CH4 + CH5 Corporate Personality + Lifting VEIL Incorp PDF

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CHAPTER 4 – LIFTING VEIL OF INCORPORATIONCH3 - CORPORATEPERSONALITY The separate legal status of a registered company, which provides it with an identity that is separate from that of its members, shareholders and employees – it’s own legal capacity EFECTS :  Can sue and be sued  Own property  L...

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CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION CH3 - CORPORATE PERSONALITY  The separate legal status of a registered company, which provides it with an identity that is separate from that of its members, shareholders and employees – it’s own legal capacity EFECTS:  Can sue and be sued  Own property  Liable for debts  Company can be party to contracts  Perpetuity – exist after members die  Allows limited liability of SH Different to limited liability! Advantages  SH can take advantage Disadvantages  Creditors

Salomon v Salomon & Co*  F: formed company, members were Salmon’s wife and 5 children, purchased his own sole trading leather business for £39k; £10k debentures (secured debt over companies assets), £20k in £1 shares, making Salomon also a member and £9k cash. Salmon was also MD of the company = MD, SH and secured creditor.  Company went into liquidation, only 1k assets realised and Salomon was owed £10k from company re debenture but there were other unsecured creditors.  Liquidator claims company was a sham, Salomon should be liable for debts as company and Salomon were one of the same, but Salomon argues he should be given £1k as priority as owed as a secured creditor  Trial judge: sole purpose of him incorporating company was to act as an agent to run his business for him – agreed with liquidator  CA Held: agreed with liquidator for different reasons - sham company, principle of limited liability was only a privilege provided by Companies Act for independent shareholders not “one substantial person and 6 dummies”  HOL: disagreed and held company had separate personality – debts not the members – debenture took priority over other debts due to separate legal entity  Lord Herschell “it is to be observed that both courts treated the company as a legal entity distinct from Salomon and the then members who composed it, and, therefore, as a validly constituted corporation” Jameel v Wall Street Journal Europe SPRL 2006  HOL: confirmed a SH can claim against a company for libel/slander/defamation and equally a company can bring a claim against it’s own shareholder vis a vis Macaura v Northern Assurance Co 1925*  F: Macaura sold timber on his estate, to Irish Canadian Saw Mills Ltd which he had majority shareholding, almost entire company assets were timber which remained on estate to be stored but this was insured under Macaura’s own name. Fire happened, insurance company argued he had no interest in the timber as it was the companies, he argued he was the company as SH and Director  HOL: (1) timber owned by company (2) Macaura had no insurable interest (3)

 Assumption that corporate personality was only for mediumlarge companies of 7+ plus members proven wrong  If SH simply hold shares as technicality that’s irrelevant  Using debentures opposed to shares is fine Issues left unresolved:  What a company can and can’t do  What separate legal personality means

 Corporate personality relates to assets (Macaura) as well as liabilities (Salomon)  Insurance must be in companies name

CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION corporate responsibility relates not only to company debts but also assets – followed Salomon  Lord Sumner “it is clear that the appellant had no insurable interest in the timber described. It was not his. It belonged to the company” Barings plc (In Liquidation) v Coopers & Lybrand (No.4) 2002  F: parent company suffered a loss as a result of it’s subsidiary  H: parent can’t claim on behalf of subsidiary as subsidiary is the proper plaintiff Giles v Rhind 2003  Facts: C and D both SH, D terminated employment and sold shares but set-up own business and poached clients against agreement which made other company go into liquidation.  Claim: company claimed but failed due to liquidation so then the claimant claimed for (i) loss of remuneration and benefits resulting from his loss of employment with the company and (ii) loss of his investment in the company as the result of his shares and loan stock being rendered valueless by the failure of the company  Question: whether the claimant was barred from recovering damages because his loss was merely reflective of a loss suffered by the company, which was the only person or entity that could claim.  Trial judge held: the irrecoverability of loss by a shareholder extended to all heads of loss which the company could have claimed but had chosen not to, and included not only loss of dividends on shares and diminution in the value of a shareholding but also all other payments which a shareholder would have received from the company if it had not been deprived of funds, regardless of whether such payments would have been received in the capacity of shareholder or employee – claimant appealed  Held: his claim for loss of remuneration and other benefits was not a claim for reflective loss and therefore he was also entitled to pursue those claims. The appeal would therefore be allowed  Reasoning: the defendant's breaches and use of confidential information to poach the company's major customer had caused the claimant's investment to be seriously damaged, his loan to become irrecoverable and his remuneration

 Corporate personality also applies to parent v subsidiary companies  The principle of no reflective loss which barred a shareholder from recovering in respect of loss suffered by the company as the result of a breach of duty owed to it did not apply where the defendant had by his own wrongdoing destroyed or disabled the company so that, by reason of the wrong done to it, it was unable to pursue its claim against the defendant

CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION and employment to be discontinued as the result of the company's business being destroyed, the claimant was entitled to pursue his claim that his shares had become valueless and he had lost his loan as a result of the defendant's actions Shaker v Al-Bedrawi 2003  Facts: claimant and a friend invested in a business and wanted 70% SH, via a trust, but when this was sold by D he re-invested profits and did not give them their proceeds. He then went bankrupt.  Claim: The claimant alleged that B had acted dishonestly, in breach of trust and in breach of fiduciary duty  Defence of defendant: The defendants contended, that the claimant was barred from recovering damages because his loss was merely reflective of a loss suffered by a corporate vehicle, either ANA Inc or ANA Ltd, which was the only entity entitled to bring proceedings.  Defence of the claimant: the claimant contended that since he and A were never shareholders of ANA Inc or ANA Ltd he had an interest in the business rather than in the shares but in any event to the extent that he had suffered a diminution in the value of a shareholding in ANA Inc, the no reflective loss rule did not apply because B was under a personal duty to him and breach of that duty had caused him personal loss, separate and distinct from any loss which might have been caused to ANA Inc  Trial judge held: (i) that the claimant and A had intended to invest in, and receive interests in, corporate vehicles established by B, in particular ANA Inc, (ii) that on the assumption that B had misappropriated the proceeds of sale, that M had taken a $1m bribe, that the purchaser of the business, M and SP had all dishonestly assisted B's breaches of fiduciary duty and that SP were guilty of deceit and knew or ought to have known that funds received by them had been misappropriated, ANA Inc would have claims for breach of fiduciary duty against B and wholly adequate causes of action in dishonest assistance and knowing receipt against the other defendants, (iii) that B would also have been liable for making unlawful distributions, (iv) that ANA Inc had no distributable reserves and the misappropriation of $6m was an unlawful distribution which was prohibited by Pt VIII of the Companies Act 1985 and ultra vires, (v) that in the absence of

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CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION being able to establish independent duties in contract, tort or equity owed to him by B the claimant did not have a cause of action against B for the misappropriation of ANA Inc's assets, (vi) and that since the claimant only had interests in shares he had no cause of action against B for an account or in constructive trust which would enable him to invoke the accessory liability of the other defendants because the damages were purely reflective of ANA Inc's loss, and (vii) that his claim against SP for deceit failed because

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it was specifically related to the residue of the $6m and reflected the damage to ANA Inc, and the claims for knowing receipt and knowing assistance were not available to a shareholder where the accessory liability alleged was the liability of a director for breach of duty. Trial judge conclusion: claimant was not entitled to proceed against any of the defendants in relation to the proceeds of sale. Appeal: on a ground not argued before the judge, contending that since B was a trustee of 70% of the shareholding in ANA Inc for the claimant and A he was bound to account to them for 70% of all profits he obtained by use of those shares and therefore the claimant's action was not that of a shareholder for breach of fiduciary duty in misappropriating a company's assets or in making an unlawful distribution but a proprietary claim made by a beneficiary under a trust for the profit made by a trustee by the use of trust property consisting of shares in a company. Appeal held: The no reflective loss principle, under which a shareholder was barred from recovering in respect of loss suffered by the company as the result of a breach of duty owed to it, did not preclude a claimant bringing an action as a beneficiary under a trust against a trustee to account for a profit made by him rather than as a shareholder, unless it could be shown by the defendant that the whole of the claimed profit reflected the company's loss which it could recover by cause of action. A beneficiary having an equitable interest in shares which were held in trust by a director in his capacity as a trustee was entitled to sue the director/trustee for an account of the profit made by him if the beneficiary's claim extended to moneys lawfully extracted by the director/trustee and in respect of which the company

CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION could have no claim against him for breach of fiduciary duty. Accordingly, if it could be shown that the $6m was misappropriated from ANA Inc or unlawfully distributed so that ANA Inc was entitled to the whole of the $6m, the no reflective loss principle would apply to bar the claimant's action.  However, since the no reflective loss principle was an exclusionary rule denying the claimant what would otherwise be his right to sue, the onus was on the defendants to establish the applicability of the principle and it would not be right to bar the claimant's action unless the defendants could establish not merely that the company had a claim to recover a loss reflected by the profit, but that such claim was available on the facts. Since that could not be shown without a trial and since it was possible that at least part of the $6m was lawfully taken by B, the claimant was not barred by the no reflective loss principle from proceeding with his claims. Hashem v Shayif 2008  The court was asked to pierce the veil of incorporation of a company in the course of ancillary relief proceedings.  Facts: H had failed to co-operate with the court. After a comprehensive review of all the authorities, Munby J said: ‘The common theme running through all the cases in which the court has been willing to pierce the veil is that the company was being used by its controller in an attempt to immunise himself from liability for some wrongdoing which existed entirely dehors the company. It is therefore necessary to identify the relevant wrongdoing – in Gilford and Jones v Lipman it was a breach of contract which, itself, had nothing to do with the company, in Gencor and Trustor it was a misappropriation of someone else’s money which again, in itself, had nothing to do with the company – before proceeding to demonstrate the wrongful misuse or involvement of the corporate structure. But in the present case there is no anterior or independent wrongdoing. All that the husband is doing, in the circumstances with which he is now faced – the wife’s claim for ancillary relief – is to take advantage, in my judgment legitimately to take advantage, of the existing corporate structure and, if one chooses to put it this way, to take advantage of the principle in Salomon.’ Lee v Lee’s Air Farming 1961* 

 Can use veil to take legitimately take advantage in ancillary relief between married couples

 Because of separate

CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION  Lee incorporated Lee’s Air Farming 1961, owned all but 1 share, appointed himself as Governing Director for life, then employed as chief pilot of the company, plane crash and widow claimed compensation under Worker’s Compensation Act  Issue: whether a company can employ SH as employee? Insurance company claimed that given he owned so much of the company, this would amount to him making a contract with himself.  New Zealand Court of Appeal: not a worker under act  London Privy Council: (1) company and Lee were legal entities an can enter into legal relations with one another – basis of Salomon (2) they had entered a contractual relationship where he was an employee (3) in his role as Governing Director he could give himself orders as chief pilot, alike a master and servant relationship, so did fit definition of worker under the act = widow entitled to compensation  Viscount Simonds “the company and the deceased were separate legal entities”

legal personality, a company can employ whoever it wants including it’s own shareholders

LIFTING VEIL OF INCORPORATION VEIL OF INCORPORATION  Law recognises separation between assets of company and those of it’s members – barrier known as veil VEIL IN-BETWEEN  if shareholders have paid up,

EXCEPTIONS TO THE SALOMON PRINCIPLE:1. LEGISLATIVE INTERVENTION  Purpose: limit the Salomon principle where it could be used as an instrument of fraud PARENT COMPANIES Misleading treating parent as separate to subsidiary companies – led to:  S.399 CA 2006 – parent company has duty to produce group accounts  S.409 CA 2006 – parent provide details of shares in subsidiaries + names + country of activities

Re Todd Ltd 1990 – S.213 Insolvency Act  H: director liable to contribute £70k towards company debts Re Patrick & Lyon Ltd 1933* – S.213 Insolvency Act 1986  F: director carried on business and delayed liquidation for 6 months after issue of debentures to himself in order to deprive the unsecured creditors of the company the right to challenge the debentures under S266 of the Companies Act 1929  H: had to prove “actual dishonesty, involving, according to current notions of fair trading among commercial men, real moral blame”  Maugham J “I will express the opinion that the words “defraud” and “fraudulent purpose” where they appear in the section in question, are words which connote actual dishonesty involving,

CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION no claims can pass through the veil LIFTING VEIL OF INCORPORATION  Where Salomon principle has potential of being abused, perpetrate fraud or other wrongdoing (unjust consequences)  Shareholders will be held liable and at fault for obligations of the company – only if involved in creating situation

FRAUD - Where a company has been created or managed in order to commit a fraud.  S.213-215 Insolvency Act 1986  

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Issue: fraud hard to prove! Requires evidence of real dishonesty - Re Patrick & Lyon. 

Court will:  Hold individuals inside company liable

S.213 Insolvency Act 1986 - “fraudulent trading” provision When winding up a company, it appears that any business of the company has been carried on with intent to defraud: (1) creditors of the company or (2) creditors of any person or (3) fraudulent purposes – court will on application of liquidator declare any persons who were knowingly parties to the carrying on of the business in this manner + liable to make contributions to company’s assets as the court thinks proper: Any person carrying out business can be called to contribute to debts of the company – shareholders, directors, employees and creditors

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S.214 Insolvency Act 1986 – “wrongful trading” – lesser offence than fraudulent trading – where directors have behaved negligently rather than fraudulently does not require proving intent to defraud – just a director, at some time before

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according to current notions of fair trading among commercial men, real moral blame” Issue: standard too high and hard to prove in practice Effect: led to S.214 Insolvency Act 1986 being introduced to cover lesser offence of “wrongful trading”

Re Produce Marketing Consortium Ltd (No.2) 1989 – S.214 Insolvency Act 1986 

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F: over 7 years company slowly drifted into insolvency, 2 directors did nothing because although company was insolvent, they hoped it would ‘turn the corner’. Their intentions were hoenst, but they ignored warning signs from company’s auditors about the financial position so didn’t put company into liquidation after point of no return H: liable under S.214 to contribute £75k to debts of the company Knox J “this was a case of failure to appreciate what should have been clear rather than a deliberate course of wrongdoing… however the fact that there was no fraudulent intent is not itself a reason for fixing the amount at a nominal or low figure”

CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION – to (1) company itself or (2) a third party  Not treat company as having separate legal personality – work out rights/liabilities people would have if company didn’t exist

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commencement of the winding up of the company, knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation but continued to trade therefore, he should be liable to contribute towards debts of the company for being unreasonable “S214(1) - if in the course of winding up the company it appears that (2) applies – court, on application of the liquidator, declare that person is to be liable to make contribution to the company’s assets as the court thinks proper” “s214(2)(a) company has gone int liquidation (b) some time before commencement of winding up, person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation and (c) that person was a director of the company at that time”

S.213 v S.214: S.213 applies to anyone involved in carrying out business = directly qualifies the limitation of liability of members – applies the exception to the Salomon principle broadly  S.214 does not directly affect liability of members as it is aimed specifically at directors – more narrow

CHAPTER 3 – LEGAL PERSONALITY + CHAPTER 4 – LIFTING VEIL OF INCORPORATION  BUT, in small companies, directors tend to be SH so can affect SH indirectly  ALSO, parent companies may also have their limited liability affected if they have acted as a shadow director (whom the directors of the company are accustomed to take instructions)  S.993 CA 2006 – criminal offence of fraudulent trading  Once an offence committed under S.213 for fraudulent trading, criminal liability can also follow with a term of imprisonment  Issue: S.993 CA 2006 criminal offence had the intention to deter fraud but actually neutralised effect of S.213 Insolvency Act 1986 due to courts high stand...