Lifting the Corporate Veil - Essay Example

?Lifting the Corporate Veil Introduction The extremely famous and somewhat revolutionary decision of Salomon v Salmon & Co Ltd [1897 introduced andupheld the corporate personality doctrine which was then defined in the Companies Act 1862. The effect of the decision was that creditors of a company that had gone insolvent would not be able to sue the shareholders of the company for its outstanding debts: the doctrine of separate corporate personality was effectively entrenched by the House of Lords. The decision brought several new effects to the company law world. Lord Herschell claimed that “the company is ex hypothesi a distinct legal person”2 and Lord McNaghten stressed that “the company is at law a different person altogether from the subscribers to the memorandum…nor are the members as subscribers liable…except to the extent and in the manner provided by the Act’.3 The House of Lords’ decision in the case of Salomon introduced and enshrined a large amount of new and novel consequences in terms of corporate personality, whilst also properly defining the scope of the then Companies Act 1862 which had not been properly clarified until Salomon. More noticeably, the House of Lords fully established the concept that the company exists as a separate personality from that of its members, causing the company to become its own entity, thus competent to sue and be sued,4 to enter into contractual agreements,5 to make profits and suffer losses in its own name,6 and to own property. The decision of Salomon also formed the beneficial concept that shareholders would be afforded limited liability in the event of insolvency of the company. Despite the passing of more than a century, the dicta of the House of Lords has stood strong as an “unyielding rock”,7 even enjoying codification in section 16(2) of the Companies Act 2006. Yet, as has tended to be the case with such a broad principle, it is not unconditionally applied to every case, and as techniques were developed which took advantage of separate legal personality, so the courts adopted exceptions to the principle under which the corporate veil could be pierced or lifted. Many theorists have attempted to establish a specific set of principles to determine when the veil will be lifted, though this has proven difficult. When will the courts disregard Salomon and lift the corporate veil? Can a specific set of criteria be established in order to determine when the veil will be lifted, or does it depend on the particular circumstances of each case? It is arguable that the courts’ previous instances of lifting the corporate veil have been difficult to predict with any degree of certainty. It will be argued however that this is not necessarily disadvantageous and any alternative approach of the courts could prove more detrimental to company law as a whole. Attempts to establish specific criteria for lifting the veil have been fruitless, as the courts have remained adamant to keep derogations from Salomon flexible. This paper will evaluate when the courts have lifted the corporate veil, and under what circumstances they chose to as opposed to when the courts have specifically refused to lift the corporate veil. Potential for reforms in the law will be explored, though it will ultimately be argued that codification of the lifting of the veil will greatly reduce, even remove the flexibility enjoyed by the courts when lifting the veil. It will be argued that this flexibility is essential in order to make the principle apply as and when the courts see fit. Have the courts approached the lifting of the veil appropriately, or is the veil’s fate left arbitrarily in the hands of the court? Is more certainty required? When Is The Corporate Veil Lifted? It is clear to see that the debate surrounding the courts’ lifting of the corporate veil has centred around the need to balance between certainty and flexibility. The courts have been presented with extremely varied situations and circumstances under which they were required to decide whether the veil should be lifted or left intact. The courts have found reasons to lift the veil, and they have also kept it intact in an equal number of cases. There is clear evidence of the courts’ care taken to retain the power to lift the veil and make exceptions to the Salomon principle as a matter of necessity. Yet is the approach of the courts simply unacceptable? Should they restrict their lifting of the veil to specific principles? Indeed, if an unambiguous set of criteria can be established to determine with clarity when the courts will be likely to lift the veil, then the principle is definable as limited in certain cases. However, if such specific criteria cannot be found, it is conclusive that the principle established in Salomon is open to arbitrary and unpredictable application. The lifting of the corporate veil has been defined by two distinct approaches to the concept of separate legal personality. Those who adopt the narrow view as located in the Companies Act 2006 claim that the property, rights and liabilities of the company belong to the company only. Those who adopt the broad approach claim that individuals of the company are prohibited from having any effect on or from being considered in terms of the legal obligations and rights of the company.8 Many claim that such a broadly applicable principle as that of Salomon must be subjected to exceptions under certain circumstances, and as a result common law and statutory exceptions to the principle of corporate personality have been described as applying to treat “the rights or liabilities or activities of a company as the rights or liabilities or activities of its shareholders”.9 Statutory Exceptions to Separate Corporate Personality Existing exceptions to the corporate veil as defined by various statutory provisions are criticised as being difficult to determine with any strong degree of certainty or predictability; it is generally observed however that statute retains the fundamentality and importance of Salomon, and as a result the veil is lifted only in extreme cases.10 Statutorily, Salomon is established as a fundamentally important concept, resulting in the requirement that exceptions to it are allowed only in certain circumstances when deemed absolutely essential. Lord Diplock has stressed in the case of Dimbleby & Sons Ltd that “any Parliamentary intention to pierce the corporate veil would be expressed in clear and unequivocal language”, though the lack of such unambiguous language still provides the possibility for the veil to be lifted through a “purposive construction’ of Parliament’s intention” in specific circumstances.11 The case of Tunstall v Steigmann further assessed the principle, and stressed the necessity and importance to achieve a clear “purposive instruction” must be clear, because implied intentions to allow the lifting of the veil will not easily be implied.12 A number of additional statutory sources supply justifications for the lifting of the veil in certain cases, for example in cases concerning tax of group structures.13 It is suggestible that such provisions do not actually justify the lifting of the veil per se, they rather serve to pose extra obligations on subsidiaries and provide for the piercing of the veil which is much less intrusive than the lifting of the veil. The Insolvency Act 1986 provides for the lifting of the veil in cases where suspected fraudulent activities are found. Section 213 operates to make shareholders or directors personally liable if it is suspected that the company has been formed with fraudulent intentions, if evidence is apparent of director misconduct (section 212) or if directors have been held to negligently continue the existence of the company if it has no prospect of avoiding insolvency (section 214).14 Indeed, such statutory provisions can be interpreted and applied broadly, though they are sufficiently manageable due to their limitations to specific situations and circumstances. Indeed the existence of the aforementioned statutory provisions accentuate the potential for company members to abuse the existence of the corporate veil, and as a result the courts have suitably highlighted the need to reduce the possibility that fraudulent activities be conducted under the safety of the corporate veil. Common Law Exceptions to the Corporate Veil It is clear that the existing case law and its depicting of the courts lifting of the corporate veil is not predictable due to the courts sporadic approach to circumstances. It is however possible to define circumstances under which the courts have appeared more willing to lift the veil and when they have refused to lift the veil. Case law indeed highlights the unpredictable approach of the courts to the sanctity of the Salomon principle. It is clear that Salomon will not be upheld in every case. The courts have been found to lift the veil in cases of suspected or evident fraud, where companies are a facade, circumstance in which agency exists and where groups of companies are formed. Each set of circumstances will be explored below in order to discover whether the approach of the courts requires reform. When the Company is a Facade The court in the case of Merchandise Transport v British Transport Commission15 pierced the corporate veil and declined to maintain the separation of the corporate personality and its members because it was discovered that a subsidiary company was created for the purpose of avoiding legal formalities in order to obtain a favourable licence. The court has also found a company facade to exist where a company was formed to avoid an employment covenant.16 It was held by Mr Richard Southwell QC that the company’s directors had intentionally ignored the separate corporate personalities of companies which were transferring assets between one another. It is necessary however to stress that the above Creasey principle was overruled by the case of Ord v Bellhaven Pubs Ltd17 on the grounds that legitimate restructuring of the company should not be viewed suspiciously provided it is apparently undertaken in good faith. The rationale behind the lifting of the veil in such situations is clearly to be limited to suspicions that the company has been created for the purpose of avoiding a legal obligation. There is a clear willingness on the part of the courts to lift the veil for the purpose of enforcing the obligation or duty, and this approach is arguably satisfactory. The courts in such cases display an evident attempt to effectively balance the importance of the Salomon principle and abuses that aim to take advantage of that principle. The courts thus look for some type of dishonesty; simple unconscionable conduct or intentions are not sufficient for the courts to lift the veil. Russell J states that the veil should only be lifted under this approach when the company appears to be “a device and a sham, a mask which he...[the defendant]...holds before his face in an attempt to avoid recognition by the eye of equity”.18 Group Companies Groups of companies are often formed for the unjustifiable purpose of avoiding tax charges and obligations and liabilities. Wholly owned subsidiaries are formed by the parent company which thus becomes a shareholder with limited liability should the subsidiary encounter financial problems.19 The courts generally approach group structure companies with suspicion, particularly because the boundaries between the groups are often blurred, thus causing confusion which the group structure can take advantage of. Lord Denning stresses that a group of companies are however a single entity and should therefore be approached in this manner,20 though Lord Roskill has declined to support this statement, and states that each company within a group structure of companies is essentially “a separate legal entity possessed of separate legal rights and liabilities so that the rights of one company in a group cannot be exercised by another company in that group”.21 The House of Lords has also criticised Lord Denning’s statement, stating in the case of Woolfson v Strathclyde Regional Council22 that the corporate veil can only be legitimately lifted if the group is obviously a facade. Interestingly, the Court of Appeal has since reconfirmed Lord Denning’s approach, adding that the corporate veil can be lifted “if it is necessary to achieve justice irrespective of the legal efficacy of the corporate structure under consideration”.23 It is suggestible that this approach to the lifting of the corporate veil is rather uncertain and also serves to dilute the security that such groups seek to achieve. The court in Adams v Cape Industries24 criticised the Court of Appeal’s approach in Re a Company and thereby narrowed the scope of its application based on the rationale that the purpose of the law is to identify legitimate functions of subsidiary companies. The lifting of the veil was hence limited to specific, individual circumstances where the court is presented with the need to interpret and apply a statutory provision or legal document, where the facade is obvious, and where the agency agreement is clear. The court has taken great care to declare the irrelevance of moral approval, stressing that only actual legality are grounds for decision whether to lift the veil or not. Agencies Agency relationships serve to make the principal responsible for the agent’s actions undertaken within the scope of the agency. The veil is often lifted when such an agency structure exists,25 though the willingness of the courts to lift the veil here is not overwhelming. The courts require that the agency exist in the form of an express agreement, though the courts approach the principle as a question of fact in terms of whether an agency will be inferred from the specific circumstances of a particular case.26 It is stressed that the Salomon principle functions to state that mere membership of a company will not always suffice to make it an agent in every set of circumstances. An agency can also not be inferred by way of the members’ executable control over the company,27 and an agency cannot be revealed if the members of the company did not consent to the formation of the agency.28 An agency is often found to exist when the agent has authoritative control over the formation of legal relations between the principal agent and third parties. The courts are however generally reluctant to lift the veil in agency situations. Conclusion It can thus be concluded that there is great difficulty in predicting with certainty when the courts will lift the veil, though fraudulent behaviour is often the main reason. While some suggest that this approach to the corporate veil has opened up the possibility for every director or company member to become criminally liable,29 it is evident that such circumstances are restricted to actually fraudulent behaviour, and that the courts keep this approach within strict limits. Indeed, an inappropriate approach of the courts to the lifting of the veil has the potential to cause great injustices in the company law sector,30 and the lack of evidence to prove such occurrences of injustice gathers much ground in arguing that they do not actually occur in reality. Should the law in this area be reformed? It is arguable that the only way in which the law can be reformed is through the codification or setting of certain principles which will restrict or define the courts’ approach to the corporate veil. However, such reforms will prove very restrictive to the courts and prevent the lifting of the veil from being applied as flexibly as it currently is. Such flexibility is necessary in order to allow the courts to pursue justice without jeopardising the innocent functions of companies. It is evident that the courts are able to fulfil this function as the law currently stands; there is little evidence of the courts abusing of its power to lift the corporate veil.31 This can also be said on a global basis: it is suggested the company law has “achieved a high degree of uniformity across developed market jurisdictions”, particularly in the practice of the ifting of the corporate veil.32 While no specific criteria van be determined which allows one to predict when the veil will be lifted, this will also serve to prevent fraudulent company members from abusing such clarity. The aforementioned circumstances under which the veil has been lifted have not seen the lifting of the veil in all such similar circumstances: the courts rather take a case by case approach and balance the importance of the Salomon principle with the need to uphold justice and prevent abuse of the corporate veil.33 The flexibility of the courts’ current approach allows them to derogate from Salomon whilst not undermining the importance of its content.34 Although it is difficult to predict when the courts will lift the veil and when they will not, it is clear that great care has been taken to preserve the importance of Salomon; there is little or no evidence of abuse on the part of the courts. It can thus be concluded that reform would undermine the current flexibility enjoyed by the courts which allows them to both preserve Salomon whilst upholding its importance depending on the specific circumstances of each case. In such situations it is worth sacrificing certainty in the interests of flexibility. Should clearer principles be enforced? Would such principles operate to protect further Salomon?35 It is to be stressed that providing exceptions to Salomon should not be interpreted as reducing the importance of its content; such exceptions are actually formed to protect it further and reduce the likelihood of abuses. Company law is often so diverse that single all-catching principles are not able to apply in a similar manner to each and every possible circumstance.36 The main purpose behind the courts’ lifting of the corporate veil is to ensure the justifiable application of Salomon. References Bainbridge, S.M. Abolishing Veil Piercing’ [2000] USL. Accessed: 19-11-2011. Source: http://papers.ssrn.com/paper.taf?abstract_id=236967 Davies, P.L. Gower and Davies: Principles of Modern Company Law (8 ed, Sweet and Maxwell 2008). Dignam, A., & Lowry, J. 2006, Company Law, 4th edn., Oxford University Press, New York. Dine, J. and Koutsias, M., Company Law (6 ed, Palgrave Macmillan 2007). Hannigan, B. Company Law (Oxford University Press 2003). Hansmann, H & Kraakman, R, ‘The End of History for Corporate Law’ [2000-2001] 80 GLJ 439. Harris, J. ‘Lifting The Corporate Veil on the Basis of an Implied Agency: A Re-Evaluation of Smith, Stone and Knight’ [2005] 23 CSLJ 5. Accessed: 20-11-2011. Source: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=870516 Hicks, A., & Goo, S.H. Cases & Materials on Company Law (5th ed, Oxford University Press 2004). Huss, R.J. ‘Revamping Veil Piercing for All Limited Liability Entities: Forcing the Common Law Doctrine into the Statutory Age’ [2001] 70 UCLR 136. Masters, JL, ‘Fraud & Money-Laundering: The Evolving \criminalization of Corporate Non-Compliance’ [2008] 11 JMLC 2. Moore, MT, ‘A Temple Built on Faulty Foundations: Piercing the Corporate Veil and the Legacy of Salomon v Salomon’ [2006] JBL 180. Ottolenghi, S, ‘From Peeping Behind the Corporate Veil to Ignoring it Completely’ [1990] 53 MLR 3 Park, WW, ‘Fiscal Jurisdiction and Accrual Basis Taxation: Lifting the Corporate Veil to Tax Foreign Company Profits’ [1978] 78 CLR 1609. Schwarcz, S.L. ‘Collapsing Corporate Structures: Resolving the Tension Between Form & Substance’ [2003] PLRP 41. Accessed 20-11-2011. Source: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=436642.. Templeman, Lord ‘Forty Years On’[1990] 11 CL 10; C Wild, S Weinstein, Smith and Keenan’s Company Law (14th ed, Pearson Education 2009). Tweedale, G, ‘Piercing the Corporate Veil: Cape Industries and Multinational Corporate Liability for a Toxic Hazard, 1950-2004’ [2007] 8 ES 2. Wild, C, Weinstein, S, Smith and Keenan’s Company Law (14th ed, Pearson Education 2009). Read More