germany. Thus the real control of the English Company was in German hands. During the 1st World War the English Company commenced an action to recover a trade debt. And the question was whether the Company had become an enemy company and should therefore, be barred from maintaining the action.
The House of Lords laid down that a company incorporated in UK is a legal entity, a creation of law with the status and capacity which the law confers. It is not a natural person with mind or conscience. It can be neither loyal nor disloyal. It can be neither friend nor enemy. But it may assume an enemy character when persons in de facto control of its affairs are residents in any enemy country, or wherever resident, are acting under the control of enemies. Accordingly the company was not allowed to proceed with action. If the action had been allowed the company would have been used as machinery, which would accomplish the purpose of giving money to the enemy. That would be monstrous and against the public policy.
But where there is no such danger to public interest, the courts may refuse to tear upon the corporate veil.
Case Reference – “Peoples Pleasure Park co Vs Rohleder” – 1908
Certain lands were transferred with express stipulation that property cannot be sold to the coloured persons. The property was transferred to a company composed exclusively of Negroes. Action was brought to annul the conveyance.
The Court rejected the argument and held that, members individually or collectively are not the corporation; the company is a separate entity. Members may be Black or white but company has no colour.
- For the benefit of revenue:
The court has the power to disregard corporate entity if it is used for tax evasion or to circumvent tax obligation.
Case – Dinshaw Maneckjee Petit, Re – 1927
The assessee was a wealthy man enjoying huge dividend and interest income. He formed four private companies and divided his income into four parts to reduce his tax liability.
The Court held that the companies were formed purely & simply as a means of avoiding super-tax and the companies were nothing but the assessee himself. So the court lifted the corporate veil & considered the companies & the assessee as the same entity.
- Fraud or improper conduct:
The courts will refuse to uphold the separate existence of the company where it is formed to defeat law or to defraud creditors or to avoid legal obligations. One clear illustration of this principle is Gilford Motor Co Vs Horne – 1933.
Horne was appointed as the managing Director of the Plaintiff Company on the condition that he shall not at any time while he shall hold the office of a MD or afterwards, solicit or entice away the customers of the company. His employment was determined under an agreement. Shortly afterwards he opened a business in the name of a company which solicited the plaintiff’s customers.
It was held that the defendant Company was a mere channel used by the defendant Horne for the purpose of enabling him, for his own benefit, to obtain the advantage of the customers of the plaintiff company, and that the defendant company ought to be restrained as well as the defendant Horne.
- Agency/trust and government Companies:
A company may sometimes be regarded as an agent or trustee of its members or of another company and may therefore be deemed to have lost its individuality in favor of its principal.
According to Cohen LJ, “a parent Company & a subsidiary Company, even a 100% subsidiary company, are distinct legal entities, and in the absence of an agency contract between the two companies one cannot be said to be the agent of the other.”
Atkinson J first noted the rule that, “it is well settled that the mere fact that a man holds all the shares in a company does not make the business carried on by that company his business. It is well settled that there may be such an arrangement between the shareholders and a company as will constitute the company the shareholders’ agent for the purpose of carrying on the business and make it the business of the shareholders.”
The learned judge referred to six points which are useful for ascertaining who really was carrying on the business—
- Were the profits treated as the profits of the Parent Company?
- Were the persons conducting the business appointed by the parent Company?
- Was the company the head and brain of the trading company?
- Did the company govern the adventure, decide what should be done and what capital should be embarked on the venture?
- Did the company make the profit by its skill and direction?
- Was the company in constant and effectual control?
If the conditions are fulfilled, the subsidiary company loses its separate personality and is treated as the agent of the principal company.
- a) Under Section 222 of the Companies Act 1994, if at any time the number of members falls below the prescribed minimum and the company carries on the business with that reduced shareholding (less than two members for private and less than seven members for public companies) for more than six months then the remaining members who know that this is the state of affairs, will be personally liable for all the debts the company contracts after the said period of six months.
- b) Section 78 requires a company to display in front of its office its name and registered address and also show its name on its seal, bill heads, notice and advertisements etc. Section 79 provides that if a company which defaults in complying with the provisions of Section 78 then every officer who has knowingly and willfully approved of the default will be liable to penalty and personally responsible for any debt of the company contracted on the bill heads etc.
Thus the directors were held personally liable on a cheque signed by them in the name of a company stating the company’s name as “L R Agencies Ltd”, the real name being “L & R Agencies Ltd.”
- c) Section 75 of the Act provides that in a limited company the liability of the directors or of any director may be unlimited if so provided by the memorandum. If a Director holds any office then his liability may also be unlimited as an officer of the if he is a director whose liability is unlimited even if the does not provide for the liability of a director to be unlimited, a limited company if so authorized by its articles may, by special resolution, alter its resolution so as to render unlimited the liability of the directors.
- d) Section 186 of the Act requires a holding company to attach with its balance sheet the auditors report, profit and loss account and certain other information of its subsidiaries. The statute thus seeks to publish a broad picture of the entire group of the companies and ignore the separate entity of the subsidiary companies.
- Formality and Expenses:
Another disadvantage of corporation is its expense and formality. Incorporation is a very expensive affair and requires a number of formalities to be complied with. As compared with it, the formation of partnership is very simple. Again administration of a company has to be carried on strictly in accordance with provisions of the Act.
- Company is not a citizen:
Neither the Constitution of Bangladesh nor the Companies Act attributes citizenship towards a company. All the Members of a Company are Bangladeshi citizens does not necessarily mean that the Company is a Bangladeshi citizen. A company is, however, a person in the eyes of law and it can claim the protection of such fundamental rights as are guaranteed to all persons whether citizens or not.
The company has, however, nationality of that country where it was incorporated and residence where it keeps house and does business.