Corporate Personality and Lifting the Corporate Veil PDF

Preview

Summary

Download Corporate Personality and Lifting the Corporate Veil PDF

Description

Workshop 2 – Corporate Personality and Lifting the Corporate Veil Legal personality and limited liability -

Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd (1915) AC 705 p713 o Viscount Haldane LC: ‘a company is an abstraction. It has no mind of its own any more than it has a body of its own’

Limited liability -

-

The liability of shareholders to pay debts incurred by the company is limited Means that shareholders are no liable to pay debts which the company owes to its creditors because it is the obligation of the company (usually through contract) to pay its creditors Creditors to whom the company owes money must claim against the company If the company has insufficient funds to meet its liabilities, creditors cannot pursue their claims against the shareholders If their company becomes insolvent, shareholders will be liable to lose money they have invested in subscribing for the company’s shares If applicable, they are also liable to make payment for any shares they have not fully paid for, but that is the extent of their liability Section 74 Insolvency Act 1986 – enshrines the concept of limited liability, confirming that the shareholders of a limited company are, generally speaking, not liable to a liquidator in the event of the company’s insolvency Is possible to incorporate unlimited companies and also there are limits to the doctrine of limited liability

The separate personality of a company -

Company = a legal entity distinct from its shareholders, directors, creditors and employees o Has a separate legal personality Concept of separate corporate personality and the related issues of limited liability = fundamental Directors, in general, owe duties to the company, not to the shareholders Shareholders usually have rights against the company, rather than against the directors Third parties with whom the company does business contract with the company, even though they negotiate with the directors Company continues to exist even if its shareholders and/or directors change

The significance of limited liability -

Limited liability – quality that has caused companies to become such useful commercial tools Personal assets of shareholders are entirely separate from the assets of the company Concept of limited liability is fundamental to: o Passive investment: shareholders can invest in a company following an assessment of the risks of losing that investment, knowing that the rest of their personal assets are safe and without having to take an active role in management

o o

Why many entrepreneurs seek to conduct business through the medium of a limited liability company Why group of companies have developed – riskier business divisions can be conducted through separate companies w/I the group without the less risky companies becoming vulnerable to creditors of the riskier companies

Salomon v A Salomon & Co Ltd (1897) ACC 22 FACTS: -

-

-

Mr Salomon (S) – sole trader who specialised in manufacturing leather boots o Many years ran business as a sole proprietor 1892 S decided to incorporate business as a limited company, A. Salomon & Co. LTD (Salomon company) to sell the sole trader business to the Salomon Company for almost £39,000 S was paid £9,000 in cash, £20,000 in shares and £10,000 by way of debenture for the business In 1897, incorporation was governed by the provisions of the Companies Act 1862: required at least 7 people subscribe as shareholder of the company Incorporation satisfied requirements: members were S, his wife, daughter and 4 sons o Each one had a share o Family didn’t have any formal or active role in running the business o From outset, S was shareholder, director and creditor

Following incorporation, decline in boot sales – strikes forced govt (major customer) to cancel some contracts Company ran into financial difficulty , S sold his debenture for £5,000 to Mr Broderip (B) Company went into insolvent liquidation and B therefore couldn’t enforce the full extent of his debenture against the company due to lack of funds B brought a claim against S, claiming he was personally liable to B Company went into liquidation and the liquidator took over the litigation before HoL on behalf of the creditors collectively, seeking to dispute the validity of the debentures Salamon case appealed First instance at CA, held that S was liable to B, but for different reasons

HELD: -

-

Decision of the High Court o Vaughan Williams J: agent principal analysis (company was agent of S) with S being required to indemnify the company for the losses sustained Decision of Court of Appeal o Lindley LJ: Company as a trustee for S as beneficiary – a trustee improperly brought into existence. Due to the requirements of the legislature not being compiled with (i.e. 7 ACTIVE members) the company was created for an illegitimate purpose. o Must therefore follow that the company did not exist

-

Decision of the House of Lords o Lord Macnaghten delivered the leading judgement, but all were in agreement that a literal interpretation of the Companies Act 1862 should be used – thus, the company was validly incorporated and therefore had a separate legal personality o S was NOT liable to the Salomon Company, not to creditors of the Salomon Company  Debentures were validly issued o HoL noted that after registration of a company, although the business may be the same as before and the same hands receiving profits, in law the company is NOT an agent of the subscribers or members o Once the memorandum is signed and registered correctly, the company ‘attains maturity on its birth’ o Stated that there is nothing in the Act requiring the shareholders to be independent or unconnected o From the moment it is incorporated the company is at law a separate legal entity and not the agent of the subscribers or trustee for them

Significance -

Following this judgement, clear that a company is a separate person and not the agent or trustee of its controller Fact that some shareholders may take no part in the management of the company = irrelevant Companies can therefore be validly used by individuals to carry on what is economic reality the business of an individual

The consequence of separate legal personality - No of consequences that follow from the fact that a company is an independent legal person 1. The company owns its own property o The property of a company belongs to the company itself and not to the shareholders o Macaura v Northern Assurance Co (1925) AC 619:  Macaura (M) owner of Killymoon estate in County Tyrone, Ireland  Sold whole of the timber on the estate to a company which he set up, in consideration of the allotment to him of 42,000 fully paid £1 shares  M and his nominees owned all shares and M was also creditor in the amount of £19,000  M took out insurance policies in his own name with Northern Assurance Co, covering timber against a fire  2 weeks later, fire destroyed almost all timber  M brought claim on insurance policy  HED: HoL held that the timber belonged to the company and not to M, therefore he was unable to claim on the insurance policy, despite owning almost all the shares in the company 2. The company enters into its own contracts

The company enters into contracts on its own behalf and benefits of liabilities under the contract belong to the company, not to the shareholders or directors o True even where the contract between the company and its sole director and shareholder o Lee v Lee’s Air Farming Ltd (1961) AC 12 (Privy Council)  Mr Lee (L) incorporated Lee’s Air Faming Ltd in New Zealand in 1954  Nominal capital of company was £3,000 divided into 3,000 shares of £1 each  L held £2,999 shares and final share was held by solicitor (New Zealand legislation at the time required companies to have 2 shareholders)  L also sole director and appointed as an employee (chief pilot) in company’s articles  1956 – L killed in plane crash when working (widow + 4 children)  L’s widow brought claim under Workers Compensation Act 1922  HELD: Privy Council found that the company and L were distinct legal entities and therefore L under his contract of employment was a ‘worker’ as defined under the Act  Widow entitled to compensation – irrelevant that L was also the vast majority shareholder and sole director 3. The company sues and is sued on its own liabilities o Adams v Cape Industries plc (1990) CH 433 (CA)  Cape (English company) was parent company of a group of wholly owned subsidiaries, some of which mined asbestos in S. Africa and other marketed the asbestos in other countries, incl. USA  Employees of Texas subsidiary company (NAAC) became ill with asbestosis and sued Cape and NAAC in Texas court  Judgement entered for breach of care  Issue before CA was whether the judgement could be enforced against the much wealthier parent company, Cape, in the English court, since Cape’s assets were all based in England  NAAC had by that time been closed down by Cape  Requirement for this was either that Cape consented to the Texas jurisdiction (which it didn’t) or that Cape was ‘present’ in the US in Texas  Claimant argued:  Cape and its subsidiaries should be treated as a single economic unit  That the subsidiaries were used as a façade concealing the true facts  That agency relationships existed between Cape and NAAC  HELD: CA rejected all of these arguments and held that the judgment couldn’t be enforced against Cape  NOTE: case was a leading authority on piercing the corporate view prior to the 2013 case of Prest v Petrodel o

Limited personality – current position -

S 16 CA 2006 – company becomes a body corporate (legal person) capable of exercising the functions of an incorporate company from the date of incorporation (date on which the Registrar issues the certificate of incorporation)

-

-

o From this date the company has its own existence and personality CA 2006 – private limited company can be formed with just 1 director and 1 shareholder Company will continue to exist even when the shareholders or directors change Shareholders: pay for their shares and are entitled to profits (dividend) dependent on their shareholding but have no entitlement to the company’s property o Shareholders ‘own’ the company but don’t have day to day control Directors: have day to day control of the company under Model Article 3 o As a company is inanimate, must act through humans

Limited liabilities – justification and issues Justifications: -

-

Encourages investment and encourages businesses to take risks, which generates money and therefore benefits the wider community Creditors will be aware that they are contracting with a limited company as the requirements of s 59 and s 60 CA 2006 are that all company names must end with Ltd (private limited companies) or Plc (public limited companies) Creditors are therefore on notice and also have the opportunity of assessing the financial visibility of a company by checking the publicly filed documents at Companies House

Issues: -

-

Creditors of companies and claimants in court actions risk being unable to receive monies due to them, as the concept prevents them from going behind he corporate structure to seek monies from those controlling the company o Accounts are only filed once a year so many not represent the current position o Small private accounts don’t give much info Issues have come before the court in a variety of cases where claimants have sought to request the courts to go behind the corporate structure and find the shareholders liable – known as piercing the corporate veil

Summary -

-

-

A company is a separate legal person – established in seminal HoL case of Salomon v Salomon Mean that a company: o Owns its own property o Enters into its own contracts o Sues and is sued on its own liabilities Shareholder have limited liability – liability is limited to the amount of their shares even when a shareholder in reality is the controlling mind of the company (e.g. sole shareholders and sole directors) Dual concepts of separate legal personality and limited liability that make companies such attractive and ubiquitous business models

-

S 16 CA 2006 – confirms that a company comes into existence as a separate legal person on the date of incorporation (date of issue of certificate of incorporation)

Piercing the Corporate Veil (PCV) Doctrine of piercing the veil – does it exist? -

PCV– situations in which the courts may go behind the corporate framework and the company’s separate legal personality to make the shareholders of the company liable This is an exception to the rule that shareholders liability is limited to any unpaid amount owing to their shares Prior to SC decision in Prest v Petrodel Resources Ltd there was uncertainty and inconsistency in the case law and even as to whether the doctrine of PCV existed SC in Petrodel clarified that the doctrine does exist and can be invoked on public policy ground but in extremely narrow circumstances where there is no alternative remedy Although, are past cases where members have been found liable, all these can be explained on general legal principles without need for PCV Following Petrodel, law is clearer – the court may PCV only where a person under an existing legal obligation or restriction deliberately evades or frustrates that obligation or restriction by setting up a company

Historical developments -

-

Prior to Petrodel, lack of coherence in case law as to whether courts could PCV Clear that the ability of courts to PCV has always been v. narrow jurisdiction, and used sparingly as to maintain certainty and respect of the principle of separate legal personality encapsulated in Salomon Even when courts have concluded PCV, members have been liable only to the extent requiring to right the wrong Cases up to 2013 can be divided into 3 broad categories o Application of statue o Common law o Application of a contractual term (intention of parties – rare)

Statutory examples -

No. of instances in which statutes allow members of a company to become liable in certain situ. These are NOT examples of PCV, rather they are instances in which those behind a company can be treated by statute as liable in specific circumstances. E.g.: o Taxation – tax legislation recognises that group structures need to be treated differently for disclosure and financial reporting  E.g. s 399 CA 2006 – requires parent companies to produce group accounts  E.g. s 409 – requires companies to provide details of the names and subsidiaries and the shares they hold in subsidiary

o

o

Employment – Employment Rights Act 1996 protects employee’s statutory rights when transferred rom one company to another within a group, maintaining the continuity of employment Corporate insolvency – S 213-215 Insolvency Act 1986 provides offence of fraudulent trading and wrongful trading where those involved in a company may in certain circumstances be liable to contribute to the debts of an insolvent company

Common law -

Little consistency in the case law prior to 2013 and many commentators disagree about the correct interpretation of the cases However, the cases in which the courts has requested to allow the PCV can be categorised as follows: o Façade or sham o Single economic entity o Agency o Tort

Façade or sham – the court HAS PCV in these instances (not an alternative remedy – but rather an example of the evasion principle) -

-

-

Gilford Motor Co Ltd v Horne (1933) Ch 935 o FACTS: former employee who was bound by a restrictive covenant not to solicit customers from his former employee set up a company to do so o HELD: Court held that the company was merely a front/ sham and issued an injunction to prevent trading Jones v Lipman (1962) 1 WLR 832: o FACTS: L entered into contract with J for sale of land, but later changed his mind and didn’t want to complete sale. Formed company in order to avoid the transaction and transferred the company, claiming he couldn’t comply with the contract as he was no longer the owner of the land o HELD: court found the company was merely a façade and granted an order for specific performance Truster AB v Smallbone (No 2) (2001) 2 BCLC o FACTS: S was former managing director of T and had transferred various sums of money (approx. £20m) to company he owned and controlled. T applied to the court to PCV and treat receipt by the second company as receipt by S on the grounds that the company had been a sham created to facilitate the transfer of money in breach of duty. The company had been involved in the improper acts and that the interests of justice demanded this result o HELD: court found the company was a sham and the device through the impropriety was conducted and therefore, because of this improper move, the court could VCP and find S liable

Specific performance -

Court when compels you -opposite of injunction Jones v Litman

Single Economic Entity (NO) -

-

-

Now established that parent companies are NOT liable for their subsidiaries other than in specific statutory circumstances Arguments before the courts concerning group structures, where claimants have sought to make parent companies liable for the debts or obligations of their subsidiaries However, now clear case law that single economic entity argument is NOT a basis for PCV DHN Food Distributors Ltd v Tower Hamlets (1976) 1 WLR 852 o HELD: Denning LJ held that group of companies is a single economic unit and should be treated as such Woolfson v Strathclyde Regional Council (1978) SLT 159 o HELD: HoL doubted Denning’s decision in DHN and held that the veil of incorporation will be upheld unless it is a sham or façade created specifically for the purpose of avoiding liability, thereby confirming that each company in a group is its own distinct entity Adams v Cape Industries PLC (1990) Ch 433: o HELD: CA refused to allow the PCV to allow the judgement to be enforced against the parent company. Consequence of the separate legal entity principle is that enterprises may purposely used company group structures to place more risky ventures/ liability in (foreign) subsidiary companies removed from the parent company

Agency – liability based on law of agency not lifting corporate veil -

-

Possible that the company may act as an agent for its parent company or shareholder and therefore the parent company or shareholder may be found liable on this basis, there is NO presumption this is the case Cases will turn on their facts and are based on the common law of agency, not the doctrine of PCV Company has power to act as an agent for its parent company or its individual shareholder if authorised However, no presumption this is the case and in absence of express agreement, v difficult to establish liability of the shareholder or parent on this basis Even where such liability has been established, argument in these cases is base don the law of agency = not a true example of a situ in which the court has ordered the PCV o HoL judgement in Salomon considered and expressly disregarded this ground on the facts of the case

Tort -

-

-

Parent companies may be liable to those dealing with their subsidiaries on the basis of tort, but this is NOT an example of PCV VTB Capital plc v Nutriek International Corp and others (2013) UKKSC 5 o FACTS:  Claimant (VTB) LENT Russagroprom LLC (RAP) money to fund the acquisition of 6 dairy plants and 3 associated companies from the first defendant (Nutriek)  RAP defaulted on the loan  VTB claimed it only lent the money on the basis of misrepresentations made by Nutriek for which the other defendants were jointly liable o CLAIMED:  Claimed that R...