All India Bar Examination (AIBE) 3-III Previous Year Question Papers with Answers

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82.

A is an executive director and the majority shareholder of XYZ Private Limited. A borrows Rs. 25,00,000/- from BCD Bank and invests such money in additional shares of XYZ Private Limited, increasing A's stake in XYZ Private Limited to approximately seventy- five per cent. As A is unable to repay the debt to BCD Bank, BCD Bank proceeds against the assets of A and XYZ Private Limited for recovery of the monies borrowed by A. Which of the following statements most accurately applies the principles below?


Principle :

Upon incorporation, a company corporate has an independent existence, being a separate and distinct legal entity from its members. In certain exceptional circumstances, however, the courts ignore the separate identity of the company and impose liability on the members or managers who are responsible for the actions of the Company. This is known as the doctrine of "lifting of the corporate veil'.

A: BCD Bank will be successful in its proceeding against XYZ Private Limited because such money borrowed by A was utilized for the benefit of XYZ Private Limited.
B: BCD Bank will not be successful in its proceeding against XYZ Private Limited as XYZ Private Limited has not directly borrowed any money from BCD Bank
C: BCD Bank will be successful in its proceeding against XYZ Private Limited because the corporate veil will be lifted by the judiciary, as A is an executive director on the board of XYZ Private Limited.
D: BCD Bank will be successful in its proceeding against XYZ Private Limited because the corporate veil will be lifted by the judiciary, but it can only recover monies equivalent to A's seventy five per cent shareholding.
E: BCD Bank will not be successful in its proceeding against XYZ Private Limited as A does not hold a hundred per cent stake in XYZ Private Limited.

The answer is: B

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Explanation

The correct option is B. BCD Bank will not be successful in its proceeding against XYZ Private Limited as XYZ Private Limited has not directly borrowed any money from BCD Bank.

Explanation:

The principle of lifting the corporate veil is applied when the company is used as a device or a sham to evade legal obligations or to commit fraud. In such cases, the courts can disregard the separate legal personality of the company and hold the members or directors liable for the acts of the company. However, this is an exceptional and rare measure, and the courts are generally reluctant to pierce the corporate veil unless there is clear evidence of abuse or wrongdoing.

In this case, there is no indication that A used XYZ Private Limited as a device or a sham to borrow money from BCD Bank. A borrowed money in his personal capacity and invested it in additional shares of XYZ Private Limited, which increased his stake in the company. This does not mean that XYZ Private Limited became liable for A's debt, as the company and A are separate legal entities. The fact that A is an executive director and a majority shareholder of XYZ Private Limited does not alter this position, as he acted in his personal capacity when he borrowed money from BCD Bank. Therefore, BCD Bank cannot proceed against the assets of XYZ Private Limited for recovery of the monies borrowed by A.

The other options are incorrect because they either assume that XYZ Private Limited is liable for A's debt or that the corporate veil will be lifted by the judiciary without any valid reason.