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Principles of liability and personality
This dissertation will discuss the principles of limited liability and corporate personality and the courts' reluctance to disregard the corporate veil the principle called “piercing the Corporate Veil”. We shall consider the circumstances in which the Courts have been able to pierce the veil of incorporation and the reasons as to why they have in most cases upheld the decision in Solomon v Solomon & Co.
All companies in the United Kingdom have to be registered and incorporated under the Companies Act which governs the principle of limited liability hence giving the owners or shareholders a curtain against liability from creditors in the case of the company falling into financial troubles. This curtain so created gives the company a separate legal personality so that it can sue and be sued in its own right and the only loss to the owners or shareholders is the number of shares held in the company on liquidation with no effect on their personal assets.
This distinct separation between the owners or shareholders and the limited company is the concept referred to as the ‘veil of incorporation' or ‘corporate veil'.
In conclusion, it shall be argued that the courts should lift or pierce the corporate veil to a significantly greater extent so as to hold erring shareholders or directors of a corporation liable for the debts or liabilities of the corporation despite the general principle of limited liability were the corporation has insufficient assets to off-set the creditor liabilities.
Limited liability and Corporate Personality
The principles of limited liability and corporate personality are the cornerstone of the United Kingdom company law since the Joint Stock Companies Act 1844, its consolidation in 1856 and the introduction of the Limited Liability Act 1855. These two principles have been so guarded by the courts as being fundamental to today's company law by upholding the separate legal personality of a corporate entity.
However, whilst the original intention of the legislation was to help companies raise capital through the issue of shares without exposing the shareholders to risk beyond the shares held, the present attraction to incorporating a company is the advantage of shielding behind the curtain of limited liability which could be abused by some businessmen.
As stated above, the doctrine of limited liability was introduced by the Limited Liability Act 1855 as a means by which companies could raise capital by selling company shares without exposing the shareholders to unlimited liability.
The principle of limited liability shields the company owners, shareholders and directors or managers against personal liability in the event of the company winding up or becoming insolvent. In such an event the liability of its owners and shareholders is limited to the individual shareholding held as provided for by the Companies Act 2006 and the Insolvency Act 1986. This means that the members of a company do not have to contribute their personal assets to the company assets to meet the obligations of the company to its creditors on its liquidation but have to contribute the full nominal value of the shares held by individual shareholders. It should be noted here that such limited liability does not shield the limited company from liability until all its debts or assets are exhausted.
This principle has so been held since the House of Lords ruling in the Solomon case in which the Lords where of the view that the motives behind the formation of a corporation was irrelevant in determining its rights and liabilities as long as all the requirements of registration are complied with and the company is not formed for an unlawful purpose.
Much as a limited company has a separate legal personality, its decisions are made by directors and managers who should use the powers conferred unto them by the company board of directors and the memorandum and articles of association, and any abuse will entail personal liability by the officer concerned.
Limited liability encompasses both the small enterprise including one-man companies and big companies hence limiting the liabilities to company assets and not to any other personal assets.
This view has been endorsed in recent times through numerous cases as evidenced in a one-man company, Lee's Air Farming. Lee was the majority shareholder and director in the company in which he was also the employee. He was killed on duty in an air accident and the court held that Lee and the company were two separate entities and hence entitled to compensation.
The courts will only in exceptional circumstances such as abuse, fraud or where the company was used as an agent of its owner disregard the doctrine of limited liability and hold members, shareholders or directors personally liable for the debts and other company obligations to the creditors in what has been termed the piercing or lifting of the "veil of incorporation". One commentator puts it plainly that “in this age of high expectations, people (and they may be good people) want to have their cake and eat it as well……They find a limited company a very useful vehicle for carrying on business because it has a separate legal personality which is responsible for all the debts of the business.”
However, there are several statutory laws which allow for the principle of limited liability to be ignored in such situations as in the reporting of financial statements of group companies, corporate crime and insolvency which we shall discuss below.
A limited company is a legal person with an existence which is separate and independent from its members as long as all the formalities of registration are adhered with in line with the Act. The corporate identity entails the company can sue and be sued in its own right without affecting its owners' or shareholders' rights. It is trite law that the only plaintiff to a wrong done to a company is prima facie company itself and not its shareholders except in instances where there is a fraud against shareholders or the acts complained of are illegal.
The company has been held as having an independent legal corporate personality since it was first held in the case of Solomon v A Solomon & Co Ltd . To emphasise this point, Lord Macnaghten said that it seemed impossible “to dispute that once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself, and that the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are".
In this case, Solomon registered his company into a limited company under the Companies Act which required a minimum of seven (7) members for incorporation. Solomon became the major shareholder with his wife and children holding a share each but the company ran into financial problems leaving no assets for the unsecured creditors on liquidation.
Whilst the court of appeal held the company to be a ‘sham' and an alias, trustee or nominee for Solomon and that the transaction was contrary to the true intent of the Companies Act the House of Lords reversed this decision and held that the company had been validly registered as required by the Act and hence had a separate legal personality from the shareholders. In arriving at this decision, Lord Macnaghten said that,
“The company is at law a different person altogether from the subscribers…….Nor are the subscribers, as members liable, in any shape or form, except to the extent and in the manner provided by the Act.”
This decision shows that the House of Lords identified that the important factor was the observance of the requirements and formalities of the Act which safeguarded the principles of limited liability and corporate personality. To date, this is the correct interpretation of the Company's Act and it is important that the principle in maintained in the advancement of commerce.
It should be noted here that the principle of corporate personality does not affect the company creditors to a large extent as far as the recovery of the debts is concerned.
Following the decision in the Solomon case, Professor Gower has described a limited company as being ‘opaque and impassable', whilst on the other hand it was described as ‘calamitous'.
Some commentators suggest that courts have been more inclined to the maintenance of the sanctity of the separate legal integrity of a company and have resisted the common law resolution of “peering under the skirts of a company to examine its linen (dirty or otherwise)” as can be observed from the numerous cases since the Solomon case.
The foregoing shows the importance to commerce of the incorporation of a company as it allows for continuity of the business transactions despite any changes in the owners, administrators, directors or shareholders of the company.
However, common law has in some exceptional instances ignored this principle in stances of abuse or fraudulent use of a sham corporate structure. The courts have ignored the corporate sham structure and peer behind the veil to identify the “directing mind and will” that control the company and such intervention being termed as lifting the veil, cloak or mask.
Whilst the courts have at times pierced the veil to benefit creditors when a company is placed under liquidation, there has been reluctance by the same courts to pierce the veil in instances which could have favourable results for shareholders.
The Directing Mind
A registered company is a separate and distinct legal entity, a body corporate possessing rights and made subject to duties being able to sue and be sued in its own right.
In the case of Lennard's Carrying Co Ltd v Asiatic Petroleum Co. Ltd, the court held that, “...a corporation is an abstraction. It has no mind of its own any more than it has a body of its own; its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation…..”
So we see here that the courts are willing to look behind the corporate veil as a matter of law so as to establish the directing officer behind the decisions and actions taken by the company.
The directing mind of a corporation is the senior person whose authority is derived from the company's board of directors to perform the functions of the company as directed and for the benefit of the company.
In the course of business, such senior persons would then delegate their authority to other employees for the efficient running of the company in which case such employees' actions or inactions would be considered as those of the “directing mind”.
Lord Reid further went on to define the “directing mind and will” of the company as the person who acts for the company as he acts as “the company and his mind which directs his acts is the mind of the company.……. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is a guilty mind then that guilt is the guilt of the company.”
Therefore, this would mean that the “directing mind and will” of the company is any employee who performs certain functions for the corporation as long as he has the authority to do so and does not act outside his mandate in which case he will be held personally liable.
In W illiams and another v. Natural life health foods ltd and mistlin, the case of a small one-person company, Sir Patrick Russell in his dissenting judgment pointed out that “the managing director will almost inevitably be the one possessed of qualities essential to the functioning of the company”, but that in itself does not mean that the director is willing to be personally liable to the company's customers.
Therefore to convict a company, the court will go behind the status of the separate legal entity distinction so as to establish the “directing mind and will” of the company controlling its activities.
However, it has been identified that the principle of limited liability can be subject to abuse and in the circumstances were there is statute will not provide justice or equity, the courts have in such exceptional circumstances disregarded the principle and held the shareholders or directors accountable for their decisions in the running of the company. The process in which the courts have disregarded the principle of limited liability is called “piercing the corporate veil” which is the main discussion of this document.
One-man Limited Companies
The Council Directive 89/667 provides for the formation of one-man private companies hence moving away from the Joint Stock Companies Act 1856 requirements. This Directive highlights the advancement in commerce and as can be indentified from the Solomon case, Mr Solomon was the owner of the company and only registered the other six shares for his wife and children to fulfil the requirements of the Act.
The company owners in these one-man corporations are in most instances also the directors of their companies and could abuse the corporate structure by registering their personal assets as those of the company hence escaping personal liability.
The courts are prepared to pierce the corporate veil in a one-man company and treat assets of the company as “property held by the defendants” were the company is held to be an alter ego of the owner.
However, the courts have shown that they are not prepared to pierce the corporate veil even in one-man limited companies as long as they are properly registered as required by the Act.
In the case lee v Lee's Air Farming mentioned above, Mr Lee incorporated Lee's Farming Limited and was the director and controlling officer as an employee of the company. On his death in an air crush whilst on duty and the family claimed workers' compensation. The court held that the company and Mr Lee were distinct and separate entities and hence Mr Lee was a worker in his own company.
Hence we see here the court's upholding of the principle set down by the rule in Solomon v Solomon which has remained controversial with changing commercial activity and globalisation.
The courts have been more willing to pierce the veil in one-man companies were the owner of the company is usually the controlling officer and does not deal with the company at arm's length. In the case of Wallersteiner v Moir , Lord Denning held that the subsidiaries were controlled by Dr Wallersteiner making them “puppets” which “danced to his bidding”.
Lord Denning is pointing out here that whilst the subsidiaries appeared to have a separate personality, they were in reality his agents or sham companies with no existence of their own and hence warranted the piercing of the veil.
This principle of corporate personality as established in the Solomon case has been extended to groups companies which we shall look at below.
Group companies comprise of the parent company with its subsidiaries carrying on their businesses not as a common enterprise or “single economic unit”, though portraying it as such to the outside world. The principle of limited liability applies to the subsidiary companies so formed as they are registered companies under the Act and as such each has a separate legal personality to the parent company and hence can sue and be sued in their own right.
The advantage of this arrangement to the group is that it limits liability to each subsidiary company in the group whilst sharing the group profits for the benefit of the group structure. Such group structures can lead to the parent company forming subsidiary companies to run its risky part of the business and hence insulating itself from liability in the event of the subsidiary company failing to meet its obligations to the creditors.
The effect of corporate personality in group companies is that each entity is legally independent and separate from other subsidiaries and the parent, hence each entity being liable for its own debts, which affirms the Solomon principle. However, Hobhouse LJ has argued that the courts should look at the whole group of companies as an economic entity.
On this subject, Lord Justice Slade said:
“Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities”. This is still the law and an affirmation of the principle in the Solomon case.
In the case of Ord & Another v Belhaven Pubs Ltd, the proprietors of a company which was in the business of acquiring old pub premises, doing them up and then letting them to tenants, duly let a renovated pub building to Ord. There had been misrepresentations made by the company as to the potential profitability of the premises which only came to light some time later. By the time Belhaven Pubs Ltd had ceased trading and could not meet its debts. Ord sought leave to substitute the parent company.
The Court of Appeal held that the defendant company which had granted the lease was legitimate and had not been a mere façade for the holding company and hence could not be substituted.
This basic principle of separate legal identity has been re-affirmed more recently in the Court of Appeal decision in Adams v Cape Industries PLC . In this case, the defendant company was a member of a corporate group with a UK parent company. The employees in its US subsidiaries were injured by inhaling asbestos dust and had successfully sued the subsidiaries in US courts. They applied to enforce judgement against the parent company arguing that Cape had been present in the USA through its subsidiaries as they formed a “single economic unit”.
The Court declined to pierce the corporate veil and held that the “fundamental principle is that each company in a group of companies is a separate legal entity possessed of separate legal rights and liabilities…”
The principle in the case of Solomon was upheld on the basis that the subsidiary companies had been legitimately formed and hence were separate legal entities distinct from the parent company.
However, there is need to look at the economic realities or the corporations with the advancement in industry with the significance of globalisation and treat group companies as one economic entity just like the legislation has been put in place for group accounts and corporate tax purposes and in this vein should concur with Lord Denning who said that:
“I decline to treat the [subsidiary] as a separate and independent entity… The Courts can and often do draw aside the veil. They can, and often do, pull off the mask. They look to see what really lies behind. The legislature has shown the way with group accounts and the rest. And the Courts should follow suit. I think that we should look at the Fork Manufacturing Co. Limited and see it as it really is - the wholly-owned subsidiary of Littlewoods. It is the preacher, the puppet, of Littlewoods, in point of fact: and it should be so regarded in point of law.”
It is argued here that the courts should be more inclined to lift the Corporate Veil to a significantly greater extent in cases involving corporate groups and as Gower rightly observes that, the law can "go behind the corporate personality to the individual members or directors, or it can ignore the separate personality of each company in favour of the economic entity constituted by a group of associated companies.
The Corporate Veil
The corporate veil is the curtain that legally separates the company from its shareholders hence holding the company as having a separate legal personality and limited liability.
In curtailing any abuses of limited liability and the protection of creditors to both small and group companies, the courts have in certain instances, though reluctantly, looked behind the corporate veil to establish the true intent of the controlling officers of the company. The courts have in the rare circumstances ignored the corporate form and looked at the business realities of the situation so as to prevent the deliberate evasion of contractual obligations, to prevent fraud or other criminal activities and in the interest of public policy and morality.
Piercing the corporate veil has not been complicated in one-man companies were the owner is usually the director and hence the controlling officer as compared to group companies which have a layered structure.
The controlling officer will be held liable and asked to account for his actions so that the company can fulfil its financial obligations to its creditors in the event of company insolvency. In the case of Royal Brunei Airlines v Tan made clear.
Lifting the Veil of Incorporation
The corporate veil is a curtain that shields company shareholders and directors from personal liability by the principle of limited liability in the event of the company being insolvent and unable to fulfil its obligations.
The lifting of the corporate veil concept describes a legal decision where the limited company shareholders or directors are held liable for the debts or other liabilities of the corporation contrary to the principle of limited liability.
Whilst there is strict liability legislation to prosecute erring limited companies for statutory offences but were there is insufficient statutory protection, the common law remedy of piercing of the corporate veil is imposed by the courts so as to put liability on the controlling officer (directing mind) of the corporation.
However, the courts have been reluctant to rebut the principle of limited liability and only in exceptional circumstances have they been willing to pierce the corporate veil to establish the true facts. In this way, certain individuals or parent-companies responsible for the company's actions are held liable so at to account for their decisions as shareholders or directors. Generally, the UK corporate law holds that the shareholders, directors or parent-companies are not liable for corporate obligations of the companies or subsidiaries they control hence maintaining the principles of limited liability and separate legal corporate personality.
The principles of separate legal personality and limited liability have been long recognised in English law and that the shareholders or directors are not liable for the debts of the company as long as it is properly administered. However, in exceptional circumstances, the courts have been prepared to look behind the company and establish the actions or inactions of the directors and shareholders using the process known as “piercing the corporate veil”.
Some commentators have argued that the decision in Solomon gives the “unscrupulous” promoters of limited companies an opportunity to abuse that Companies Act which is not in the spirit in which the Act was enacted.
Piercing the corporate veil is the process whereby the court ignores the principle of corporate personality and holds the shareholders or directors liable for their actions so that they meet the company obligations in their personal capacities. The courts will pierce or the “veil” were the corporate structure has been used as an instrument of fraud or to circumvert the law.
It has been argued that whilst the courts have used the doctrine of "piercing the corporate veil" though reluctantly, it is still not well understood leading to uncertainties in the legal process. Some commentators have argued that the exceptional circumstances in which the courts have justified the piercing of the corporate veil is uncertain as evidenced by the number of contradictory decisions by the courts. Goulding further argues that ‘it is not possible to distil any single principle from the decided cases as to when the courts will lift the veil' due to the diversity of the cases, though they are more willing in cases of extreme abuse.
In the leading case on this subject, Solomon v Solomon discussed above, the House of Lords maintained that “individuals could organise their affairs as they wanted and that if they chose to do so via incorporation they were entitled to the protection of limited liability as long as the incorporation was in accordance with the formal rules of the relevant legislation”.
Though it is English trite law that the incorporation of a company protects the members from company liability by the principle of limited liability, there are both statutory and common law exceptions to the principle in cases of abuse of the corporate structure.
Gower and Davies argue that the courts are willing to lift the veil were statutory wording of a particular statute is explicit and specifically provides for it."HIT_2" name="HIT_2"> The courts have resisted the temptation to pierce the veil because they consider it just to do so though they are more willing in exceptional circumstances or were they feel that the shareholders or directors are concealing the true facts.
The company is vicariously liable for any torts committed by its employees or agents whilst acting in the course of the official duties and ‘shall not be called into question on the ground of lack of capacity' whilst the employee or agent remains the primary tortfeasor.
It is therefore clear that the “directing mind and will” of the company can sometimes be personally liable for torts, for which the company is also liable, for their fraudulent acts though done on behalf of the company.
There are various Acts which specifically provide for the lifting of the corporate veil under both civil and criminal jurisdictions which impose strict liability on limited companies.
Duty to prepare Group Accounts
Whilst each company in a group of companies has a separate legal corporate identity and hence required to prepare individual company accounts, section 399 (2) requires that the parent company prepares group accounts at the end of the financial year so as to “give a true and fair view of the assets, liabilities, financial position and profit or loss”. In this way, it can be concluded that the Act looks at the group of companies as a ‘single economic entity' and in effect lifts the corporate veil contrary to the principles of corporate personality and limited liability without affecting the corporate structure.
Failure to obtain a trading certificate
The Act prohibits a registered company from trading or obtaining credit before obtaining a trading certificate and any directors or shareholders not adhering to these provisions are in contravention of the Act. Any directors or shareholders breaching the Act shall be jointly and severally liable to indemnify the third parties for any loss or damage suffered as a result of the company's failure to comply with its obligations. Here the legislation is explicit and a director or shareholders breaching the law will be held liable for the company's obligations before the trading certificate is obtained hence a statutory piercing of the veil of incorporation.
Liability of a disqualified director
The Act gives the courts wide powers to make a disqualification orders and bar a person from holding the position of director or any other management positions of a company on grounds of breaches of company law or matters other than criminal convictions and such disqualification shall not exceed 15 years.
The person disqualified from being a director but who in contravention of the disqualification order, continues to act as director shall be personally liable for all the debts that the company incurs when he was so acting. Equally, any person who knowingly acts on the instructions of a disqualified person shall be jointly and severally liable for the company debts with the disqualified director.
We see here that the legislation has removed the veil on disqualified directors and hold them liable for actions they undertook on behalf of the company hence concurring with Lord Denning's forceful assertion that “the legislature has shown the way……And the courts should follow suit."
Insolvency Act 1986
The Insolvency Act 1986 provides exceptions to the principles of limited liability and corporate personality, were there is breach of the company structure to defraud creditors. We look at these exceptions below which when breached leads to the piercing of the veil of incorporation and the directors or shareholders are held personally liable for continuing to trade whilst knowing that the company was in financial difficulties and would not survive.
This act provides that on winding up, any officer deemed to have knowingly used the company business structure to defraud creditors will be personally liable for the debts of the company and will have to contribute to the discharge of the debts. This Act reduces the chances of the use of the Salomon principle as an instrument of fraud by directors who should have known the true intent of their actions.
Wrongful trading applies where the director of an insolvent company allows the company to continue trading on credit or getting credit with the knowledge that there was no reasonable prospect of the company avoiding liquidation. In such situations and on the application of the liquidator, the Act empowers the courts to lift the ‘veil of incorporation' of an insolvent company and hold the company directors liable and to make a contribution to the company's assets.
Some commentators argue that the impact of this section has been a “great disappointment” due to varied judicial approaches which has created a high degree of legal uncertainty and hence a low number of successful court actions.
However, the significance of the Act is that any directors who permit a company to continue trading when there is no prospect of repaying trade debts and avoiding liquidation shall incur personal liability by the courts piercing the ‘veil of incorporation' for the benefit of the creditors.
Phoenix Companies(The Phoenix Syndrome)
The “Phoenix Companies” refers to a situation where one company is put into insolvent liquidation and another company with the same or similar name is registered with a view of defrauding the creditors by transferring the company assets to a new company.
The Insolvency Act 1986 s 216 provides that anyone who was a director of a company during the 12 months before it went into insolvent liquidation shall become personally liable if he becomes involved with the management of a company with a name similar to that of the insolvent company or a name similar as to suggest that they are associated. Section 217 empowers the courts to lift the corporate veil in such cases and hold the director jointly and severally liable with the company for the debts of the “Phoenix Company” so formed.
Landlord and Tenant Act 1954
Section 30 (3) of the Act provides that “where the landlord has a controlling interest in a company any business to be carried on by the company shall be treated ……….as a business to be carried on by him.”
This is also an instance where statute has set aside the Solomon principle and held the landlord liable for the business carried on by his company so as not to disadvantage the tenants.
The above statutory exceptions are but a few examples and to underlie the seriousness of this subject, some commentators, such as Gower, have warned that the principle of limited liability is subject to abuse and hence the need for stringent regulation.
Common Law Exceptions to the Corporate Veil
There have been varied approaches that courts have taken in deciding the situations in which they would pierce or not pierce the veil of incorporation and such legal uncertainty makes it extremely difficult for aggrieved parties to instituting legal action against a director for the actions or inactions of the company.
This uncertainty makes it extremely difficult for the litigants to predict when the courts will or will not pierce the corporate veil at common law, as compared to where the Act is explicit of parliamentary intention as discussed above.
The interpretations have been varied by different court rulings hence the continuing need to seek common ground so as to look to the substance. Simon Goulding argues that “it is not possible to distil any single principle from the decided cases as to when the courts will lift the veil….”
In the case of Kensington International Limited, Cooke J was in agreement with the earlier rulings of Staughton LJ and Walker R J and quoted that it was “better to speak of “substance”, “truth”, “reality” and that which was “genuine”, rather than use the words “disguise, cloak, mask, colourable device, label, form artificial, sham, stratagem and pretence”.
This is the reality of the matter and the courts would be doing justice and be seen to be fair to all parties, if the standard could be set that they look to the legal substance of the matters involved so that there is minimal difference in principle in the approach in matters requiring the piercing of the veil of incorporation.
The “agency” exception
Whilst a company can act as an agent of a parent company or shareholders, it should however be with the authority of the members and there should be clear evidence as to the scope of the authority. Once such authority is established, the directors and the shareholders are then bound by way of Principal/ Agent relationship and shall be held liable for the actions and/or inactions of the company. In this case the Courts are obliged to pierce the corporate veil and treat the actions or inactions of the company as that of the directors or shareholder which is in contrast to the Solomon case where it was held that a company could not be an agent of the directors or its shareholders.
In the case of Smith, Stone & Knight v Birmingham Corp, where a holding company claimed compensation as an owner-occupier through its subsidiary on the ground that its was its agent and carrying on the business of the parent company, Atkinson J allowed the claim as a matter of economic fact.
In the more recent case of Re F.G. (Films) Ltd, an American parent company set up a British subsidiary to produce a film which would then be classified as a British film. The court held that the British company's participation in financial terms was negligible and had been formed for the sole purpose hence creating and agency relationship.
The “sham” or “façade” Companies Exception
The universally accepted definition of a “sham” company was given by Lord Justice Diplock when he said that if the word had any meaning at all, it meant “acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intended to create”.
The courts have a difficult task of establishing that a company is a mere façade or a sham as they have to identify the motive of those behind the company, called the “centre of the personality of a corporation”, controlling the activities of the company. The courts also have to establish the need to pierce the corporate veil where special circumstances exist indicating the company was a mere façade concealing the true facts.
The rapid increase of companies being incorporated with a large number being one-man companies is a matter to be closely monitored as more and more companies go into voluntary liquidation. The need for monitoring will arise due to the ease with which an unscrupulous trader can incorporate a company which could be no more than a “cloak” for the purpose of shielding themselves against pre-existing liabilities.
For instance, in the case of Gilford Motors , the defendant, in an attempt to get round the covenant preventing him from soliciting customers from his former employers established doing the same business though being run by the wife. The court held that the company was a mere “sham or cloak” and granted an injunction against the company. Lord Hanworth observed that the company was a “cloak or a sham”, “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”.
Hence, whilst the company was guided by the principle of corporate personality and had its own management, the controlling brain and mind was Mr Horne, which led the court to pierce the corporate veil.
Another example where the court has pierced the veil on the ground of a company being a mere façade or a sham was in Jones v Lipman in which the defendant entered into a contract with the plaintiff to transfer land but later changed his mind. The defendant then set up a company to which he transferred the property in an attempt to put it beyond the reach. The court pierced the corporate veil and made an order for specific performance noting that the company was a device, sham or mask, set up to deliberately evade an outstanding obligation.
The more recent decision in which a ‘sham' or ‘façade' was established was in the case of Kensington International Ltd v Congo where the claimant, Kensington, had entered into credit agreements with the Republic of Congo. Following non-payment of debts, the claimant sought to enforce the judgments against Glencore in respect of payment to the Republic of Congo for a cargo of Congolese oil.
This was a decision against dishonest dealing and the court was prepared to pierce the veil of incorporation it felt that a corporate structure was merely a ‘sham' or ‘facade' being used for the purpose of avoiding the settlement of its existing obligations.
The cases noted above indicate that the courts are prepared to “pierce the corporate veil” in circumstances where individuals defraud creditors through fraudulent corporate structures which they set up to disguise the state of affairs.
The fraud Exception
It is long established British trite law that the Solomon principle will not be used as an engine of fraud, to evade existing obligations or any form of abuse of the corporate structure.
In Gilford Motor Company Ltd v Horne, a former director was bound by a restraint covenant not to solicit for customers from his former employers on leaving employment. He set up a rival company with the potential of breaching the covenant. The Court held that the company was a mere front, a device or a stratagem for Mr. Horne to mask the underlying situation and hence pierced the veil of incorporation and granted an injunction to enforce the covenant against both Horne and the company.
And in the case of Jones v Lipman, the defendant had entered into a contract to convey his land to the plimtiff but later changed his mind. He then formed a company to which he conveyed the land to avoid the completion of the transaction.
Russell J granted specific performance against both the defendant and his company which he described as “the creature of the First Defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity”.
Hence we notice here that the court was prepared and did pierce the veil of incorporation as the company was formed specifically to “evade an existing obligation” hence holding it as a sham.
In Standard Chartered Bank v Pakistan National Shipping Corporation case, a director made a deliberately false and misleading statement in order to obtain payment on a letter of credit. In passing his ruling, Lord Hoffmann commented that, “No one can escape liability for his fraud by saying ‘I wish to make it clear that I am committing this fraud on behalf of someone else and am not to be personally liable.”
The House of Lords held that a director cannot escape personal liability for deceit on the grounds that he acted as he did on behalf of and for the benefit of his company.
This case shows that whilst the company will be vicariously liable for acts of its employees, the courts are prepared to pierce the veil of incorporation and hold the employees accountable for their decisions. Therefore, the director was sued in his individual capacity as his actions where found to have been fraudulent though the bank still remained a party to the action as the employer.
The courts have been prepared to pierce the corporate veil in instances of fraud where the director or owners have exceeded their authority and in instances where the courts deem the director or owners are trying to evade their existing obligations towards third parties.
Some commentators have argued that the principle of corporate personality has been maintained in the cases involving fraud where the courts have pierced the corporate veil and hence maintaining the sanctity of the spirit of the Solomon principle.
The “alter ego” Exception
By “alter ego”, the courts have implied that the owners or directors will be held liable for the actions or inactions of the company where it is established that the corporate structure was not being treated as a separate entity but for the promotion of personal interests.
The more recent case is that of Gencor ACP Ltd v. Dalby , where Gencor ACP was a group of companies. Dalby was the group managing director and following its take over, it was alleged that Dalby had dishonestly diverted company assets and business opportunities to himself and another foreign company under his direct control.
The court was prepared to lift the veil of incorporation on both Dalby and his offshore company and hold both liable for profits and commissions made on sales of company assets.
We can then conclude from this case that the courts are prepared to lift the corporate veil where an individual directly controls a company and uses it as a front or alter-ego for his own personal gain as in reality Dalby and his off-shore company where one and the same.
The interests of justice exception
The courts justified the ‘interest of justice' or fairness exception in cases where it was thought that the directors or shareholders where abusing the corporate structure to evade an existing obligation and as such being an injustice to the aggrieved parties.
In the case of Creasey v. Breachwood Motors Ltd, the plaintiff had been employed as garage manager by Breachwood Welwyn Ltd. He was unfairly dismissed and the employer attempted to evade the payment of damages for wrongful dismissal by forming another company, Breachwood Motors Ltd and transferring the company to it.
The court held that the plaintiff could claim for damages from the newly formed company as they felt that the new company had been formed specifically to allow the owners to evade their obligations and which could not stand in the “interests of justice”. The court hence pierced the corporate veil using the ‘interest of justice' argument but we should noted here that this outcome overruled by Ord & Another v Belhaven Pubs Ltd, discussed above, where the court had held that the company had not been a mere façade of the holding company and hence the holding company could not be substituted for a subsidiary which had gone out of business.
The “interests of justice” exception was rejected in Adams where the court stated that the only instance when the corporate veil could be pierced was when special circumstances exist indicating the company as ‘a mere façade concealing the true facts'.
And in the case of Trustor A. B v. Smallbone, where a company director fraudulently paid money out of the company to himself and his own sham company which case is discussed above. The court declined to fix liability on the director, for monies that the sham company had paid to other third parties holding the view that it was not appropriate to pierce the veil merely in the “interests of justice”, even though the doing so would not prejudice the interests of other parties.
However, whilst it is clear that the courts do not find it appropriate to pierce the corporate veil just because justice demands so, they are ready to “draw back the corporate veil to do justice when common sense and reality demanded it…………”
It would be particularly fair to the parties in such cases if the courts could embrace the stance of common sense.
The “single economic unit” exception
The Companies Act 2006 does not provide that companies forming a group of companies should be regarded as a “single economic unit” which means that every individual entity in a group is bound by the principles of limited liability and separate personality. However, whilst each company within a group of companies constitutes a separate legal entity, the courts are inclined to ignore the distinction between the various group companies and treat the group as a single economic unit, which effectively means piercing the veil of incorporation.
There have been exceptional circumstances in which the courts have been prepared to pierce the corporate veil and treat the group of companies as a single unit and hold liable the parent company or any other unit in the group liable for the obligations of any other unit in the group.
In the case of Creasey v Breachwood Motors in which the defendant company had been used for an improper purpose of evading the payment of damages for wrongful dismissal of an employee (discussed above). The court was prepared to pierce the corporate veil and substitute the new company for the old and hence hold the new company liable as it had been formed for the purpose of evading an outstanding obligation.
However, in the case of Ord v Belhaven, discussed above, the Plaintiffs' action against the parent company for the obligations of a subsidiary which had ceased trading due to group restructuring was declined in the absence of any impropriety, sham or concealment in the restructuring of the group. The court held that the parent company could not be substituted for the subsidiary company as the group companies were distinct legal entities and could not be treated as a “single economic unit”.
Likewise, the "single economic unit" exception was more recently rejected in the case of Adams v Cape Industries Plc , where it was held that a member of a group of companies was entitled to shield itself from liability by ensuring that “the legal liability (if any) in respect of particular future activities of the group…..…..will fall on another member of the group rather than the defendant company”.
This outcome re-emphasises the long held principle laid down in the case of Solomon v Solomon which unfortunately does not take into consideration the sophistication of the present international trade structure and globalisation. Equally of concern should be the rise in the number of one-man companies which offers a leeway to unscrupulous people forming companies for fraudulent purposes and shielding behind the veil of incorporation.
It is important that the courts look at the circumstances prevailing in particular cases and pierce the veil of incorporation in appropriate situations. Cases of large multi-national companies, such as the Union Carbide disaster of Bhopal which killed scores of people and left many others maimed for life should serve as a clear warning to all concerned in this globalised world. The parent company argued that Union Carbide Bhopal was a separate and distinct legal entity to Union Carbide US when the evidence suggested otherwise and this blocked litigation against the parent company. Hence in the long term, the big corporate companies in the industrialised countries will register their subsidiary companies in developing or countries with lax laws so as to shield themselves from liability in case of serious disasters like the Bhopal. It is hence incumbent upon the courts to look to the economic realities of group companies and the interest of justice, which in reality is what the courts stand for and hence creating some predictability in such cases.
The courts have identified this argument and commenting on the “single economic unit” said that the subsidiary companies must be identified as being totally under the control of the parent company albeit in very exceptional circumstances. Therefore, the courts have to go further and not let the parent companies evade their obligations where there is evidence and by taking into consideration the economic realities of the corporate structure. The courts have rightly pointed out that:
“To a layman at least the distinction between the case where a company trades itself in a foreign country and the case where it trades in a foreign country through a subsidiary, whose activities it has power to control, may seem a slender one.”
It can therefore be argued that the courts should be more willing to treat corporate groups as “single economic units” and hence pierce the veil of incorporation in all cases through the “economic realities” argument.
The Current Judicial Thinking
Whilst the courts have been more reluctant to lift the veil in the absence of a sham or a façade, it is clear that they will not pierce the veil of incorporation just because it is in the “interests of justice”.
However, the courts have continued to disregard the principles of corporate personality and limited liability and pierced the veil of incorporation where the corporate structure has been used as a vehicle of fraud.
Hence, whilst the uncertainty on the principle of corporate rumbles on within the judiciary system, the corporate world has made great strides and the corporations have developed into global structures with a very high potential of abuse of the corporate structure. However, the good news is that the courts seem to be ready to pierce the veil of incorporation where the company had been used as a device or a façade to conceal the true facts and thereby evading or concealing its obligation.
In this regard, there is need for the courts to be more consistent and clear regarding the circumstances, whether special or otherwise, when they are prepared to pierce the veil of incorporation, just like the legislature has led the way by bringing in stringent legislation on this subject.
It has been acknowledged at the beginning of this paper that the principles of limited liability and corporate personality are at the heart of commercial enterprises and the existence of the companies. But, it is noticeable that the general reasoning of the courts on the principles or corporate personality and limited liability, and the cases requiring the courts to pierce the veil of incorporation has been “confusing and, at times, contradictory”.
Noting, but not acknowledging the dishonesty with which subsidiaries and other small one-man companies could be formed to evade obligations, Staughton L.J has rightly pointed out that “the creation or purchase of a subsidiary company…………may not seem to some the most honest way of trading.” This is an acknowledgement by the court that companies do indulge in wrongdoing and as such should make them readily able to pierce the veil of incorporation and limited liability against the directors and shareholders or owners. There would be no need for the parent company or indeed directors of small companies to hind behind the veil of incorporation if the subsidiary company so formed was to trade within the scope of the law. Otherwise, the parent companies or directors whose subsidiary companies to fail to meet their obligations or are involved in some form of wrongdoing should not be insulated from liability. Gower observes that the limited liability principle arose at the time that groups of companies and indeed multi-national corporations were unknown and hence the need for the courts to distinguish the conditions prevailing from Solomon to today.
Hence, whilst the courts are not prepared to pierce the corporate veil so as not to go against the rule in the Solomon's case, they are ready to go against this rule where there are special circumstances depending on the facts of each individual case. Such special circumstances could then be argued as the courts demanding that justice between the parties prevails and hence justifying the piercing of the veil of incorporation. As can be seen from the cases covered in this paper, the courts have had considerable difficulty in determining the point at which they are prepared to pierce the veil of incorporation and hold the directors or owners accountable for the obligations of the company. It is noticeable that there have been some departures from the strict view taken in the case of Adams and there seem to be signs that the courts seem to be relaxing the strict approach and are ready to pierce the veil of incorporation.
It can be argued that the court, when faced with a proposal to pierce the corporate veil, is very reluctant to do so were there is adequate legislation to resolve the issues. In this regard, they have made it abundantly clear that they have no general discretion to simply pierce the veil “in the interest of justice”. However, the courts are more readily willing to pierce the veil of incorporation only if the plaintiff is unable to obtain another remedy by way of statute and would suffer a great a massive injustice or loss.
It can further be argued that it would not be in the interest of corporate law if the directors or shareholders are allowed to permanently hide behind the shield of limited liability as veil piercing is a hindrance to some unscrupulous directors and shareholders who would want to abuse the corporate structure to evade obligations.
However, there is need for a clear guidance as to when the courts will lift the veil of incorporation so as to establish certainty and predictability which has been a major flaw in the veil piercing doctrine. Establishing of such clear guidelines would reduce the uncertainties and difficulties associated with piercing the corporate veil that the courts face hence reducing on costs and the time spent on resolving cases requiring the piercing of the corporate veil.
It has been clearly established that only in the limited range of cases in which a trader exploits the corporate form as a mere sham or façade to disguise otherwise unlawful activity will a court feel justified.
Whilst the courts are reluctant to pierce the veil of incorporation, there is judicial willingness to look at the reality of the situation as can be inferred from the statement by Cooke J that:
“there is, in my judgment, no doubt that transactions or structures, which have no legal substance, and which are set up with a view to defeating existing claims of creditors against the entity responsible for setting up those transactions or structures and lying behind them, can, if they are purely a sham and a façade, be treated by the court as lacking validity. This enables the court to deal with the underlying reality and not the mask or creature that is being put forward with the object of deceit or dishonest concealment.”
It is suggested that a more radical change in the judiciary is coming when the occasions on which the veil can be lifted will be robustly pursued to see that justice prevails. This can be established following the comments of Lord Donaldson MR in the Atlas case, where he acknowledged the complex nature of the big corporations and said that:
“We live in a time of rapidly growing commercial and financial sophistication and it behoves the courts to adapt their practices to meet the current wiles of those defendants who are prepared to devote as much energy to making themselves immune to the courts' orders as to resisting the making of such orders on the merits of their case.”
The above comment should be the way to the future, as the sophistication of modern corporate structures enhances, so should the judiciary move with the times if justice has to be dispensed fairly. Such comments have not escaped what has been argued by some writers that robust legislation and judicial opinion and confirms that directors and shareholders in private companies can no longer escape personal liability by the reliance on the protection afforded by the principle of separate legal personality of their company as the courts become more receptive to the need for piercing the corporate veil.
The conclusion that can be drawn from the above case law and legislation that the English courts are ready and prepared to pierce the veil of incorporation where there is an attempt by directors or owners evade their obligations through the use of companies considered to be a sham or façade. The courts will go to great lengths to establish the facts and deal with the underlying reality and not the mask or creature that is being put forward with the object of deceit or dishonest concealment.
The courts are entitled to pierce the veil of incorporation and as such should continue to look at the realities of the situation when deciding whether or not it is prudent to lift the veil, and hold those are in reality responsible for the actions of the company to account.
To show the stance the courts have now moved to is not as strict as the stance taken in the ruling of the case of Adam, the House of Lords were prepared to make detailed inquiries into the internal workings between the parent company and its subsidiaries and in real sense pierced the veil of incorporation though not acknowledging so.
Of equal importance is the issue of multi-national companies which use their subsidiary companies in the developing world for processes which would in most cases be toxic and dangerous to human health.
It has been shown from case law in the last 100 years since Solomon that the veil of incorporation of a limited company is not ‘opaque and impassable' as asserted by Gower but can be pierced if justice demands it.
And to end where we started by quoting Lord Denning and conclude that, whilst the ‘interest of justice' exception was overruled in Ord v Belhaven, there are fresh signs of the courts relaxing the strict approach taken in Adams as evidenced in the case of Ratiu v Conway where Auld LJ argued, with the agreement of the entire bench, that there was a “readiness of the courts, regardless of the precise issue involved, to draw back the corporate veil to do justice when common sense and reality demanded it … …………..there is…….a powerful argument of principle…..for lifting the corporate veil where the facts require it.”
It now remains for the courts to weigh the advantages and disadvantages of resisting the doctrine of the piercing of the corporate veil, more than 100 years since Solomon's case and the advances made in the corporate world with the introduction of multinational companies and globalisation.