Where a creditor can look beyond the company: personal guarantees, Section 141 NI Act, Sections 339 and 66, and the limits of lifting the veil.
A creditor of a company will usually find that the company, and not its directors or shareholders, is the debtor. That follows from the principle that a company is a legal person separate from its members. The principle has exceptions, and the law has also created personal liability for directors in specified cases. This note explains where a creditor can look beyond the company. It is general information, not advice on a particular company.
The starting point
A company, once incorporated, has its own legal personality, and its debts are its own. The members are liable, at most, for the unpaid amount on their shares, and the directors are not liable for the company's contracts merely because they signed them on its behalf. A creditor who has dealt with a company should expect to look to the company's assets, and to any security or guarantee the creditor took at the time.
Contractual routes to the directors
The most reliable way to reach a director or promoter is a personal guarantee, given in writing and drawn to meet the requirements of Sections 126 to 147 of the Indian Contract Act, 1872. A creditor should ask whether guarantees were given and, if so, whether they are still in force. A promoter's undertaking, or a letter of comfort, is weaker, and its effect depends on its wording.
Liability created by statute
- Dishonoured cheques. Under Section 141 of the Negotiable Instruments Act, 1881, where the drawer of a dishonoured cheque is a company, every person who was in charge of and responsible to the company for the conduct of its business at the time of the offence is also liable to be proceeded against.
- Fraudulent conduct of business. Section 339 of the Companies Act, 2013 allows the National Company Law Tribunal, in the course of the winding up of a company, to make persons knowingly party to the carrying on of its business with intent to defraud creditors, or for any fraudulent purpose, liable without limitation of liability for the company's debts.
- Fraudulent and wrongful trading in insolvency. Section 66 of the Insolvency and Bankruptcy Code, 2016 allows the Adjudicating Authority to direct that persons who carried on the business with intent to defraud creditors contribute to the assets of the corporate debtor. Section 66(2) applies to directors who knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency and who did not exercise due diligence to minimise the potential loss to creditors.
- Specific statutes. Some tax and labour statutes impose liability on directors for particular dues.
Lifting the corporate veil
Courts have, in limited circumstances, disregarded the separate personality of a company. The Supreme Court considered the principle in State of U.P. v. Renusagar Power Co. (1988), and indicated that the veil may be lifted where the company is a sham or a mere cloak for the personal affairs of its members, or where it is used to commit fraud or to avoid legal obligations. Courts treat the doctrine with caution. It is not a means of reaching shareholders because a company has failed to pay, and it is raised mainly where assets have been moved to a related entity to defeat creditors, or where the company has been used as a device to evade an existing obligation.
Evidence that matters
- Transfers of assets or business to a related company shortly before or after default.
- Common directors, shareholders, premises or staff between the debtor and a successor entity.
- Payments from the company to directors or relatives that are not explained by the books.
- Funds that were received for a specific purpose and were applied to another.
- Statements and documents in which directors personally assured the creditor.
The sources are largely public. The Ministry of Corporate Affairs records show the directors, the filings and the registered charges, and the audited accounts disclose related-party transactions.
A creditor's best protection against the limits of corporate personality is taken at the beginning of the relationship, in guarantees and security. Where that was not done, the statutory routes, and in clear cases the doctrine of lifting the veil, are the remaining ones, and each requires the creditor to prove specific facts.
This note is general information on the law at the date of publication. It is not legal advice, and it should not be relied on without advice on the facts of a particular matter.
