Corporate groups or controlling shareholders
Introduction
In order to render controllers of corporate groups or controlling shareholders individually accountable for the debts of the company, the courts are empowered to lift the veil of incorporation. However, this is drastic and has to be resorted to only under extreme circumstances. As the extant case law clearly indicates, such a course of action is not resorted to as a matter of course. Instances, wherein such activity had been directed against inactive shareholders of public companies, have not come to light. In the main, case law had dealt with instances of deliberate distortion of facts. The legislation of the United Kingdom holds liable any person who intentionally conducts company business, with the object of defrauding creditors, if that company is shut down[1].
The term lifting the veil of incorporation or lifting the corporate veil is used to refer to the practice of viewing the true nature of a company, subsequent to ignoring its distinct existence in law, under certain circumstances. The constituents of a company and its members are not treated differently, according to this doctrine.
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The principal distinguishing factor of a company is that it is treated as a separate legal entity that is not only distinct from but also independent of its constituents. This specific property of a company, bestows a number of advantages on a company. Although, a company is deemed to be distinct from its members, the fact remains that it is an association of persons, who not only own the entire property of the company, but also enjoy all the benefits that ensue from its commercial activities. The effect of being considered a separate entity under law has the effect of ignoring these true beneficiaries of the company, after its formation and legal entity status bestowal.
In the normal course of events, this status of a separate legal entity, enjoyed by a company is acceded to. In fact, this doctrine of corporate personality of a company forms the basis of the law of corporation. Nevertheless, such the benefits accruing from the enjoyment of a status of a separate legal entity cannot be utilized for unlawful business purposes[2].
In the course of settling disputes, the courts are at times, compelled to determine the identity of the persons who really control a company. Such instances, transpire when the legal entity of the company is employed for perpetrating acts of a fraudulent nature, indulging in inappropriate behaviour or committing acts that harm public policy[3].
In all such instances, the courts lift the veil of incorporation. Such a measure by the judiciary falls within its discretion and is dependent on the economic, moral and social issues that pertain to the company. As such the courts intervene and dispel the veil of incorporation, whenever, the latter is utilized by a company to conceal its malafide acts[4].
Upon incorporation a company becomes a separate entity. It acquires the corporate personality by donning the corporate veil. A company is a separate entity from the shareholders who had formed it. The law considers an incorporated company as an independent entity. However it is an artificial person and behind the corporate veil, there are the shareholders of the company. Similarly, the assets of the company are not the assets of shareholders and its debts are not those of its shareholders[5].
Salomon v Salomon & Co[6]: Statement of Authority
The principle of corporate veil was established in Salomon v Salomon & Co. That case had demonstrated that a company has a unique identity, which is different from its directors and shareholders. The court held that the acts of the company in its corporate role were not those of its shareholders. Its liabilities were different from the liabilities of its shareholders, although they held the shares of the company[7].
Salomon had been a sole trader in the boot and leather business. He had formed a limited company, with his family members as shareholders. Subsequently, he had sold his earlier business at an estimated cost of £40,000, which was an over estimation of the assets, by nearly £8000. In the new company, his wife, daughter and four sons held one share each; and Salomon held the remaining shares of the company. This company bought the old business of Salomon and issued shares and debentures for £10,000 and the business was sold on a floating charge of assets. Eventually the company was wound up. At the time of declaring insolvency, the company’s liabilities had included debenture, which had exceeded the cost of its assets by £7,700[8].
The creditors of the old company claimed that both Salomon and the company were one and same. They contended that the debenture held by Salomon were to be deemed as null and void. They further argued that Salomon could not be his own creditor. One of the creditors Broderip had given loan to Salomon who had issued some debenture as security for that loan. Subsequently, Salomon replaced his old debentures with new ones. Salomon failed to pay interest on the debentures, with the result that Broderip initiated legal action against the company. At that juncture, the company had been liquidated, in order to evade payments to other creditors. Acceptance of Broderip’s claim would have precluded the other creditors from receiving any amount from the company towards their dues from it. The liquidator of the company had insisted that Salomon should refund the creditors, because the assets of the company had been inflated, and because forming a new company would permit evasion of the responsibility to pay back the amount due to its creditors. Hence the liquidator turned down the purchase agreement on the grounds of an intentional fraud by Salomon. The trial court concurred with the argument of the creditors that Salomon and his company was one and the same. They also opined that as such he could not become a creditor to the company and that his debenture should not have any effect. The case was referred to the House of Lords, which held that his debentures were to be deemed to be valid, although there was the involvement of an element of fraud. Their Lordships opined that the company had been formed properly, with the consequence that it had become a separate legal entity in the eyes of law. The company was held to be totally independent of Salomon[9].
The case of Salomon had further established the legal position of family companies in which the majority of shares were controlled by one person. It also demonstrated the availability of incorporation for small as well as large companies. Thus corporate personality tends to limit liability not only to the capital amount of the company, but to mitigate the risks attached to debentures. Although the ruling in this case was controversial, it served to distinguish a limited company from its shareholders and directors. This established the corporate entity of an incorporated company[10].
Lifting the Veil defined
Piercing the corporate veil is a process adopted by the courts, whereby they disregard the corporate personality, with the intention of determining the identity of the persons hiding behind the corporate veil, who had indulged in activities that had affected the corporation. The courts pierce the corporate veil, identify the offender and impose liability on that person. Piercing the corporate veil of a company implies that the courts had ignored the corporate identity of the company and identified the actual person who had acted from behind the corporate veil. The fundamental objective in lifting the corporate veil is to prevent the misuse of the corporate personality by its directors or shareholders. By piercing the corporate veil the courts expose the true nature of a company[11].
The court in Salomon case had established that an incorporated company attains a legal personality that is distinct from that of its members. However, the courts do not apply this principle to incorporated companies all the time. Under certain circumstances, courts would pierce this corporate veil. The Companies Act 1985 specifies the situations, in which the courts can lift the veil of incorporation.
Examples of Statutory Lifting of the Corporate Veil
1. During a National Emergency
The courts monitor companies during wartime to determine whether any misuse of the corporate personality had transpired. Accordingly, courts may lift the corporate veil, in order to determine the true composition of a company. National emergencies, like economic crises, warrant the intervention of the courts. Under such circumstances, the courts intervene and lift the veil of incorporation of the company.[12]
Daimler v Continental Tyre and Rubber Co[13]
This was what had happened in Daimler v Continental Tyre and Rubber Co. In that case the court had lifted the corporate veil, during the World War I. It had done this in order to determine the nationality of the company and to ensure whether it belonged to the enemy company, because the shareholders of that company were German nationals. Subsequently, after lifting the veil of incorporation, the court successfully established the fact that the company belonged to the enemy.[14]
2. In Cases of Fraudulent Abuse of a Company
The courts will show the least reluctance to pierce the corporate veil, if any fraudulent element is detected behind the corporate garb. The courts do not permit recourse to the principle established in Salomon, to promote fraudulent activities. Such cases can be referred to as fraudulent cases.[15]
Gilford Motor Company Ltd v. Horne [1933][16]
In Gilford Motor Company Ltd v. Horne, the defendant, Horne left the plaintiff company to establish his own business. At the time of his leaving the plaintiff company he had agreed to a restrictive covenant, which restricted the defendant from soliciting customers of his former company. Later on, he set up a company that was dealing in the same type of business. The defendant argued that he was bound by the covenant, since the company was a separate person. The Court of Appeal held that the defendant had formed the company as a device to mask his intentions. This established that the primary objective of forming the company was to perpetrate a fraud. The Court ruled that the company was a facade to conceal his fraudulent activities.[17]
Jones v. Lipman [1962][18]
In Jones v. Lipman, there was a contract between the defendant and the plaintiff with regard to the sale of land. Subsequently, the defendant changed his mind and did not want to complete the sale. The defendant established a company and transferred the property to the company in order to avoid the transaction. Lipman then claimed that he was not the owner of the land and therefore he could not complete the contract. The judge held that the company formed by the defendant served as a mask for him and that the defendant had attempted to avoid recognition by law. Accordingly, the judge granted an order of specific performance.[19]
Inferences from 1 and 2
These cases served to demonstrate that courts do not permit the use of the corporate veil as a façade, behind which fraudulent activities are carried out. The courts disapprove any connection between such persons and the company. There could be several reasons for the courts to lift the corporate veil of the company and to identify the fraudulent elements in the company. However, in the absence of a clear and precise policy or principle, such piercing of the corporate veil results in uncertainty, despite the fact that the objective of the courts is to restrict the fraudulent use of the corporate veil.
The decision of the Court of Appeal in Adams v Cape Industries plc[20] and Jones v Lipman[21] are instrumental in specifying the court’s stance in lifting the corporate veil, in situations where the accused had used the corporate personality for evasion. These are first, when the defendant attempts to evade the limitations imposed on his conduct and secondly, in the event that third parties obtain a right of relief against the defendant. The courts do not lift the corporate veil for future purposes. However, using corporate personality to mitigate future liabilities is permitted[22].
The courts determine the level of deception in any particular case. In Hilton v Plustile Ltd[23], both the plaintiff and the defendant had agreed to use the corporate personality of the company in an agreement relating to tenancy, in order to circumvent provisions of the Rent Act 1977. The Court of Appeal held that the plaintiff had been aware of the issue, at all times, and was consequently, precluded from invoking a piercing of the corporate veil[24].
The discussion in Adams case clarifies the effect of deception on third parties. The issue was whether the corporate personality of a company could be used to invoke a piercing of the corporate veil and whether this was justified. The court held that it should be first established that the company had been used as mask to conceal the facts. Therefore, it was essential to determine, whether the motive to commit fraud had been in existence. If the defendant rejected the plaintiff’s legal rights, then the fraud exception would come into force. Further if there was no legal right on the part of the plaintiff, then the defendant’s intention to deceive the plaintiff could become tentative and would not have any future consequences. As such the fraud exception had to be fulfilled, in order to employ the corporate form to evade the legal right[25].
Brief overview of Adams v Cape Industries[26]
The issue in this case was that the holding company had to be permitted, on the basis of the corporate form, to avoid the risk of indirect liabilities for the group’s asbestos trade in the USA. The argument sought to enable the holding company to be in a position to regulate the affairs of the group. However, this argument lacked reason. The courts lifted the veil of incorporation, because the company’s corporate form had been employed in such a way that the liability for the deeds of the group fell on the subsidiary instead of the holding company. This was neither correct nor relevant. Further, a single economic unit operating its business through a group of companies would hinder the trade union in complying with the legal provisions relating to industries.
The Court of Appeal held that if the corporate form was used for the purpose of evading the legal liability, with respect to future activities of the group, then the liability would fall on some other member of the group but not on the defendant company. Under the provisions of the law, the plaintiff could not bring about a lifting of the corporate veil against the defendant company, because the defendant company was also a member of that group[27]. Thus, the Court dismissed the argument. The argument had aimed at lifting the veil of incorporation of the corporate group, since it had operated as a single economic unit.[28]
In order to lift the corporate veil, the Court of Appeal held that it had to treat the Cape group, as a single economic entity, treat the subsidiaries as a mere façade or consider them to be agents of the Cape group. The court argued that the activities of the perpetrator may be substantial in other similar cases. In those cases, the existence of an intention to deceive the plaintiff had been present. Moreover, the Court held that there was no such intention in Adams case. This made it necessary to determine, whether the motive for deception was essential for establishing fraudulent exemption. In addition, the other important factor to be ascertained was regarding the nature of the legal right that was not available to the plaintiff.[29]
The position prior to Adams v Cape Industries
The position earlier to Adams in establishing a group of companies as a single economic unit was unclear and uncertain. In this context, there were a number of similar cases, in which the holding company had regulated its subsidiaries, even though the principle of single economic entity had been established. Moreover, the holding company had exerted significant control on the corporate policies of subsidiary companies.[30]
Holdsworth v. Caddies[31]
The appellant company had employed the respondent as its managing director. The House of Lords opined that the appellant company could require the respondent to serve in the former’s subsidiary company. This decision was based on the fact that the subsidiary company was a component of the holding company.[32]
Scottish Co-op v. Meyer[33]
In this case their Lordships held that the relationship among a group of companies was to be considered as a single legal entity. Thus, the subsidiary’s veil of incorporation was to be pierced.[34]
DHN Food Distributors Ltd v. Tower Hamlets[35]
In this case the holding company DHN, was conducting business from the premises of Bronze Ltd, which was its subsidiary. A transport business, solely for DHN was conducted by the remaining company in the group. The Borough Council of Tower Hamlets issued a purchase order on the land from which the business was being conducted. The Court held that Bronze Ltd was to be compensated and that additional compensation for disturbance had to be paid for the disturbance so caused. The Council contended that the latter compensation was unnecessary, as the business was not conducted independently from those premises. The court opined that the three companies were to be considered as a single legal entity.[36]
The position after Adams v Cape Industries
The decision in Adams v Cape has made it very clear that the courts are reluctant to pierce the corporate veil, merely, because a company has the capacity to manipulate the corporate policies of another company. In situations where a holding company controls the policy of its subsidiary, there should be a fascia regarding the incorporation of the latter. As such the courts are averse to any departure from the principles established in Salomon case.[37]
Woolfson v Strathclyde RC[38]
With Woolfson, it became mandatory to establish a fascia. In this case their Lordships did not pierce the corporate veil, despite similarities with the DHN Food case. As such the House of Lords did not consider the Appellate Court’s decision to pierce the corporate veil to be tenable.[39]
Unlike the Adams case, wherein there had been a holding company subsidiary company relationship; the Woolfson case entailed the control over a group of companies by an individual. A person named Woolfson owned 99.9 per cent of the shares in the Campbell Ltd. A lady held one share, while Woolfson held 999 shares in Campbell Ltd. Along with her husband and Woolfson, the three of them associated. However, there was no single controlling authority. This single share owned by the claimant’s wife was sufficient to deprive Woolfson of the right to claim as an owner cum occupier. The House of Lords opined that the different companies involved in this dispute were separately controlled and as a consequence, the veil of incorporation was to be left undisturbed, because the relationship between the companies was a facade.
The Appellate Court made it very clear that an economic connection between companies was by itself insufficient to classify them as a single economic entity. In the Adams case, Cape was an UK based company, which was continued by NAAC in the US. The CPC was a US company, whereas the AMC was a Liechtenstein registered company that had a marketing base in the US. The latter performed the role of Cape’s agents in US markets and the AMC
The Cape, based in the UK, was continued by NAAC in USA; CPC, an American marketing base and Liechtenstein registered company AMC, which acted as Cape’s agents in American market; AMC were the middle-men between Cape and CPC. After the liquidation of NAAC, the Appellate Court had to decide, whether it would be possible to enforce the judgment against Cape in the UK courts.
It was contended by Cape that it ceased to be liable with respect to the NAAC after the latter’s liquidation, because that act effectively nullified its presence in the US. This was accepted by the court, as it was of the opinion that the NAAC was not dependent on Cape, despite its controlling influence on NAAC’s general corporate policy. As such the court held that there was no exercise of absolute control over NAAC by Cape. Hence, it concluded that there was a lack of a façade. It further opined that a façade exists whenever an entity has no corporate independence of its own, it was an agent and nothing more or it had been employed for some illegal or deceitful purpose.[40]
Conclusion
A company is eligible to obtain total legal protection, only when the courts regard its status to be distinct and separate from that of the individuals who constitute it. The case law on this topic demonstrates that a corporation should perform its business activities, only in its corporate capacity. If an injured party sues for compensation, the courts determine whether the corporation acts as a separate and distinct entity and uphold its corporate status. If the courts find that the company had done so; then it does not hold its principals, such as its directors and shareholders, to be personally liable. In order to obtain and maintain this status, the corporation should adhere to a number of formalities. If the company fails in this very important aspect, the courts would disregard its corporate personality and fix personal liability.
In general, the court declines to consider a corporation to be legally distinct from its constituents, if it is a group of companies that form an economic unit or if some form of illegality is involved in its constitution. Moreover, the directors of a company cannot seek protection behind the corporate veil if the number of members of that company is less than required by law or the company’s commercial activities transpire in the absence of the registrar’s certificate. Moreover, in accordance with the Insolvency Act 1986, wrongful trading by the directors makes them personally liable.
Perhaps the main benefit of incorporation is that the principals’ liability is restricted to the assets of the company and their personal assets are not made liable. Nevertheless, the courts will pierce the veil of incorporation or make the principals personally liable.
The term piercing the veil of incorporation implies the rescinding of the corporate personality, in order to identify the human factor behind the corporate garb. In general, the courts pierce the corporate veil whenever the humans acting behind it indulge in fraudulent activities.
BIBLIOGRAPHY
1. Abbot R.K., Company Law, 5th Edition Reprint, 1995, DP Publications, London.
2. Adams v Cape Industries plc [1990] Ch 433.
3. Clement Chigbo. Corporate, Limited Liability And Lifting the Veil Of Incorporation. Retrieved on January 28, 2008 From <http://www.jonesbahamas.com/?c=135&a=9631>
4. Cushman, Robert Frank, et al. Design – build Contracting Formbook. 1997. Aspen Publishers Online.
5. Daimler v Continental Tyre and Rubber Co [1916] 2 AC 307.
6. DHN Food Distributors Ltd v. Tower Hamlets [ 1976 ] 1 WLR 852.
7. Fournet, Carolina. International Crimes: Theories, Practice and Evolution. Cameron May Ltd. 2006.
8. Gilford Motor Company Ltd v. Horne [1933] Ch 935.
9. Gillen, Mark. Chapter 14. The Legal Status of Corporations. Retrieved on January 30, 2008 from <http://209.85.173.104/search?q=cache:SYsdWvdHbNEJ:www.law.uvic.ca/mgillen/315/documents/Ch14-CorporatePersonality.pdf+broderip+v.+salomon&hl=en&ct=clnk&cd=18&gl=us>
10.Godfrey D, Watts E. Lifting the Corporate veil. Retrieved on January 28, 2008 from <http://www.middletonpotts.co.uk/library/default.asp?p=90&c=162>
11.Gogna, P.P.S. A Textbook of Company Law. S. Chand. ISBN: 8121920086.
12.Goldberg, Louis. An Inquiry Into the Nature of Accounting. Ayer Publishing. 1980.
13.Goulding S., Company Law, Second Edition, 1999, Cavendish Publishing Ltd., London, England.
14.Griffin S., Company Law: Fundamental Principles, 2006, Longman.
15.Hilton v Plustile Ltd [1989] 1 WLR 149.
16.Holdsworth v. Caddies [1955] 1 WLR 352.
17.Jones v. Lipman [1962] 1 WLR 832.
18.Kraakman, Reineier 2004 Oxford University Press.
19.Larson, Aaron. Piercing the Corporate Veil. Expert Law. August 2004. Retrieved on January 28, 2008 from < http://www.expertlaw.com/library/business/corporate_veil.html >
20.Mead, Larry. Fundamentals of Ethics, Corporate Governance and Business Law. Butterworth – Heinemann. 2006.
21.Owens, Keith. Law for Non – Law Students. Routledge Cavendish. 2001.
22.Puig, Gonzalo Villalta. A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine. Murdoch University Electronic Journal of Law. Retrieved on January 30, 2008 from < http://www.murdoch.edu.au/elaw/issues/v7n3/puig73a.html>
23.Sadhu A. Lifting the corporate veil. Retrieved on January 28, 2008 from
< http://www.legalserviceindia.com/articles/corporate.htm>
24.Salomon v Salomon & Co [1897] AC 22.
25.Schneeman, Angela. The Law of Corporations and Other Business Organizations. Thomson Delmar Learning. 2002.
26.Scottish Co-op v. Meyer [1959] AC 324.
27.Woolfson v Strathclyde RC 1978 SLT 159.
[1] Kraakman, Reineier 2004 Oxford University Press P 93 - 94
[2] Cushman, Robert Frank, et al. Design – build Contracting Formbook. 1997. Aspen Publishers Online. P. 29.
[3] Cushman, Robert Frank, et al. Design – build Contracting Formbook. 1997. Aspen Publishers Online. P. 29.
[4] Schneeman, Angela. The Law of Corporations and Other Business Organizations. Thomson Delmar Learning. 2002. P. 168.
[5] Larson, Aaron. Piercing the Corporate Veil. Expert Law. August 2004. Retrieved on January 28, 2008 from <http://www.expertlaw.com/library/business/corporate_veil.html>
[6] [1897] AC 22.
[7] Puig, Gonzalo Villalta. A Two-Edged Sword: Salomon and the Separate Legal Entity Doctrine. Murdoch University Electronic Journal of Law. Retrieved on January 30, 2008 from < http://www.murdoch.edu.au/elaw/issues/v7n3/puig73a.html>
[8] Goldberg, Louis. An Inquiry Into the Nature of Accounting. Ayer Publishing. 1980. P.139
[9] Gillen, Mark. Chapter 14. The Legal Status of Corporations. Retrieved on January 30, 2008 from < http://209.85.173.104/search?q=cache:SYsdWvdHbNEJ:www.law.uvic.ca/mgillen/315/documents/Ch14-CorporatePersonality.pdf+broderip+v.+salomon&hl=en&ct=clnk&cd=18&gl=us>
[10] Gogna, P.P.S. A Textbook of Company Law. S. Chand. P. 16. ISBN: 8121920086
[11] Gogna, P.P.S. A Textbook of Company Law. S. Chand. P. 16. ISBN: 8121920086
[12] Clement Chigbo. Corporate, Limited Liability And Lifting the Veil Of Incorporation. From
http://www.jonesbahamas.com/?c=135&a=9631
[13] [1916] 2 AC 307
[14] Abbot K.R., Company Law, (5th Edition Reprint, 1995, DP Publications, London) 42
[15] Goulding S., Company Law, ( Second Edition, 1999, Cavendish Publishing Ltd., London) 67
[16] [1933] Ch 935
[17] Goulding S., Company Law, ( Second Edition, 1999, Cavendish Publishing Ltd., London) 67
[18] [1962] 1 WLR 832
[19] Goulding S., Company Law, ( Second Edition, 1999, Cavendish Publishing Ltd., London) 68
[20] [1990] Ch 433.
[21] [1962] 1 WLR 832.
[22] Mead, Larry. Fundamentals of Ethics, Corporate Governance and Business Law. Butterworth – Heinemann. 2006. P. 168
[23] [1989] 1 WLR 149
[24] Owens, Keith. Law for Non – Law Students. Routledge Cavendish. 2001. P. 676
[25] Fournet, Carolina. International Crimes: Theories, Practice and Evolution. Cameron May Ltd. 2006. Pp. 160 - 161
[26] [1990] Ch 433.
[27] Godfrey D, Watts E. Lifting the Corporate veil. Retrieved on January 28, 2008 from < http://www.middletonpotts.co.uk/library/default.asp?p=90&c=162.
[28] Griffin S., Company Law:( Fundamental Principles, 2006, Longman: Pearson Education Limited, Essex, England) 17
[29] Sadhu A. Lifting the corporate veil. Retrieved on January 28, 2008 from
< http://www.legalserviceindia.com/articles/corporate.htm
[30] Griffin S. ( n 20 ) 18
[31] [1955] 1 WLR 352
[32] Griffin S. ( n 20 )17
[33] [1959] AC 324.
[34] Griffin S. ( n 20 ) 17
[35] [ 1976 ] 1 WLR 852.
[36] Griffin S. ( n 20 ) 18
[37] Griffin S. ( n 20 ) 18
[38] 1978 SLT 159.
[39] Griffin S. ( n 20 ) 19
[40] Griffin S. ( n 20 ) 19 - 20
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