Statutory and Common Law Examples of Lifting the Veil on Corporate Personality - Essay Example

Outline and Critically Discuss the Sta y and Common Law Examples of `Lifting the Veil` on Corporate Personality By Date Statutory and Common Law Examples of `Lifting the Veil` on Corporate Personality Introduction The corporate veil refers to the concept of separate legal personality of the corporation and reinforces the idea that liability is limited so that the members of the corporation are not personally liable for the corporation’s debts.1 The concept of separate legal personality and limited liability was confirmed by the ruling in Salomon v Salomon and Company.2 However, there are exceptions to the corporate shield under both statutory and common law. This paper analyses some examples where the corporate veil can be lifted under both common law and statutory law. Statutory Examples of Lifting the Veil of the Corporation There are several statutory examples in which the courts are prepared to lift the veil of the corporation. For example under the Proceeds of Crime Act 2002, in which the court can make a confiscation order against a convicted criminal has been used to lift the corporate veil.3 Guidelines have been established setting forth the limitations for which confiscation orders can be made that lift the corporate veil. It was held in R v Seager by Aikens LJ that under the criminal law there are three circumstances in which the corporate shield may be lifted. Firstly, if it is established that the convicted criminal attempted to hide his criminal activities and the proceeds of those activities behind the corporation’s separate legal personality, the veil may be lifted.4 Secondly, the corporate veil may be lifted in cases where the convicted criminal committed crimes constituting the criminal offence for which he/she is convicted. Finally, the shield may be lifted where the “transaction or business structures constitute a ‘device’, ‘cloak’, or ‘sham’, i.e. an attempt to disguise the true nature of the transaction”.5 In other words, the Proceeds of Crime Act 2002, will be used in instances where it is clear that the company was used as an instrument in crime for either evading criminal liability or for hiding the proceeds of crime.6 There are several other statutes, particularly revenue statutes where the corporate veil is lifted for the collection of taxes. Moreover, the corporate veil can also be lifted under the Landlord and Tenant Act 1954 and Trading with the Enemy Act 1939.7 Both statutes are used to determine whether or not the individual and the company are so intricately tied that it is difficult to distinguish between the two.8 The statutes considered here are the Insolvency Act 1986 and the Companies Act 2006. There are four examples under the Insolvency Act 1986 in which the corporate veil may be lifted. Under Section 122(1)(g), the corporate veil may be lifted to determine whether or not the corporation was established and operated pursuant to its by-laws so that the corporation may be wound up fairly.9 The main premise of Section 122(1)(g) is to determine whether or not it is fair and equitable that the corporate veil be lifted.10 Thus Section 122(1)(g) is not used for assigning personal liability, but merely for examining whether or not the company was operated for the purposes that it was established. Section 213 of the Insolvency Act 1986 provides that if the court is satisfied that the company’s business or any part of it was conducted with the intention to “defraud” the company’s creditors or any “other person” or “for any fraudulent purpose”, the court is at liberty to make an order directing: Any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make contributions (if any) to the company’s assets as the court thinks proper.11 It was held in R v Grantham that when a corporate manager in managing the affairs of a company obtains credit in circumstances where it is known that the company cannot repay the credit, the individual is acting with an intent to defraud the creditor.12 However it was held in Re: L. Todd that a finding of fraudulent intent will only be established if it is shown that the director or manager of the corporation acted unreasonably and dishonestly.13 Even so, establishing fraudulent trading and fraudulent intent under Section 213 of the Insolvency Act 1986 is not as clear-cut as it may seem. For instance it was held in Morphitis v Bernasconi that one business transaction will not amount to fraudulent trading. Moreover, even if there is evidence of fraudulent trading or intention, the fraud must have a link to the damages claimed.14 In Morris v Bank of India, it was held that even where an employee is found to have been acting fraudulently to the detriment of a creditor or third party, the company will not incur vicarious liability unless it can be shown that the employee acted as an agent of the company and the management knew or should have known of the employee’s fraudulent activities.15 Section 214 deals with wrongful trading and applies in instances where a company goes into liquidation as a result of insolvency and the director knew that the company did not have the potential to avoid insolvency, but conducted business nonetheless.16 In such a case the director may be liable for the company’s debts incurred while trading notwithstanding the directors’ knowledge that the company’s insolvency was inevitable.17 Sections 216 and 217 of the Insolvency Act 1986 combine to allow the lifting of the corporate veil and for the assignment of personal liability in cases where an insolvent company’s name is used in the formation of another company by members of the insolvent company during liquidation.18 The name of the new company need not be exactly the same as that of the insolvent company. Once the name is close enough and suggests some form of association, the corporate veil can be lifted to establish personal liability.19 Statutory provisions are obviously intended to ensure that creditors and third parties are protected from intentional deceit and fraud which tends to suggest a deliberate scamming of creditors and third parties. However, the Companies Act 2006 seeks to protect members of the company. The idea is to ensure that those in a position of power and control do not take unfair advantage of those members who rely on and trust those in a position of power. To this end, Section 994 of the Companies Act 2006 provides for the lifting of the corporate veil in circumstances where: The company’s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself)”.20 Section 994 of the Companies Act 2006 will permit the lifting of a corporate veil to reveal that a parent company owns and controls a subsidiary in cases where the subsidiary petitions the court claiming unfair prejudice.21 Moreover, shareholders of a parent company may also claim unfair prejudice where the directors of the parent company are also the directors of a subsidiary holding.22 The statutory provisions examined in this section demonstrate that there are a variety of civil and criminal remedies intended to protect third parties and company members from fraudulent and dishonest dealing. In proving these protections, the lifting of the corporate veil is used to safeguard against indiscriminate dealing by corporate directors and owners. At common law these safeguards are further defined ensuring that where statutory guidelines are inapplicable, the corporate veil will be lifted in appropriate cases. Common Law Examples of Lifting the Corporate Veil Within two years of establishing the separate legal personality of the corporation under the ruling in Salomon, courts were lifting the corporate veil.23 For example in Aptrope v Peter Schoenhofen Brewing it was held that a parent company in Britain holding the majority of shares in a company in the US was a façade since the main business was conducted in the US.24 Thus the corporate veil could be lifted to determine if the parent company was no more than a sham. In Guilford v Horne, the defendant was a director of the plaintiff company under a contract of employment. Under the terms of the contract of employment the defendant was prohibited from taking up customers of the plaintiff company once his employment came to an end. However, once the defendant’s employment ended he set up his own company which essentially competed with the plaintiff company for its customers. The plaintiff company argued that the company established by the defendant was no more than a sham to hide his prohibitive activities. It was held by the Court of Appeal that the defendant deliberately established the company as a sham to hide what he was contracted not to do: take business from the plaintiff company upon termination of the employment contract.25 The corporate veil was lifted to allow a subsidiary that was doing business on the property of the parent company to obtain compensatory damages on the grounds of agency.26 Atkinson J. established the grounds upon which the separate legal personality of a corporation can be ignored and veil of the corporation lifted. In this regard, the corporate veil could be lifted where it is necessary to establish who is actually running the company’s business: the holding company or the subsidiary. The corporate veil could be lifted where there were questions about whether or not the parent or subsidiary company was obtaining profits, or which company was the “brains” of the business or in control of the business.27 In Rainham Chemical Works, Ltd. v Belvedere Fish Guano Co. the House of Lords lifted the veil of the corporation to assign liability to directors in a personal capacity for a tort claim related to damages arising out of the use of explosive material.28 Thus, the law of tort has been used to ensure that liability for injuries and damages can be claimed notwithstanding the doctrine of separate legal personality. It was held in Jones v Lipman that in circumstance in which a corporation appears to be nothing but a shell for hiding the true structure of the business or to avoid accountability, the company will not be accorded the benefit of separate legal personality and therefore the corporate veil can be lifted. In Jones, the defendant attempted to renege on an estate contract by transferring the property under the contract to company deliberately formed for that purpose. The court therefore found that the company was no more than a “a mask” to avoid responsibilities under a personal contract.29 According to Lord Denning the principle of separate legal personality established under Salomon must be approached cautiously. It must not be assumed that the court may not look behind the corporate veil. The courts and the legislature have all demonstrated that where it appears that a company is no more than a sham or a mask or is taking unfair advantage of the corporate shield, the separate legal personality of the corporation can be lifted permitting a look at all that resides behind the corporate shield so that liability can be apportioned fairly or so that the ends of justice can be met.30 In D.H. N. Food Distributors Ltd. v Tower Hamlets London Borrough Council the Court of Appeal allowed compensation for damages for interruptions of the business under the Land Compensation Act where the land in question and the relevant had different corporate owners.31 According to Lord Denning the single economic unit doctrine would apply in that the companies involved were in fact partners and should not be accorded distinction.32 However, the House of Lords ruled in Woolfson, that the single economic doctrine used in D.H.N. can only be used to lift the corporate veil where there is evidence that the businesses were no more than a façade intended to hide the reality of business structure and ownership.33 The Court of Appeal in Bank of Tokyo v Karoon took a similar approach adding that in lifting the veil of the corporation, the concern is with the legality of the façade and not the economic merits of the arrangement between companies.34 The case of Adams, demonstrates yet another example of when the common law will permit the piercing of the corporate veil. In this case, a company used asbestos and it resulted in claims for personal injuries from its subsidiaries in the U.S. In settling these claims, the company phased out its U.S companies and formed new subsidiaries in the U.S. However new claims arose relative to the phased U.S. subsidiary at which time the company sold its business and effectively could claim that it had no assets in the U.S. It was held by the Court of Appeal, that it would only be possible to determine whether or not the company had a presence in the U.S. if the corporate veil was lifted. Lifting the corporate veil would inform the court of whether or not the subsidiaries and the holding company were one or if the subsidiaries were nothing more than a façade.35 In Adams, The Court of Appeal ruled that with the exception of case where the outcome depends on: ...the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon v Salomon & Co. Ltd. merely because it considers that justice so requires. Our law, for better or worse, recognizes 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.36 In summing up the law as it relates to the lifting of the corporate veil, the Court of Appeal noted, that under company law in the UK and other branches of law, where it can be shown that a company operates as a sham or no more than a mere façade designed to hide the true nature of its holdings and business structure, the separate legal personality established in Salomon will not apply. Therefore in questionable circumstances the court may closely examine the nature and holdings of subsidiaries. However, in Adams where it is proven that the defendant company phased out its holdings in the US for the express purpose of escaping liability for taxes and personal, the company may have acted without a moral conscience, but it did act within the law.37 Moreover, the Court of Appeal held that where subsidiary holdings were under the control of the parent company and acted with the holding company’s authority, the doctrine of agency would operate to ensure that the holding company was bound by the activities of the subsidiary holdings. However, in Adams, it was determined that the subsidiary holdings were acting on their own and independent of control and authority from the holding company. Thus the subsidiary holdings were not in a position to bind the holding company to any of their activities. Therefore the holding company could not be said to have been present in the U.S. through subsidiary holdings.38 Conclusion The statutory and common law examples for lifting the corporate veil operate on the presumption that company management do not take advantage of the shield accorded separate legal personality. As has been demonstrated in this essay, where company owners and managers use the company as an instrument of fraud or for deliberately incurring debt and then subsequently escaping liability for that debt, the courts are willing to ignore the concept of separate legal personality and in doing so will lift the veil of the corporation where it is fair and reasonable to do so. Bibliography Adams v Cape Industries Plc [1990] Ch. 433. Aptrope v Peter Schoenhofen Brewing Co. Ltd. [1899]4 TC 41. Bank of Tokyo v Karoon [1987] AC. Cheng, T. K. (2011) “The Corporate Veil Doctrine Revisited: A Comparative Study of the English and the U.S. Corporate Veil Doctrines.” Boston College International & Comparative Law Review, Vol. 34: 329-412, 336. Citybranch Ltd. Rackind [2004] EWCA Civ 85. Companies Act 2006. D.H. N. Food Distributors Ltd. v Tower Hamlets London Borrough Council [1976] 1 WLR. Ebrahimi v Westbourne Galleries [1973] AC 360. Guilford v Horne [1933] Ch. 935. Insolvency Act 1986. Jones v Lipman [1962] 1 WLR 832. Littlewoods Mail Order Stores v Inland Revenue Commissioners [1969]1 WLR 1241. Morphitis v Bernasconi [2003] EWCA Civ 289. Morris v Bank of India (2005) EWCA Civ 693. Nicholas v Soundcraft [1993] BCLC 360. Proceeds of Crime Act 2002. Rainham Chemical Works, Ltd. v Belvedere Fish Guano Co. [1921]2 AC 465. Re Produce Marketing Consortium Ltd (No 2) [1989] 5 BCC 569. Re: L. Todd (Swanscombe) Ltd. [1990] BCC 125. R v Grantham[1984] 3 All ER 166. R v Seager[2010] 1 WLR 815. Salomon v Salomon and Company [1897] AC 22. Sealy, L. and Worthington, S. (2008). Cases and Materials in Company Law. Oxford, UK: Oxford University Press. Smith, Stone and Knight Ltd. Birmingham Corporation [1939] All ER 116. Thorne v Silverleaf [1994] BCC 109. Woolfson v Strathclyde Regional Council [1978]SLT 90. Read More