Company Law 5. The judiciary should be prepared to "lift the corporate veil" in the interests of justice. Discuss.
[22032] Company Law
5. The judiciary should be prepared to "lift the corporate veil" in the interests of justice. Discuss.
Following the judgement of that found in Salomon1, it has become a fundamental principle in company law that the corporate veil ( or veil of incorporation), often enables members of a company a sense of limited liability, protected by the principle that constitutes the "separate personality" of the company. In the following discussion, we shall establish to what degree this ruling and subsequent ones are adhered to in regard to both a corporate sense, but also in a judicial capacity by the courts.
Supported by Salomon, upon incorporation, a firm becomes a separate legal entity distinct and separate from the individuals contained within it, such as shareholders and its directors2. As a company is a corporation, it is therefore seen as a person before the eyes of the law, quite distinct from the individuals that are its members. In this way, as a distinct person, the company can own property, have rights and therein be subject to certain liabilities3. Furthermore, the company does not hold any property for example merely as an agent or trustee for its members4, they cannot sue individually or collectively to enforce rights which the company has against third persons otherwise than in exceptional circumstances5, nor can they be sued in respect of its liabilities6. This legal recognition of the corporate entity's independence strengthens what we have established as the corporate veil, and separates the legal identity of the company from that of its individual constituents. However, the principle may cause a certain amount of difficulty and it has become apparent that the veil may be lifted so that the human and commercial reality behind the corporate personality can be taken account of7 ultimately in the interests of justice.
Indeed, the law therefore has had to develop so as to not deny the obvious legitimate opportunities and economic benefits that the veil of incorporation provides. An example being the encouragement for the setting up of financially risky ventures without the possibility of the individual facing bankruptcy8 - and the abuses that the veil is open to by allowing the veil to offer a shield of inequity to those that wish to deflect the power of the provisions of the Companies Act9. In this way, the corporate veil can be seen as a tool to further and encourage investment within companies, especially as the liability for doing so may be limited. Regardless of some disdain for companies to have separate legal personality10, without the veil protecting individuals, corporations may find it increasingly hard to seek external and internal investment in the aim to expand. A further example can also be seen if a subsidiary company declines into insolvency, the parent company may not necessarily be liable for any debts caused therein11. This last point therefore introduces the theme as to when the corporate veil should be lifted in the interests of justice. Furthermore, although the courts would generally not hold an individual liable for an action that is legally the responsibility of the corporation, it may do so if the individual's actions were to perpetrate a fraud or to attempt to pass personal liability to the company. Moreover, as shall be discussed, the lifting of the veil may ensue if holding only the corporation liable would be unfair to the claimant in certain circumstances.
Even through the advantages detailed above regarding the use of the corporate veil, the internal affairs of a company are never completely concealed from view since publicity has always accompanied incorporation12. In addition to this, there are several situations where the courts are prepared to lift the veil of incorporation. Either to diminish the corporate personality to account for individual members, or to ignore the separate personality of several companies in a group, in favour of the economic entity constituted by the group as a whole.
As suggested, the Companies Act 1985 enables a company to be incorporated with a separate legal identity and limited liability. However, specific provisions of the Act13, and similarly other related legislation14, have, in certain instances paved the way for the piercing of the corporate veil. Yet having said this, the courts usually require a clear and unambiguous statutory provision when it comes to holding individuals accountable15. For the majority of the examples that shall be given below, judges do not seek to extinguish the corporate veil so as to deny the existence of the corporate entity; instead they ...
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As suggested, the Companies Act 1985 enables a company to be incorporated with a separate legal identity and limited liability. However, specific provisions of the Act13, and similarly other related legislation14, have, in certain instances paved the way for the piercing of the corporate veil. Yet having said this, the courts usually require a clear and unambiguous statutory provision when it comes to holding individuals accountable15. For the majority of the examples that shall be given below, judges do not seek to extinguish the corporate veil so as to deny the existence of the corporate entity; instead they are aimed at penalising the human constituents of a company for some form of malpractice in the overall interest of maintaining law and justice. Furthermore, when it does come to the possibility of lifting the veil, some judges are unwilling to do so lightly, which we should examine as to whether a more lenient approach should be adopted by the courts16.
"It is only in special circumstances which indicate that there 'is a mere façade concealing the true facts' that it is appropriate to pierce the corporate veil...17"
Thus, the scope and rational of the doctrine provides checks and balances whereby the court has various legal mechanisms by which it can pierce the protective layer of the veil where needs justify it. The courts will look at the realities of the situation when deciding whether or not it is prudent to lift the veil, and impose liability to those responsible for the actions of the company18.
Firstly, it was seen in the case of Daimler19, that the courts have been willing to lift the corporate veil when the country is at war, or a degree of economic conflict. The justification for this being, that upon lifting the veil, it would prevent, for example, the payment of monies from companies registered within the UK to terrorist organisations or groups. This can be seen to be extremely relevant with the current stance given regarding acts of terror by the British government, and subsequently through the introduction of the Terrorism Act therein20. Obviously this example of the judicial lifting of the corporate veil is rather extreme, and has a limited amount of application, but it is good to give an example as to how the case law has developed the test for checks and balances regarding this issue. Further to this, the avoidance of legal obligations of individuals within a company has prompted other significant case law regarding the doctrine in question. It is helpful at this point to look back at the Salomon decision, and to gauge that the motive behind a company's incorporation is highly relevant to the determination of whether or not the corporate veil may be dislodged by the courts to impose a liability on the individual members21.
Subsequently following the judgement in Salomon, the legislature as a whole have always been concerned to minimise the extent to which the principle of separate legal entity could be used as an instrument to perpetrate fraud. As a result, the offence of fraudulent trading for example was introduced within the Insolvency Act 198622. The general lifting of the veil is found when in the course of the winding up of a company, it appears to the court that any business of the firm has been carried out with the intent to defraud creditors of the company for any fraudulent purpose. Therein, the courts can rule that those individuals can be called upon to contribute to the overall debts of the company because of their own, individual, activities involved. In Re Todd23, a director was found liable to contribute over £70,000 to the debts of the company, and moreover, there is always a possibility that criminal liability for the individual could ensue thereafter following the piercing of the veil to account for their actions. Through statute such as this, a good example can be seen on how the judiciary are able to use legislation made available to them to hold directors24 and members of the company liable for fraudulent activities. This tool enables the courts to maintain the principle found in Salomon, but also acts as a good measure of checks and balances to hold corporations accountable for any degree of malpractice engaged by individuals within the company.
Lifting the corporate veil often presents the judiciary with extremely hard choices as to where the loss as a whole should lie. Moreover, the courts have a hard decision when it comes to treating the company as a separate legal entity on one side of the coin, but maintaining justice and ensuring accountability on the other25. In this way, and through the use of case law to strengthen this discussion, over time the judiciary have swung from strictly applying the Salomon principle in these difficult situations, to taking a more interventionist approach to try to achieve justice in a particular situation.
In Gilford Motor Company Ltd26 a former employee who was bound by a covenant not to solicit customers from his former company to his own, tried to claim that although individually he may be bound by such a covenant, his new company was not. It was held in this case by the courts that the new company was merely a front, and subsequently issued an injunction against him having pierced the corporate veil to account for individual liability. This was consequently supported in Jones27, where an order for specific performance was issued by the courts in the interests of overall justice for the claimant who had a reliance on the activities of the defendant. Thus, he, or rather the corporation as a whole, were held to perform regarding the remedy, and the courts were adamant that no individual should be allowed to hide behind the veil to escape detection for their behaviour therein28.
By the 1960s the increasingly sophisticated use of group structures was beginning to cause the courts some difficulty with the strict application of the Salomon doctrine. At this point, the courts began to give varying opinions which meant the theory of the corporate veil became perplexed some what. The rules in company law meant that it was uncertain as to whether the courts would hold subsidiary companies as separate legal entities, such as stated in Salomon, or whether they should be classed as a single economic unit. In DHN Ltd29 it was argued that a group of companies was in reality a single economic entity and should be treated as one. Yet two years later however, the House of Lords in Woolfson30 specifically disapproved the former regarding views on group structures, in finding that the veil of incorporation would be upheld unless it was a façade, further confusing the application of the principle. The case of Adams31 represents a significant move by the judiciary towards introducing more legal certainty into the interpretation of Salomon and subsequently the corporate veil32. Generally the court found that in cases where groups had been treated as a single economic unit, the judges were involved in the interpretation of statute. Therefore this exception to maintaining corporate personality is qualified by the fact that there has to first be some lack of clarity about a statute which would allow the court to treat a group as a single entity.
"...save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon v. A. Salomon & Co. Ltd. [1897] A.C. 22 merely because it considers that justice so requires.33"
Adams therefore narrowed the situations where the veil of incorporation is lifted to effectively three situations. Through the interpretation of statute, where the company is a mere façade, and finally where a subsidiary is an agent of the company34. Moreover, while there have also been some notable departures35 from the Court of Appeal's interpretation in Adams of when the veil may be lifted, this highly influential case has dominated judicial thinking since36.
As can be seen through the discussion above, the courts went through an uncertain time regarding whether they should lift the corporate veil to account for an individuals (or company's) actions or not. Companies and company law as a whole would be at a considerable disadvantage if the principles set out in Salomon were not adhered to, especially as many new, small businesses rely heavily that their members may not be liable for debts early on. Having said this however, it is an essential purpose for the courts to at least be seen to be upholding the law, and following procedures in the interests of justice. As suggested certain unlawful business activities should not be allowed to exist, and so subsequently the courts must take a substantial stand in order to protect justice on the whole. It is useful to note at this point, that in some jurisdictions, corporate directors can be held directly liable, alongside the corporation itself, for certain statutory offences37, such a stance showing that companies and their individuals are not exempt from all liabilities as first thought.
Following Adams and Trustor AB, we can see that the courts are only willing to lift the veil in particular or special circumstances, and are usually reluctant to do so, regardless of the advantage of legal certainty that this would bring. The aforementioned examples may be seen to be significant circumstances for the veil to be lifted by the courts, or alternatively and perhaps more controversially, they may be seen as masking the fundamental justification for denying the preservation of the corporate veil, namely to prevent injustice. Indeed Lord Denning has stated the tool for lifting the veil should be used by the courts as a discretionary power, as apposed to using it in such defined circumstances as stated above38.
Regardless of the specific rules set in Adams, the disadvantage of the courts taking the "interests of justice" approach, is that it is dependent upon the individual merits of a case, and its individual circumstances. Therein this surely will encourage a degree of judicial subjectivity which may lead to an uncertainty in the law. Yet having said this, it is ultimately the role of the courts to uphold justice, especially when it is an individual acting unlawfully and not necessarily the company, as a separate person. In general, the following quote is useful to sum up by;
"...the court will use its powers to pierce the corporate veil if it is necessary to achieve justice irrespective of the legal efficacy of the corporate structure under consideration."39
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Bibliography
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* "Company Law" B. Pettet, 2nd Edition, 2005, Pearson
* "Some Reflections on Company Law Reform" - Otto Kahn-Freund (1944) 7 The Modern Law Review 54
* "Company Law" - K R Abbott, 4th Edition, 1990, DP Publications
* "The veil of incorporation-fiction or façade?" - Georgina Andrews, BLR (2004), vol.25 No.1 Pages 4-7
* "Casebook on Company Law" - Josephine Bisacre - Pitman Publishing 1992
* "A temple built on faulty foundations" - Marc Moore, JBL 2006, 180-203
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Salomon -v- Salomon & Co Ltd - [1897] AC 22, HL
2 "Company Law" - Brenda Hannigan, 2003, Oxford University Press, P63
3 "Pennington's Company Law" - Robert Pennington, 7th Edition, 1995, Butterworths, P39
4 Macaura -v- Northern Assurance Co Ltd - [1925] AC 619 at 626
5 Foss -v- Harbottle - (1983) 2 Hare 461
6 Daimler Co Ltd -v- Continental Tyre and Rubber Co - [1916] 2 AC 307, Lord Parker at 338
7 "Smith & Keenan's Company Law" - Denis Keenan, 12th Edition, 2002, Longman Publishing
8 "Company Law" B. Pettet, 2nd Edition, 2005, Pearson, p31 - "Members do not have to contribute their own money... to meet the debts of the company"
9 Companies Act 1985
0 Regarded the decision in Salomon "calamitous" - "Some Reflections on Company Law Reform" - Otto Kahn-Freund (1944) 7 The Modern Law Review 54
1 Re Southard and Co Ltd [1979] 1 WLR 1198, and Stocznia Gdanska SA -v- Latvian Shipping Co et al - [2002] 2 Lloyd's Rep 436
2 "Company Law" - K R Abbott, 4th Edition, 1990, DP Publications, P41
3 Companies Act 1985 ss. 24 ( as amended by SI 1992 No. 1699 [Single Member Private Limited Companies Regulations], 108, 117(8), and 349 (4)
4 Insolvency Act 1986 ss. 213-14, see also Lindholst -v- Fowler [1988] BCLC 166
5 See general comments of Lord Diplock - Dimbleby & Sons Ltd -v- NUJ [1984] 1 All ER 751 at 758
6 "The veil of incorporation-fiction or façade?" - Georgina Andrews, BLR (2004), vol.25 No.1 Pages 4-7
7 LJ May - National Dock Labour Board -v- Pinn & Wheeler Ltd. Et al 1989 (Reference unknown - Lexis transcript) - from - "Casebook on Company Law" - Josephine Bisacre - Pitman Publishing 1992
8 See DHN Food Distributors Ltd -v- Tower Hamlets LBC [1976] 1 WLR 852 CA
9 Daimler -v- Continental Tyre & Rubber Co [1916] 2 AC 307
20 Terrorism Act 2000
21 See "A temple built on faulty foundations" - Marc Moore, JBL 2006, 180-203
22 Insolvency Act 1986, s213
23 Re Todd Ltd, BCLC 454 [1990]
24 Insolvency Act 1986, s214, - Wrongful trading regarding directors in particular
25 See Lee v. Lee's Air Farming Ltd [1961] AC 12
26 Gilford Motor Company Ltd -v- Horne (1933) Ch 935
27 Jones -v- Lipman [1962] 1 All ER 442
28 See also - Trustor AB -v- Smallbone [2001] 2 BCLC 436, and Ord -v- Belhaven Pubs Ltd [1998] 2 BCLC 447
29 Per Lord Denning - DHN Ltd -v- Tower Hamlets (1976) 1 WLR 852
30 Woolfson -v- Strathclyde RC (1978) SLT 159
31 Adams -v- Cape Industries PLC (1990) 2 WLR 657
32 See also - "Piercing the corporate veil" - Paul Friedman, NLJ (2006) Vol. 156 No 7209 P148
33 (Adams -v- Cape Industries PLC (1990) 2 WLR 657) at Ch 536 LJ Slade
34 See Re FG (Films) [1953] 1 WLR 583, Smith, Stone and Knight -v- Birmingham Corporation [1939] 4 All ER 116
35 Creasey -v- Breachwood Motors Ltd (1992) BCC 638
36 See also - Trustor AB -v- Smallbone (2002) BCC 795
37 See Ontario ( Canada) Environmental Protection Act.
38 Lord Denning's judgements in Littlewoods Mail Order Stores Ltd -v- IRC [1969] 1 WLR 1241
39 LJ Cumming-Bruce - Re a Company (1985) 1 BCC 99 421 (p99 425)