Piercing the Corporate Veil - Essay Example

Piercing the Corporate Veil I. Introduction The House of Lords firmly established the concept of separate legal personality and confirmed the concept of limited liability in Salomon v Salomon and Company.1 In other words, Salomon established that once company has been lawfully incorporated, it had a separate legal personality and was not to be regarded as the trustee or agent of those who had control of the company. Even, so the courts have demonstrated a willingness to go behind the corporate personality or to pierce the veil of the corporation in exceptional circumstances.2 The courts’ attitudes toward lifting the corporate veil has spanned over three periods culminating in an approach that is decidedly more inclined to favour the separate corporate personality established in Salomon and thus to only pierce the veil of the corporation in exceptional circumstances. The first stage of the application of the principle permitting the lifting of the corporate veil is referred to as the “experimentation” stage.3 The second stage occurred after the Second World War and ended in 1978 with the decision in Woolfson v Strathclyde Regional Council 4and is referred to as the “heyday of the doctrine”.5 The third period began with the Woolfson decision which persists to this day.6 The decision of Adams v Cape Industries Plc [1990] Ch. 433 essentially provided a statement of the common law position relative to piercing the corporate veil and essentially set the tone for a more conservative approach to the doctrine placing the judicial emphasis on the ruling in Salomon.7 This research study examines the rules permitting the piercing of the corporate veil and identifies a progressive trend toward a flexible approach in which the courts during the so-called golden era applied broad principle permitting the lifting of the corporate veil in circumstances in which justice required it. This research study also identifies the conservative approach spearheaded by Woolfson and fortified by Adams in which the position today remains one in which lifting the corporate veil is not regarded as something that courts are at liberty to apply in circumstances where justice requires it. Thus an examination of the three different stages of the corporate veil doctrine will identify the various circumstances in which the courts will life the corporate veil and the current status today in which the corporate veil is only lifted in limited circumstances: where the company is no more than an instrument to hide the wrongdoing of those who control the company.8 II. The Experimentation Period Not long after the ruling in Salomon, courts began piercing the corporate veil.9 In just two years after the Salomon ruling the court looked behind the corporate veil of a subsidiary in Aptrope v Peter Schoenhofen Brewing and ruled that the British parent company that held the majority shares in a US company was conducting business in the US since the parent company was obviously the “head and brains” of transactions abroad.10 Athrope therefore set a precedent in which lifting the corporate veil could be justified in circumstances where the company was found to be a “cloak or sham” and there was another entity acting as the “head and brains” of the company.11 According to Cheng, what “follows was a period of considerable enthusiasm for the corporate veil doctrine”.12 For instance in Guilford v Horne, Mr. Horne was a director of the plaintiff and subject to an employment contract in which he could not redirect the plaintiff’s customers to him in the event he was no longer employed by the plaintiff. Upon being terminated, Mr. Horne set up the defendant company and competed with the plaintiff. Although there was no covenant relative to competing, the plaintiff argued that the company had been formed as an instrument of fraud to consciously hide Mr. Horne’s improper conduct. The Court of Appeal ruled that it was convinced that Mr. Horne had consciously established the company as a cloak or a sham to carry out business transactions that he knew the plaintiff would have a difficulty with.13 In Smith, Stone and Knight Ltd. Birmingham Corporation [1939] All ER 116, Atkinson J pierced the corporate veil so that a subsidiary conducting its business on the holding company’s property could claim compensation on agency grounds.14 Again in Rainham Chemical Works, Ltd. v Belvedere Fish Guano Co. the House of Lords permitted the lifting of the corporate veil to attach personal liability on directors/controller in a tort claim relative to explosives.15 Cheng observes that during the experimentation period: The lack of a well-defined approach to the doctrine meant that English courts had to experiment with existing common law concepts such as agency, trusteeship, and tort liability principles to resolve corporate personality issues.16 Even so, Atkinson J. did attempt to establish a set of guidelines that would or should justify the piercing of the corporate veil. According to Atkinson J. the corporate veil can justifiably be pierced in cases where there were questions relative to who was actually conducting the business; whether or not the profits were really the parent company’s profits; whether or not the parent company was the brains of the operations; and whether or not the parent company was in actual control.17 Even so, there was no clearly defined principle allowing the piercing of the corporate veil and the courts were virtually at liberty to construct their own justifications for piercing the corporate veil and were essentially inclined to ignore the doctrinal basis established in Salomon relative to the virtually impenetrable nature of the corporate veil. III. The Golden Era There were a number of notable cases during the so-called Golden Era evidencing a high degree of flexibility in which the courts would lift the corporate veil on various grounds primarily relating to achieving justice and fairness. For instance in Jones v Lipman the court held that where a company is no more than a façade used to hide the essential facts or more importantly as an instrument designed to sidestep duties, the corporate veil will be pierced.18 On the facts of the case, Mr. Lipman had entered into a contract for the sale of real property to the plaintiff. However, Mr. Lipman subsequently had a change of heart and to avoid his contractual obligations, transferred the property subject to the contract to a company that was formed for the transfer and a company that he was the sole owner and controller. The court ruled that the: The defendant company is the creature of the first defendant, a device and a sham, a mask he holds before his face in an attempt to avoid recognition by the eye of equity.19 Agency also formed the basis for piercing the corporate veil during the Golden Era. For instance in Firestone Tyre and Rubber Co. Ltd. Lewellin it was held that the British manufacturing company was an agent for a US holding company and thus justified lifting the corporate veil.20 Likewise in Re FG (Films) Ltd. agency was determined in a case where fraud or illicit practices was attributed to a US holding company established by a British subsidiary for the production of a film. The court ruled that there was agency and the film was actually American and thus could not be registered under the relevant British statute.21 Lord Denning’s ruling in Littlewoods Mail Order Stores v Inland Revenue Commissioners is instructive. Lord Denning stated that it was important to approach the Salomon doctrine with caution: It has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see. But that is not true. 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.22 Essentially, Lord Denning advocated for a flexible approach to the application of the corporate veil doctrine. However, as Cheng notes there is a wealth of difference between compulsory group accounting reporting in consolidated scenarios and segregating companies forming a part of a group for the purposes of attaching liability and ignoring the doctrine of distinct legal personalities as required by law. Compulsory accounting reporting is intended providing information and legislatures usually require the consolidation of accounts for purposes that typically have no connection to questions of liability. 23 Nevertheless Lord Denning continued to be flexible relative to his approach to piercing the corporate veil. In D.H. N. Food Distributors Ltd. v Tower Hamlets London Borrough Council Lord Denning may have taken flexibility to an extremely high level. In D.H.N. the Court of Appeal permitted a holding company compensatory damages for disruptions in business activities pursuant to the Land Compensation Act despite the fact that the business as well as the land in question were held by different companies. According to Lord Denning, the case involved “three companies in one”.24 Lord Denning proceeded to describe the single economic unit theory: This group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point.25 According to Cheng, however, Lord Denning’s decision was a turning point for the British judiciary in terms of the application of the corporate veil doctrine. The decision in D.H.N. was followed by a determined shift away from the flexible and liberal approach to departures from or exceptions to the rule articulated in Salomon.26 The judiciary thereafter entered the final stage of the piercing of the corporate veil doctrine. IV. The Final Stage The decision in Woolfson marks the beginning of the final stage of the corporate veil doctrine and the application of exceptions to the rule in Salomon. In Woolfson, the House of Lords directly referring to the D.H.N. ruling questioned whether or not the principle was “properly applied” in that the principle commands that the corporate veil be pierced only “where special circumstances exist justifying that it is a mere façade concealing the true facts.”27 In Bank of Tokyo v Karoon the Court of Appeal expressly criticised the single economic theory enunciated in D.H. N. In Bank of Tokyo Lord Goff expressed the view that: Counsel suggested beguilingly that it would be technical for us to distinguish between parent company and subsidiary in this context; economically, he said, they were one. But we are concerned not with economics but with law. The distinction between the two is, in law, fundamental and cannot here be abridged.28 A trend was developing in which the courts were turning away from the liberal departure from the rule in Salomon and instead turned toward fortifying the rule. The law was essentially stated in Adams. In Adams, the defendant company dealt in asbestos until 1979. Its international marketing subsidiary was another British company (Capasco) and it also has an American marketing subsidiary (NAAC). In 1974 a number of persons sued the defendant, Capasco and NAAc for personal injuries arising out of the asbestos installed in a factory. Although the defendant settled the matter it closed NAAC in 1978 and formed other subsidiary companies to reorganize its business interest in the US and to phase out its presence in the US.29 In 1978 and 1979 a number of other similar claims relative to asbestos were filed in the US against the defendant and Capasco. In 1979 the defendant sold its asbestos business and as a result had no US assets. Default judgments had been entered in the latter claims and the plaintiff filed an action for enforcement of those judgments in the UK. The question for the court was whether or not the defendant company was present in the US via its subsidiaries. The Court of Appeal ruled that the defendant company would only be present in the US via its subsidiaries if the corporate veil was pierced and the groups were treated together with the defendant company as a single persona or if the subsidiaries were no more than a façade or were the defendant company’s agents.30 The Court of Appeal ruled that: 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 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.31 The Court of Appeal acknowledged that it was firmly established in English law that where a company is merely a façade intended to conceal the true facts, is an exception to the rule in Salomon. For the purpose of determining whether or not the company is a mere façade, the motives of those involved is usually important. Thus the Court of Appeal examined the motives of the defendant company in the formation of subsidiaries and found that while the defendant company may have formed subsidiaries to narrow or eliminate its presence in the US for the purpose of avoiding tax liabilities and other forms of liabilities, this may have been morally wrong, but it was perfectly legal.32 With respect to agency, the Court of Appeal ruled that if the subsidiaries were acting under the control and with the authority of the defendant company, the subsidiaries would bind the defendant company. However, the Court of Appeal found that since the subsidiaries were conducting their day-to-day business activities free of control and authority from the defendant company, they could not bind the defendant company. As a result, the defendant company was not present in the US via its subsidiaries.33 Adams essentially narrowed down the situations and circumstances in which the corporate veil can be pierced. There are three situations in which the court may life the corporate veil: Where the interpretation of a statute or a document such as a contract is being interpreted. Where fairness is not an issue, only where the document or statute is unclear will the courts intervene. Where the company is found to be no more than a façade. Where the subsidiary is found to be an agent of the parent company. For the most part, Adams is still good law. However, there have been some instances in which the courts have been willing to relax the parameters set by Adams. Ratiu v Conway the court ultimately contradicted the ruling in Adams, by relying on the historical development of the judicial tendency to lift the veil of the corporation. Auld J observed that the courts have demonstrated “readiness” “regardless of the precise issue involved, to draw back the corporate veil to do justice when common sense and reality demand it”. 34 Lord Auld went farther to state that indeed, in principle, a strong case can be made “for lifting the corporare veil where the facts require it.”35 While there was apparently a softening of the Adams’ approach in Samengo-Turner v J&H McLennan (Services) Ltd. the case was determined on the basis of the fairness or lack thereof in permitting a group of companies to escape liability relative to employment claims under a statute. In this case it was essentially determined that lifting the veil of the corporation was necessary to give effect to the statute and to permit the plaintiffs to achieve that which the statue intended.36 Therefore the extent to which Adams has been altered is in doubt considering the ruling in Ben Hashem. This case indicates as does Adams that the veil of the corporation can only be lifted in limited and specific circumstances. The Adams case however, may be too narrow in its approach and there is an apparent willingness on the part of the courts to depart from the strict parameters. Adams appears to determine that even if a company was formed to avoid specific liabilities in circumstances that might be morally wrong, the company will not be deemed a sham if those motivations were lawful. Arguably, the manipulation of law in Adams however was for the purpose of avoiding liability in general which is arguably, the purposes for which companies are incorporated. Moreover, the formation of the subsidiaries and the subsequent phasing out of the subsidiaries were not for the purpose of avoiding personal liabilities but instead were meant to avoid corporate liabilities, a lawful business transaction. V. Conclusion The judicial piercing of the corporate veil has developed in an unpredictable and uncertain manner. There was a determined trajectory toward entirely ignoring the rule in Salomon, so much so that it appeared as though the separate legal personality of the company was the exception rather than the rule. The initial stage immediately following the ruling in Salomon essentially challenged the separate legal personality of the company by creating unique circumstances in which the corporate veil can be lifted. A discernible pattern emerged in which the corporate veil would be lifted in circumstances where it was assumed that justice requires it. The Court of Appeal’s judgment in Adams appears to have reined in the corporate veil doctrine by establishing that the separate legal persona of the corporation is the rule and lifting the corporate veil is the exception. However, there are some signs that the strict boundaries established by Adams have been relaxed, although in a limited way. Thus some flexibility appears to be reentering the corporate veil doctrine. This is not necessarily detrimental to the rules established in Adams. There may be cases in which lifting the corporate veil is entirely necessary and justified and the circumstances do not fall within the narrow confines of Adams. For now at least, Adams has changed the judicial culture of systematically lifting the corporate veil in wide range of circumstances, including the lifting of the veil for permitting a claim in tort. Thus for the time being, Adams for the most part remains good law. 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 45. Ben Hashem v Ali Shayif [2009] A FLR 115. 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. D.H. N. Food Distributors Ltd. v Tower Hamlets London Borrough Council [1976] 1 WLR 852. Firestone Tyre and Rubber Co. Ltd. Lewellin [1957] 1 WLR 352. Guilford v Horne [1933] Ch. 935. Jones v Lipman [1962] 1 WLR 832. Littlewoods Mail Order Stores v Inland Revenue Commissioners [1969]1 WLR 1241. Moore, M. T. (2006). “A Temple Built on Faulty Foundations: Piercing the Corporate Veil and the Legacy of Salomon v Salomon.” Journal of Business Law, 180-203. Rainham Chemical Works, Ltd. v Belvedere Fish Guano Co. [1921]2 AC 465. Ratiu v Conway [2006] 1 All ER 571. Re FG (Films) Ltd. [1953] 1 WLR 483. Salomon v Salomon and Company [1897] AC 22. Samengo-Turner v J&H McLennan (Services) Ltd.[2007] 2 All ER 813. 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. Woolfson v Strathclyde Regional Council [1978]SLT 90. Read More