Company Law Adams v Cape

LLB

Company Law

Essay Title:

‘We do not accept as a matter of law that the court is entitled to lift the corporate veil as against a defendant company which is the member of a corporate group merely because the corporate structure has been used so as to ensure that the legal liability (if any) in respect of particular future activities of the group (and correspondingly the risk of enforcement of that liability) will fall on another member of the group rather than the defendant company. Whether or not this is desirable, the right to use a corporate structure in this manner is inherent in our corporate law’. Adams v Cape [1990] Ch 433 at 544 per Slade LJ.

Discuss

Ever since the historic decision of Salomon v Salomon [1897] AC 22 the courts have struggled to give cognisance to existing economic realities within groups of companies whilst at the same time maintaining the sanctity of the separate legal entity.

The case established the modern day concept that a company is a separate legal entity distinct from the personality of its directors, shareholders, or other subsidiary companies; hence the concept of the corporate veil. Various attempts have been made to weaken or lift the veil, with the judiciary swinging from strictly applying the Salomon principle to taking a more interventionist approach to try to achieve justice in a particular situation. Group activities still cause problems and the courts have sometimes ignored the separate personality of companies within a group.

Large corporate groups often operate as a multinational enterprise (MNE), that is, where a number of individually incorporated companies related to each other through common ownership and control are located in various jurisdictions.

It is submitted that there are often very good reasons to sue a parent company rather than the subsidiary. Often the subsidiary has limited assets and offers little scope for recovery. Even if the subsidiary is still available and has assets, or the parent corporation can be made directly accountable before local courts for its operations, there is strong motivation to proceed against the parent company in its own jurisdiction. The reason being that local law may be less favourable to plaintiffs than the law and practice of the parent company. However, the question of the liability of multinational corporations for the default of their subsidiaries remains uncertain.

Liability of a corporate group or an MNE can be established in various ways. However, liability of contract based MNEs is restricted. To extend such liability would violate the principle of privity of contract and the veil of incorporation. In equity based MNEs the liability can be of two types: direct and derivative. The direct liability imposes liability on a parent for its own actions including its own negligent breach of duty of good governance of a subsidiary or a breach of contract by a subsidiary that is acting as an agent for a parent. The derivative liability imposes liability on the parent company for the acts of its subsidiary, even though they are separate companies. This may be done by lifting the corporate veil or by establishing a singe economic entity.

Whilst statutory deviations to the principle of corporate entity exist, these do little to undermine the general principle of corporate personality. As to common law exceptions, it is difficult to perceive in what form they are conceived other than by the generalised and indefinable equitable spirit of fairness and justice. Those exceptions are: fraud/façade, the single economic unity argument and the agency relationship, the distinctions between which can be easily blurred.

Fraud/Façade

This is a preview of the whole essay

Fraud/Façade

Usually, where the motive of the holding company in forming or operating a subsidiary company is to perpetrate a fraud, the corporate veil will be lifted. The motive/intention is viewed objectively, to be inferred from the circumstances and evidence of the case. In Gilford Motor Company Ltd and Horne (1933) Ch 935 a former employee who was bound by a covenant not to solicit customers from his former employers set up a company to do so. He argued that while he was bound by the covenant the company was not. The court found that the company was merely a front for Mr Horne and issued an injunction against him. In Jones v Lipman (1962) 1 WLR 832 Mr Lipman had entered into a contract with Mr Jones for the sale of land. Mr Lipman then changed his mind and did not want to complete the sale. He formed a company in order to avoid the transaction and conveyed the land to it instead. He then claimed he no longer owned the land and could not comply with the contract. The judge found the company was but a façade or front for Mr Lipman and granted an order for specific performance.

However, it will not be a fraudulent abuse of corporate principles to manipulate the corporate structure of a group of companies so as to ensure that legal liability falls on a particular member of the group. The formation of subsidiaries by multinational corporations is normally done for commercial reasons, be they based on taxation advantages or compliance with local requirements. In Adams v Cape Industries plc Slade LJ speaking for the Court of Appeal rejected the proposition that the principle covered the evasion of ‘such rights of relief as third parties may in the future require’. Hence the deliberate restructuring of the US operations of Cape Industries plc to limit its exposure to future asbestos-based claims, did not justify piercing the corporate veil. In Re Silicone Gel Breast Implants Products Litigation it was held (on much the same reasons as those given in Adams v Cape) that lifting of the veil was only allowed ‘upon a showing of improper conduct or that the corporation was either formed or used for some illegal, fraudulent or unjust purpose’.

Single economic entity/Enterprise liability

Another situation where the veil may be lifted occurs where the dominant corporation ignores the formalities of separate corporate existence of the subsidiary. In Scottish Co-Operative Wholesale Society v Meyer [1958] 3 All ER 66 the House of Lords found that the economic reality of a group relationship was such that the corporate veil of the holding company’s subsidiary should be lifted to create one economic entity. Although in this case the subsidiary company was not wholly owned by its holding company, the holding company did control the corporate policy of the subsidiary. In DHN Ltd v Tower Hamlets (1976) 1 WLR 852 Lord Denning argued that where justice so demanded a group of related companies could be treated as one unit for the purposes of the law, but the correctness of that decision was doubted by the House of Lords in Woolfson v Strathclyde RC (1978) SLT 159. Indeed, the decision to dislodge the veil in the DHN case is hard to justify.

The most likely circumstances in which the veil will be lifted is where the subsidiaries are wholly owned, but in the Adams v Cape case, although NAAC was a wholly owned subsidiary of Cape, it would appear that the question relating to the ownership of the subsidiary is not the only factor to be taken into consideration. The fundamental reason for removing the veil from subsidiaries so as to create one economic entity would seem to be dominated by the question of 'control'. Somewhat surprisingly in the Adams v Cape the Court of Appeal whilst admitting that Cape had overall control of the policy directives of NAAC, refused to equate this with 'control'. According to the judgment the required element of control was not present because NAAC had the ability to enter into its own contracts without the need to seek Cape's approval. Whilst in theory this might have been the case, if NAAC had disobeyed Cape's policy proposals would Cape have simply ignored such disobedience?

Agency

An ability to establish an agency relationship between a holding company and its subsidiary will facilitate a finding that the holing company is responsible for the actions of its subsidiary. In the case of Salomon, agency, in the sense that the company was an agent of the shareholder, had been rejected by the House of Lords. However, in Smith, Stone and Knight Ltd v Birmingham Corporation (1939), Atkinson J lifted the veil to enable a subsidiary company operating business on land owned by the holding company to claim compensation on the grounds of agency. In the context of an agency relationship between separate entities, agency may be tentatively defined as a relationship which is based upon the express or implied consent of both the subsidiary and its holding company, that the former will act on the latter’s behalf, and by the subsidiary so acting it will be made subject to the holding company’s control. Thus, in Adams v Cape the Court of Appeal held that the veil of incorporation could be pierced when there was an express agency agreement between parent and subsidiary. However, in the absence of such agreement there is no presumption of one. In Cape it was found that the subsidiaries were independent businesses free from the day-to-day control of Cape and with no general power to bind the parent.

In Adams v Cape Industries plc [1990] Ch 433, a large number of consolidated actions for personal injuries were brought in a Texas court against the subsidiaries that had supplied asbestos to a factory in Texas. In the actions under review, the subsidiary companies of the defendants took no part in the actions and default judgments were obtained in the global sum of $15,645m. The question then arose as to whether the judgment could be enforced against the defendant English companies in England. The Court of Appeal refused an appeal from the judgment of Scott J dismissing the actions for enforcement of the Texas default judgment. On plaintiff’s first argument, the 'presence' issue, although Slade LJ described the interposition of the subsidiary companies as a facade, he rejected to conclude that the English companies and their subsidiaries were a single economic entity; even though he accepted that the English company could exercise overall control of the subsidiaries. The arrangements did not entitle the court to pierce the corporate veil. As the subsidiary companies were separate legal entities it could not be said that the English companies, who were not trading in the USA, were present in the foreign jurisdiction. The Court of Appeal went on to say that even if they were wrong on the first issue, they would not have enforced the default judgments in any event because the way in which the global sum had been arrived at offended against the ideas of natural justice.

The apparent rigidity of the Court of Appeal's decision in this case begs the question as to when the veil will be lifted.

Prior to judgment in Adams v Cape the courts had shown a general reluctance to define a specific set of accepted instances by which the corporate veil could be dislodged. Lord Denning advocated that a court’s power to lift the veil should be viewed as a discretionary power as opposed to a tool, which could only be used in specific and defined circumstances. However, in Adams v Cape the Court of Appeal forcefully denied that the corporate veil could be disturbed by considering issues relevant to the justice of a case. Yet in Creasey v Breachwood Motors Ltd [1992] BCC 638 it was held that the court had the power to lift the veil ‘to achieve justice where its exercise is necessary for that purpose’. The judicial movement in support of piercing the corporate veil to ‘achieve justice’ has been firmly suppressed in several influential cases concerned with how the Salomon doctrine should be applied to the way in which group structures are organised. A number of subsequent cases have generally followed the Adams v Cape approach, and Creasey v Breachwood Motors Ltd was recently overruled by the Court of Appeal in Ord v Belhaven Pubs Ltd [1998] BCC 607, where the Salomon doctrine was affirmed with an example of an application of the ‘mere façade’ test. Surely, in future cases judges will find themselves focusing on that exact meaning.

While the disadvantage of the justice approach is its dependence on the judicially perceived merits of an individual case, a dependence which may lead to uncertainty in the law, the rigidity of the rules expounded in Adams v Case may in future lead to an unreasonable and unjust conclusion in situations where the corporate form is used as a shield to protect a holding company in a situation where that protection unfairly prejudices the rights of an innocent party.

Bibliography

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‘Lifting the veil’, Lowry and Dignam, Chapter 3

also see Macaura v. Northern Assurance Co Ltd [1925] AC 619; Hobart Bridge Co Ltd. v FCT, [1951] 82 CLR 372, 385; Industrial Equity v Blackburn (1977) 52 ALJR 89

‘Control of Corporate Groups’, Tom Hadden, Institute of Advanced Legal Studies, University of London, 1983, at p5

more frequently equity and contract based (Muchlinski)

typically by way of parent-subsidiary association

Frequently, such corporations invest in developing countries because of a perception, rightly or wrongly, that standards of industrial safety or environmental protection are more relaxed there (see Sithole v Thor Chemical Holdings Ltd [1999], unreported). ‘The Liability of Muli-national Corporations for the Torts of Their Subsidiaries’, Peter Nygh, European Business Organisation Law Review 3, p56

In re Union Carbide Corporation Gas Plant Disaster at Bhopal, India F Suppl 842 (SDNY 1986); Mehta v Union of India

Connolly v RTZ

e.g., s 24 of the Companies Act 1985; s 213 and s 214 of the Insolvency Act 1986; s 349(4) of the Companies Act 1985; s 117(8) of the Companies Act 1985; Dimbleby & Sons Ltd v NUJ [1984] 1 WLR 427

Where statutory regulations, which are concerned with liability to pay tax, are imposed on a group structure the courts are apt to lift the corporate veil, where there is conflict between the corporate entity rule and the statutory intention of the legislation. Thus, in order to tax profits made in the UK by a subsidiary company (where the holding company is based outside the UK) the group may be treated as one entity.

‘Holding Companies And Subsidiaries – The Corporate Veil’, Stephen Griffin, Company Lawyer 1991, 12(1), 16-17

see 10

and although that might make the company morally culpable there was nothing legally wrong with this

‘The Liability of Muli-national Corporations for the Torts of Their Subsidiaries’, Peter Nygh, European Business Organisation Law Review 3, p66-67

‘Holding Companies And Subsidiaries – The Corporate Veil’, Stephen Griffin, Company Lawyer 1991, 12(1), 16-17

‘Control’ can be exercised in many forms, but at its core lies the concept of one company being able to control the other either through the first company holding the majority of the voting rights of the second, or through its ability to determine the composition of its governing board, or through its ownership of the majority of the issued shares of the second company. Control need not be based on legal authority, it may be purely factual.

‘Holding Companies And Subsidiaries – The Corporate Veil’, Stephen Griffin, Company Lawyer 1991, 12(1), 16-17

Cavendish law cards, 4th edition, 2004

Garnac Grain Co Inc v HMF Faure and Fairclough Ltd [1968] AC 1130

Company Law, Ben Pettet, 2nd Edition, Longman Law Series, 2005, p25

Re Polly Peck plc [1996] BCC 486, Re H Ltd [1996]

Company Law, Fundamental Principles, Stephen Griffin, 3rd Edition, Longman, 2000, p18-25