Principles of Limited Liability and Corporate Personality: Issue of the Corporate Veil

Introduction

This paper will consider the limited liability principles, corporate personality and the unwillingness of the courts to ignore the corporate veil principle knows as “piercing the Corporate Veil”[1]. Situations in which the courts have had the ability to pierce the veil of incorporation will be discussed, as well as the reasons why they have generally upheld their decision as in the case of Solomon v Solomon & Co[2].

The Companies Act[3] requires every company in the United Kingdom to register and to be incorporated[4]; the Act also oversees the limited liability principle, which provides the shareholders or the owner with protection against liability to creditors in the event of the company encountering financial difficulties[5]. This protection is applied in order to provide the company with a distinct and unique legal personality, which enabled it, in its own right, both to sue and to be sued[6]; this means that the only deprivation encountered by the shareholders or the owners is, in the case of liquidation, the loss of the company shares which they hold, but there is no impact upon their personal assets.

This specific dissociation between the shareholders or owners of the limited company is the notion known as the ‘corporate veil’[7] or the ‘veil of incorporation’[8].

Finally, it will be contended that the courts ought to lift or pierce the corporate veil to an effectively greater extent, in order to regard errant directors or shareholders of a company as being responsible for that company’s liabilities or debts, regardless of the general limited liability principle, in a situation where the company has inadequate assets to offset its creditor liabilities.

Limited liability and Corporate Personality

The standards of corporate personality and limited liability have been the keystone of company law in the United Kingdom since the inception of the Joint Stock Companies Act 1844, its consolidation in 1856 and also the incorporation of the Limited Liability Act 1855[9]. Both of these principles have been so carefully protected by the courts as being foundational to current company law by maintaining the distinct legal personality of a corporate entity.

Nevertheless, this legislation’s initial objective was to assist corporations to accumulate capital by issuing shares, but without placing the shareholders at a greater risk than that of the shares they hold.  However, the current attraction of incorporating a company carries the benefit of sheltering behind the screen of limited liability which some business people could exploit.

Limited Liability

As aforementioned, the principle of limited liability was initiated by the Limited Liability Act 1855[10] as a method by which corporations could amass capital by selling shares without placing the shareholders at risk of unlimited liability[11].

If a company becomes insolvent or liquidated, the limited liability doctrine protects the owners, directors, managers and shareholders against any personal liability[12]. In such case, the owners’ and shareholders’ liability is limited to their individual shareholding as specified in the Companies Act 2006[13] and the Insolvency Act 1986[14]. Therefore, in practice, company members are not required to pay their personal assets to the corporation’s assets for the purpose of satisfying the corporation’s obligations to its creditors on liquidation; however, individual shareholders are required to pay the complete nominal value of their shares. At this point, it is significant to record that this limited liability does not protect a limited company from liability until the time when all of its assets or debts are completed[15].

Moreover, this precept has continued to be applied since the House of Lords pronounced a judgement in the Solomon case, in which they ruled the opinion that the motives at the basis of a company’s foundation had no relevance in determining that company’s liabilities and rights, provided that every registration requirement was observed and that there was no illegal reason behind the formation of the company[16].

Although limited companies have distinct legal personalities, the decisions within them are made by managers and directors who ought to utilise the authority given to them by their board of directors, as well as the articles of association and memorandum; consequently, any exploitation will involve liability incurred by the person concerned.

Limited liability includes businesses of every kind, ranging from small one-person companies[17] to large corporations[18], therefore the liabilities are restricted to company possessions rather than to other personal assets.

This opinion has recently been affirmed by many instances which occurred in a one-man company, Lee’s Air Farming[19]. Lee was a director and the majority shareholder in this company; he was also an employee. Lee was fatally injured in an aircraft accident, and the court was of the opinion that Lee and the company were in fact, two different and distinctive entities, consequently, he was entitled to receive compensation[20].

It is only in extreme circumstances, such as exploitation, deception, or in cases where the company was utilised by its owner, as an agent, that the courts will disregarded the principle of limited liability and hold directors, shareholders or members as being personally responsible for the debts and for other company obligations to the creditors in what has been called the piercing or lifting of the “veil of incorporation”. This has been highlighted by one commentator as follows: “nowadays, in the era of high expectations, limited company is found as a useful tool for carrying on business due to the fact that it is know that it has a separate legal personality which is responsible for all the loans and debts of the company”. Moreover, many statutory laws exist which permit the doctrine of limited liability to be ignored in circumstances such as the reporting of group companies’ financial statements, insolvency and corporate crime[21]; these matters will be discussed below.

Corporate Personality

A limited company can be defined as a legal entity having a distinct existence which is independent of its members[22], provided that all of the registration formalities are observed and comply with the Act. A company’s corporate identity implies that it can sue and can be sued in its own right, with no impact upon the rights of its shareholders or owners. This is a platitudinous law in which the only plaintiff to a transgression made to a company is a prima facie company itself, and not its shareholders, with the exception of cases where there is a complaint that the acts are unlawful or there are accusations of deception against the shareholders.

A company has been considered as having an independent legal corporate personality since this was initially determined in the case of Solomon v A Solomon & Co Ltd[23]. In order to stress this matter, Lord Halsbuy said that it appeared “to dispute that once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself, and that the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are”[24].

In this situation, Solomon registered his company as a limited company in accordance with the Companies Act which required at least seven members for the company to be incorporated. Solomon became the majority shareholder and his wife and children each held a share; however, the company encountered financial difficulties and left no assets for the unsecured creditors on liquidation.

Although the Court of Appeal judged the company to be a ‘sham’ and an alias[25], and that a trustee or nominee for Solomon claimed that the transaction was contrary to the true purpose of the Companies Act, the House of Lords reversed this decision and ruled that the company had been validly registered according to the Act and consequently possessed a distinct legal personality from that of the shareholders[26].  In reaching this decision, Lord Macnaghten said: “The company is at law a different person altogether from the subscribers……. Nor are the subscribers, as members liable, in any shape or form, except to the extent and in the manner provided by the Act”[27].

This ruling indicated that the House of Lords recognised that the decisive element was the compliance to the formalities and requirements of the Act, which protected the principles of corporate personality and limited liability. This is currently the proper interpretation of the Companies Act and it is essential that this law is sustained in the progression of commerce.

At this point, it is important to be aware that the corporate personality principle has no significant impact upon the company’s creditors regarding debt recovery. Subsequent to the ruling in the Solomon case, Professor Gower commented that a limited company is ‘opaque and impassable’ whereas it was also considered to be “calamitous”[28].

It has been implied by some commentators that courts have had a greater tendency to sustain the sanctity of a company’s distinct legal integrity and have subsequently opposed the common law resolution of “peering under the skirts of a company to examine its linen (dirty or otherwise)”; this is apparent from the many cases which have been judged since the Solomon case.

These facts indicate the significance to commerce of a company’s incorporation as it permits the continuity of business transactions irrespective of any changes in the company’s shareholders, directors, administrators, or owners.

Moreover, in certain extreme circumstances, common law has ignored this principle in cases of exploitation or deceptive utilisation of a sham corporate framework[29]. This framework has been ignored by the courts in order to search behind the veil as an attempt of “directing mind and will” which govern the corporation and to apply the intervention which is known as lifting the mask, cloak or veil[30].

When a company has entered liquidation, although the courts have, on some occasions, pierced the veil in order to benefit the creditors, the same courts have been reluctant to pierce the veil in cases which could have resulted in an advantageous outcome for shareholders.

The Directing Mind

A registered company is defined as a distinct and independent legal entity and a corporate body, which has rights and is subject to duties; it may, in its own right, sue or be sued[31].

In the Lennard’s Carrying Co Ltd v Asiatic Petroleum Co. Ltd[32] case, the court ruled that: “…a corporation is an abstraction. It has no mind of its own any more than it has a body of its own; its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation….”[33].

Therefore, it is apparent that the courts are prepared to glance behind the corporate veil as a legal matter, in order to establish the identity of the directing officer from whom the decisions originate, as well as the actions undertaken by the corporation.

A company’s directing mind is the senior person whose authority is derived from the board of directors in order to undertake the company’s activities as directed and for the its benefit[34].

During the execution of the company’s business, such senior persons would subsequently delegate their authority to other employees in order to operate the company effectively; when this situation applied, the actions or inactions for these employees would be regarded as being those of the ‘directing mind’[35].

Lord Reid proceeded to describe the “directing mind and will” of a company as the person who acts on the company’s behalf, as “the company and his mind which directs his acts is the mind of the company.……. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is a guilty mind then that guilt is the guilt of the company.”

Consequently, this would indicate that the “directing mind and will” of the company is any of its employees who undertakes certain functions on the company’s behalf, provided that he possesses the authority to undertake this action and does not act beyond his mandate, in which situation he would be personally responsible.

In the case of Williams and another v. Natural Life Health Foods Ltd and Mistlin, being of a small one-person company, Sir Patrick Russell in his dissenting judgment ruled that “the managing director will almost inevitably be the one possessed of qualities essential to the functioning of the company”; however, this does not in itself imply that the director is prepared  to accept personal responsibility for the customers of the company.

Consequently, if a court is to convict a company, it will go behind the distinct legal status of the company in order to establish the “directing mind and will” of the company as it controls its activities.

Nevertheless, it has been recognised that the doctrine of limited liability can be exploited, and in a situation where a statute will not supply equity or justice, the courts have, in such an unusual situation, ignored the principle and ruled that the directors or the shareholders are responsible for their decisions in the functioning of the corporation. The procedure by which the courts have ignored the precept of limited liability is known as “piercing the corporate veil”; this is the principal subject of this paper.

One-man Limited Companies

Council Directive 89/667, which specifies the foundation of private one-person companies, departs  from the requirements of the Joint Stock Companies Act 1856. This directive emphasises the commercial development, and as can be recognised from the Solomon case, Mr Solomon, who owned the corporation, registered as few as six shares for his wife and children in order to satisfy the Act.

In these one-man companies, the owners are usually also the directors of their company and therefore, are in a position of being able to exploit the corporate framework by registering their personal assets as those of the company, consequently, avoiding personal liability.

In the case of a one-man company, the courts are willing to pierce the corporate veil and consider the company’s assets as being “property held by the defendants” where the company is deemed to be an alter ego of its owner.

Nevertheless, the courts have demonstrated that they are unwilling to break through the corporate veil, even in one-person limited companies, provided they are correctly registered in accordance with the Act.

In the aforementioned Lee  v Lee’s Air Farming, Mr Lee incorporated Lee’s Farming Limited of which he was a director and controlling officer as well as an employee of the corporation. Following his death in the air crash whilst on company duty, his family claimed workers’ compensation. However, the court ruled that Mr Lee and the company were independent and distinct entities, consequently Mr Lee was considered to be an employee in his own company.

Therefore, in this case, it is observed that the court’s endorsement of the principle stipulated by the rule in the Solomon v Solomon case, has remained controversial in the face of globalisation and changing commercial activity.

The courts have been more prepared to pierce the veil in the case of one-person companies in a situation where the owner of the company is normally also the controlling officer and whose dealings with the company are not remote.  In the Wallersteiner v Moir case, Lord Denning ruled that the subsidiaries were controlled by Dr Wallersteiner which made them “puppets” which “danced to his bidding”.

In this case, Lord Denning is saying that although the subsidiaries appeared to have a distinct personality, they were, in practice, his agents or sham companies, having no independent existence and that consequently, this upheld piercing the veil.

This corporate personality precept as demonstrated in the Solomon case has now been extended to group companies; this matter will be considered next.

Group Companies

A group company is defined as a parent company having subsidiary companies which do not continue their businesses as common entities neither as “single economic units”, although this is the impression that is given to the world in general. The principle of limited liability is relevant to the subsidiary companies which are formed in this way because they are companies registered under the Act and, effectively, each has a distinct legal personality to the parent company; consequently, they can sue and be sued in their own right.

This is advantageous to the group because it limits liability to each subsidiary company, while simultaneously sharing the profits of the group for the group framework’s benefit. Group frameworks of this kind can result in the parent company formulating subsidiary companies to operate the precarious areas part of the business, and by so doing, insulating itself from liability if a subsidiary company fails to satisfy the obligations to its creditors.

The impact of corporate personality within group companies is that each subsidiary has legal independence, and is distinct from the other subsidiaries and from the parent company; therefore, each entity is responsible for its own debts, a situation which endorses the Solomon principle. Nevertheless, Hobhouse LJ has contended that the courts ought to consider the entire group of companies as an independent economic entity.

Lord Justice Slade, when commenting on this matter, said: “Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense are the creatures of their parent companies, will nevertheless under general law fail to be treated as separate legal entities with all the rights and liabilities which would normally be attached to separate legal entities”.  This remains legally binding, and is an endorsement of the principle in the Solomon case.

In the Ord & Another v Belhaven Pubs Ltd case the company’s owners were in the business of acquiring former public house premises, restoring them, and subsequently letting them to tenants; they let one renovated pub building to Ord. Falsification had been made by the company regarding the premises’ potential profitability; however, this did not become apparent until later, by which time Belhaven Pubs Ltd had ceased trading and was unable to pay its debts. Therefore, Ord attempted to gain leave to substitute the parent company.

The Court of Appeal ruled that the defendant company which granted the lease had acted legitimately and had not simply acted as a façade on behalf of the holding company and that it could therefore not be substituted.

This basic precept of distinct and independent legal identity has been re-affirmed in more recent times by a decision of the Court of Appeal in the case of Adams v Cape Industries PLC. The defendant company, in this case, belonged to a corporate group with a United Kingdom parent company. The health of this company’s employees in its United States subsidiaries was harmed by the inhalation of asbestos dust, and they successfully sued the subsidiaries in the US courts. They attempted to enforce judgement against the parent company, claiming that Cape had been present in the United States in its subsidiary companies because they formed a “single economic unit”.

The Court refused to pierce the corporate veil and judged  that the  “fundamental principle is that each company in a group of companies is a separate legal entity possessing separate legal rights and liabilities…”

The precept in the Solomon case was vindicated on the interpretation that the subsidiary companies had been formulated legally; consequently, they were independent legal entities, separate from the parent company.

Nevertheless, it is necessary to consider the companies’ economic realities in view of industrial development, and with the effect of globalisation, to regard group companies as one economic entity, in the same way as legislation was introduced for group accounts and corporate tax purposes. This is in agreement with the opinion of Lord Denning, who said:

“I decline to treat the [subsidiary] as a separate and independent entity… 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. I think that we should look at the Fork Manufacturing Co. Limited and see it as it really is – the wholly-owned subsidiary of Littlewoods. It is the preacher, the puppet, of Littlewoods, in point of fact: and it should be so regarded in point of law.”

In this situation, it is contended that the courts ought to be more disposed towards lifting the corporate veil to a significantly greater degree in situations which involve corporate groups, and as Gower correctly comments that the law can “go behind the corporate personality to the individual members or directors, or it can ignore the separate personality of each company in favour of the economic entity constituted by a group of associated companies.”

The Corporate Veil

The corporate veil is defined as the curtain which legally divides a company from its shareholders; therefore, it considers the company to have a distinct legal personality and a limited liability.

In restricting any exploitation of limited liability and in safeguarding creditors of both small and group companies, the courts have in some situations, nevertheless reluctantly, glanced behind the corporate veil in order to authenticate the genuine intent of the company’s controlling officers. However, on rare occasions, the courts have disregarded the corporate form and considered the business realities of the situation in order to avoid the deliberate evasion of contractual obligations; the purpose of this is to avert deception or other criminal activities in the interest of public morality and policy.

In one-person companies, in which the owner is normally the director and hence the controlling officer, piercing the veil has been straightforward; this is a different situation when compared with group companies having a layered framework.

The controlling officer will be considered as being responsible and therefore requested to account for his actions, in order that the corporation may satisfy its financial obligations to the creditors if the company becomes insolvent, as clarified by the Royal Brunei Airlines v Tan case.

Lifting the Veil of Incorporation

The corporate veil is defined as a curtain which protects directors and company shareholders from personal liability by the rule of limited liability, where a company becomes insolvent and is unable to satisfy its obligations.

The lifting of the corporate veil concept involves a legal decision by which the directors and shareholders of a limited company are considered to be responsible for that company’s debts or additional liabilities contrary to the rule of limited liability.

Although there is strict liability legislation to prosecute limited companies which err by committing statutory offences, in cases where there is insufficient statutory protection, the common law solution of piercing the corporate veil is enforced by the courts in order to attach the liability to the company’s controlling officer.

Nevertheless, there has been a reluctance on the part of the courts to overturn the rule of limited liability, and it is only in extreme situations where they have y been prepared to pierce the corporate veil in order to obtain the authentic facts. When this applies, some parent-companies or individuals who are responsible for the corporation’s actions are held liable in order to account for their decisions as directors or shareholders. Corporate law in the United Kingdom, normally requires that directors, shareholders, or parent-companies cannot be held liable for the corporate obligations of the companies or subsidiaries which they control; therefore, sustaining the principles of limited liability and distinct legal corporate personality.

In English law, the precepts of distinct legal personality and limited liability have been accepted for a considerable length of time; this law states that the directors or shareholders cannot be liable for the company’s debts, provided that the company is administered correctly. Nevertheless, in extreme situations, the courts have been willing to look behind the corporation and establish the actions or inactions of the shareholders and directors by utilising the process called “piercing the corporate veil”.

According to certain commentators, the decision in the Solomon case, provides “unscrupulous” promoters of limited companies with an opportunity to misapply the Companies Act, and that this is not within the spirit for which this Act was formulated.

The procedure of piercing the corporate veil is the means by which the court disregards the rule of corporate personality and considers the directors or shareholders to be responsible for their actions, in order that they may satisfy the corporation’s obligations in their personal capacities. The courts will pierce the veil in cases where the corporate framework has been utilised as a means of deception or in attempt to circumvent the legal process.

It has been contended that although the courts have utilised the principle of “piercing the corporate veil” (though reluctantly), this concept is not clearly comprehended which results in uncertainties in the legal procedure. It has been suggested by certain commentators that the extreme circumstances where the courts have justified piercing the corporate veil is uncertain, as shown by the number of contradictory decisions which the courts have made. Furthermore, Goulding contends that “it is not possible to distil any single principle from the decided cases as to when the courts will lift the veil” because of the many different cases, although they are more prepared to do so in situations of excessive exploitation.

In the principal case on this matter, Solomon v Solomon, which has been previously discussed, the House of Lords ruled  that: “individuals could organise their affairs as they wanted and that if they chose to do so via incorporation they were entitled to the protection of limited liability as long as the incorporation was in accordance with the formal rules of the relevant legislation”.

Although it is English common law that the incorporation of a corporation safeguards its members from company liability by the rule of limited liability, in situations of exploitation of the corporate framework, there are exceptions both in common and in statuary law to this principle.

Statutory Exceptions

Gower and Davies contend that the courts are prepared to lift the veil in cases where the statutory wording of a particular rule is unequivocal and expressly provides for it. The courts have avoided the inducement to pierce the veil simply because they regard it as being right to do this, although they are certainly prepared to do so in exceptional situation or in cases where they perceive that the directors or shareholders are obscuring the real facts.

Tortious Liability

A corporation is vicariously responsible for any torts effected by its agents or employees whilst undertaking official duties and ‘shall not be called into question on the ground of lack of capacity’ while the agent or employee continues to be the primary tortfeasor.

Consequently, it is obvious that the “directing mind and will” of the corporation may occasionally be personally responsible for torts, for which the company is also responsible, because of their deceptive actions, although these are committed on the corporation’s behalf.

Many acts are exclusively relevant to the lifting of the corporate veil in both criminal and civil jurisdictions which impose stringent liability upon limited companies.

Duty to prepare Group Accounts

Although each company within a group has a distinct legal corporate identity and is therefore required to present individual company accounts, it is stipulated by Section 399 (2) that the parent company presents group accounts at the conclusion of each financial year in order to “give a true and fair view of the assets, liabilities, financial position and profit or loss”. By this means, it can be deduced that the Act considers the group of companies to be a ‘single economic entity’, which effectively lifts the corporate veil contrary to the rules of corporate personality and limited liability, but has no impact upon the corporate framework.

Failure to Obtain a Trading Certificate

The Act forbids a registered corporation from trading or securing credit prior to obtaining a trading certificate; and shareholders or directors who do not comply with these regulations contravene the Act. Any shareholders or directors who contravene this Act shall be severally and jointly liable to indemnify third parties for any damage or loss sustained because of the corporation’s failure to observe its requirements. The legislation in this situation is distinct and any shareholders or directors who are in contravention of the law will be considered responsible for the company’s obligations prior to the acquisition of a trading certificate; consequently, this is a statutory piercing of the veil of incorporation.

Liability of a Disqualified Director

This Act provides the courts with extensive powers to issue disqualification orders and to forbid a person from occupying a director’s position or any other management position within a corporation on the grounds of contravening company law or other matters apart from criminal convictions; such disqualification shall not exceed a time period of 15 years.

A person who is disqualified from holding a director’s position, but who breaches the disqualification order, by continuing to act as director shall be personally responsible for all the debts incurred by the corporation while that person was acting as a director. Similarly, any person who knowingly acts on the directions of a disqualified person shall be severally and jointly responsible for the debts of the corporation with which the disqualified director has been involved.

In this case, it is evident that the legislation has lifted the veil on disqualified directors and considers them to be responsible for the actions which they performed on the company’s behalf ; this is in agreement  with Lord Denning’s powerful  affirmation that “the legislature has shown the way……And the courts should follow suit.”

Insolvency Act 1986

The Insolvency Act 1986 provides exceptions to the limited liability and corporate personality rules, in situations where there is a contravention of company structure in defrauding creditors. As explained below, when these exceptions are breached, the action results in a piercing of the veil of incorporation, in which case the shareholders or directors are held personally responsible for persisting with trade while simultaneously being aware that the corporation was encountering financial problems and that it would not survive.

Fraudulent Trading

This act stipulates that when a company is liquidated, any officer deemed to have knowingly utilised the company’s business framework in order to defraud creditors shall be personally responsible for the company’s debts and will be required  to contribute to the debts’ discharge. Furthermore, this act reduces the possibility of directors, who ought to have been aware of the true intention of their actions, from using the Salomon principle as a means of deception, who should have known the true intent of their actions.

Wrongful Trading

When a director of an insolvent company permits that company to continue trading on credit or to obtain credit while being aware that there was no reasonable possibility of that company averting liquidation, then wrongful trading is considered to apply. In such circumstances, and on the liquidator’s application, the Act empowers the courts to remove the ‘veil of incorporation’ of an insolvent company and to hold the directors of the company to be responsible and to contribute to the assets of the company.

Some commentators contend that the effect of this section has been a “great disappointment” as a result of many different judicial methods which have generated a high level of legal uncertainty, and consequently few successful court actions.

Nevertheless, an important element of the Act is that any directors who allow a corporation to continue to trade in a case where there is no possibility of repaying trade debts and averting liquidation shall incur personal responsibility as the courts pierce the ‘veil of incorporation’ to the creditors’ advantage.

Phoenix Companies (The Phoenix Syndrome)

The “Phoenix Companies” indicates an occasion where one company goes into liquidation while another company is registered under the same or a similar name with the intention of deceiving the creditors by transferring the assets to the newly-registered company.

Section 216 of the 1986 Insolvency Act stipulates that anyone in the position of company director during a twelve-month period before the company was liquidated shall become personally responsible if he becomes involved in managing a company with a similar name to that of the insolvent company or a name which is sufficiently similar as to apply there is an association. In such circumstances, Section 217 gives power to the courts to remove the corporate veil in and to consider the director to be severally and jointly liable, together with the company for the debts of the “Phoenix Company” which has been formulated.

Landlord and Tenant Act 1954

Section 30 (3) of this Act stipulates: “where the landlord has a controlling interest in a company any business to be carried on by the company shall be treated ……….as a business to be carried on by him.”

Furthermore, in a situation where the statute has disregarded the Solomon principle and considered the landlord to be held responsible for the business conducted by his company in the order that the tenants shall not be disadvantaged.

The statutory exceptions described above represent a small number of instances and emphasise the importance of this matter. Certain commentators, for example Gower, have warned that the precept of limited liability is subject to exploitation and therefore, it is necessary to apply strict regulation.

Common Law Exceptions to the Corporate Veil

The courts have applied many different methods as they have decided whether or not to pierce the veil of incorporation; such legal uncertainty leads to exceptional difficulty for aggrieved parties to institute any legal action against a director for a corporation’s actions or inactions.

This uncertainty leads to extreme difficulty on the part of the litigants as they attempt to forecast whether or not the courts will pierce the corporate veil at common law; when compared to a situation where the Act is explicit of parliamentary intention as aforementioned.

Different courts have applied different interpretations, consequently there is a continuing requirement to search for the common ground in order to consider the substance. According to Simon Goulding: “it is not possible to distil any single principle from the decided cases as to when the courts will lift the veil….”

In the Kensington International Limited case, Cooke J agreed with the earlier rulings of Staughton LJ, and Walker R J and quoted that it was “better to speak of ‘substance’, ‘truth’, ‘reality’ and that which was ‘genuine’”, rather than use the words “disguise, cloak, mask, colourable device, label, form artificial, sham, stratagem and pretence”.

The authentic situation is that the courts would be acting justly and would be perceived to be impartial to all parties, provided they set the standard which they consider to be the legal substance of the matters concerned, in order for there to be minimal variation in principle in how situations which need the piercing of the veil of incorporation are tackled.

The “Agency” Exception

Although a corporation is able to act as an agent of the shareholders or of a parent company, this ought to be with the members’ authority and it is necessary for there to be distinct evidence regarding the range of such authority. Subsequent to the establishment of this authority, the shareholders and the directors are under obligation to apply by way of the Principal/ Agent relationship, and furthermore shall be liable for the actions and/or inactions of the corporation. In such a situation, the courts are under obligation to pierce the corporate veil and to regard the company’s actions or inactions of the company as those of the shareholders or the directors; this is different from the Solomon case in which it deemed that a corporation may not be an agent of its shareholders or the directors.

In the Smith, Stone & Knight v Birmingham Corp case, in which a holding company claimed compensation since it was an owner-occupier by means of its ground subsidiary that was an agent and was continuing with the parent company’s business. Atkinson J accepted the claim as a matter of economic reality.

More recently, in the case where F.G. (Films) Ltd, an American parent company, formed a British subsidiary in order to present a film which would, as a result, be regarded as a British film; the court ruled that the participation of the British company was insignificant from a financial aspect, and that it had been formulated with the singular purpose of generating an agency relationship.

The “Sham” or “Façade” Companies’ Exception

Lord Justice Diplock, in providing a definition of a ‘sham’ company which was universally recognised, stated that if the word ‘sham’ had any meaning, then such meaning is: “acts done or documents executed by the parties to the ‘sham’ which are intended by them to give to third parties or to the court the appearance of creating between the parties’ legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intended to create”.

The courts encounter a difficult assignment when they seek to establish if a company is simply a sham or a façade since they need to recognise the motive of the people behind that company, who are known as the “centre of the personality of a corporation”, who control the corporation’s activities. Furthermore, the courts are required to establish the necessity to pierce the corporate veil where there are exceptional circumstances which indicate that the corporation was simply a façade, hiding the real facts.

The rapid increase in the number of companies being incorporated, many of which are one-person companies is a matter that needs to be carefully supervised as an increasing number of companies is entering voluntary liquidation. The monitoring requirement will apply because of the fact that it is a straightforward task for an unscrupulous trader to incorporate a company which could simply be a “cloak” to protect themselves against pre-existing liabilities.

An example of this is the Gilford Motors in which the defendant, in an attempt to bypass the covenant which forbade him to solicit customers from his previous employers established the performance of same business but it was operated by his wife. In this case, the court ruled that the company was simply a ‘sham’ or ‘cloak’ and granted an injunction against the company.  It was detected by Lord Hanworth that the company was a ‘cloak’ or a ‘sham’, “a mere channel used by the defendant Horne for the purpose of enabling him, for his own benefit, to obtain the advantage of the customers of the plaintiff company”.

Therefore, although the corporation was guided by the corporate personality principle with its own management, the controlling mind was that of Mr Horne, and resulted in the court piercing the corporate veil.

A further instance of a court piercing the veil on the ground was where a company was simply a façade or a sham was the Jones v Lipman case where the defendant entered a contract with the plaintiff in order to transfer land, but subsequently, he changed his mind. Following this, the defendant established a company to which he transferred the property, by which he sought to place it beyond reach. In this case, the court pierced the corporate veil and provided an order for a specific performance, commenting that this company was a mask, sham or device, established to avoid an outstanding obligation intentionally.

More recently, a decision was made in which a ‘façade of a ‘sham’ was discovered in the Kensington International Ltd v Congo case, in which the claimant, Kensington, entered into a credit agreement with Congolese Republic. Subsequent to the non-payment of debts, the claimant attempted  to enforce the judgments against Glencore regarding the payment to the Congolese Republic for oil cargo.

This was a judgement against dishonest dealing, in which case the court was willing to pierce the veil of incorporation since it was of the opinion that a corporate structure was simply a ‘facade’ or a ‘sham’ which was being utilised for the sake of averting the settlement of its existing debts.  The aforementioned cases show that the courts are willing to “pierce the corporate veil” in situations where individuals deceive creditors by deceptive corporate frameworks which they establish in order to conceal the true state of affairs.

The Fraud Exception

In British common law, it is well established that the Solomon principle will not be utilised as a means of deception, in order to avoid current obligations or any form of exploitation of the corporate framework.

In the case of the Gilford Motor Company Ltd v Horne, a previous director was bound by a restraint covenant that, after leaving his employment, he should not solicit for customers from his former employers; nevertheless, he established a rival company having the potential to breach the covenant. In this case, the court ruled that the corporation was simply a front, a stratagem or a device to enable Mr Horne to conceal the fundamental situation; therefore, the court pierced the veil of incorporation and granted an injunction to enforce the covenant against both Horne and the corporation.

Bibliography

James- Pearce Smith, ‘Can the corporate veil still be pierced? ‘ [2014] 1(1) St John’s Chambers 1-8

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