Lifting the Corporate Veil PDF

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Lifting the Corporate VeilPiercing/Lifting the “Corporate Veil”Lifting the Corporate Veil In certain circumstances, the legislature and the courts are prepared to depart from the principle of separate corporate personality (and in effect, limited liability) in a process generally described as ‘lift...

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LW225- Company Law

Lifting the Corporate Veil Piercing/Lifting the “Corporate Veil”

Lifting the Corporate Veil  In certain circumstances, the legislature and the courts are prepared to depart from the principle of separate corporate personality (and in effect, limited liability) in a process generally described as ‘lifting the veil’ of incorporation.

 The “corporate veil” metaphorically symbolizes the distinction between the company as a legal person and the shareholders. That curtain of separation is called the “corporate veil”.

 The effect of lifting the corporate veil is that the shareholder(s), rather than the company, is/are regarded as the relevant actor(s) on whom the obligations of the company are placed. Lifting the veil operates as an exception to the general rule that shareholder(s) is/are separate from the company.

Recap: Corporate Groups

LW225- Company Law  Parent-Subsidiary relationship  Why business is organised as corporate groups – tax, regulations, asset-shielding, investment, illicit activities  Are parent companies and subsidiaries responsible for debts of one of the subsidiaries?  No general principle that companies in a group are treated as one.

How Did the Corporate Veil Get So Strong? Salomon v Salomon & Co Ltd [1896]  Cornerstone of modern company law

 S was sole trader, registered A. Salomon & Co and sold business to it ▪ members: himself, wife, daughter, 4 sons

 Purchase price £39,000: £20,000 paid by way of £1 shares, £9,000 cash and £10,000 debentures giving a charge over the company’s assets.

 Companies Act 1862 required a minimum of 7 members.

 Purchase price £39,000: £20,000 paid by way of £1 shares, £9,000 cash and £10,000 debentures giving a charge over the company’s assets

 Meant S was controlling shareholder and secured creditor at the same time.

 S sold debentures to Broderip, company went into insolvent liquidation, liquidator sought to have S held personally liable for the company’s debts.

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 The claimant argued that formation of the company was a ‘mere scheme’ to enable S to carry on business and enjoy profits without risk.

Salomon: Previous Stages  High Court – (Broderip v Salomon (1893)) ▪ Vaughan Williams J – ‘dummies’ + agency.

 Court of Appeal (1895) ▪ Lindley LJ – Company as a trustee.

 House of Lords (1896)

 Emphasised separate legal personality of A Salomon and Co. Ltd.

Salomon: House of Lords  Lord Halsbury:

 ‘once the company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself’.

 Lord Macnaghten:

 ‘The company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and manner provided by the Act.’

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 Kahn-Freud describes decision in Salomon as calamitous.

Separate Legal Personality  Separate legal personality – CA 2006, s.16.

 Consequences: - Company

 Is a separate entity from the shareholders.  Can acquire its own rights and responsibilities  Has perpetual succession.  Can own property, separate from its shareholders. ▪ Can sue and be sued.  The rule in Foss v Harbottle (1843) applies  only the company can bring an action for any wrong suffered by the company  Members enjoy limited liability.

Limited Liability  A company is limited liability (by guarantee or shares) if this is declared in its constitution – CA 2006, s.3.  Notion that members only liable for the amount they’ve agreed to contribute:  [on the winding up of a company] in the case of a company limited by shares, no contribution is required from any member exceeding the amount (if any) unpaid on the shares in respect of which he is liable as a present or past member (s.74(2)(d) Insolvency Act 1986) Liability of members limited to extent of their subscription in the company’s shares.  Easier to raise capital, encourages trading in shares.

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Adams v Cape Industries (1990)  The case was about the allocation of liability within a corporate group. The claimants (who were victims of corporate torts) wanted the corporate veil to be lifted in order to make the parent company (Cape Industries) liable for the obligations of its American-based subsidiaries.  Cape Industries was an English company, sitting at the head of a group of companies, which included wholly-owned subsidiaries. The basic business of the group was the mining and marketing of asbestos. The mines were in South Africa and asbestos was marketed in the US, among other countries.

 The US-based claimants were initially claiming damages from NAAC, a US-based subsidiary of Cape Industries for personal harm suffered from exposure to asbestos products.

 Action initially commenced in the US courts in 1974 (Tyler 1 proceedings)

 The Tyler 1 proceedings were settled in 1977.

 Problem: NAAC had now run out of money/insurance

 The Tyler 2 proceedings commenced in 1978.

 Judgment against NAAC in the US was obtained but NAAC did not have sufficient assets to satisfy the damages awarded.

 The plaintiffs therefore sought to enforce the judgment against Cape Industries, the English parent of NAAC.

LW225- Company Law  A key question was whether, for purposes of establishing jurisdiction over the defendant, Cape Industries could be said to have had a presence in the US at the relevant time.

 The parent company would be present in the US if:

1. The company has its own fixed place of business in the US. 2. The company's business is transacted from that fixed place of business.  Parent company does not present in US UNLESS corporate veil pierced.

 While the litigation was on-going, the Cape Industries Group reorganized the US side of its operations. It did so to reduce the chances of it being successfully sued in the US, and to make it difficult to enforce any US judgment outside of the US.

 The reorganization: the group liquidated NAAC. Cape replaced NAAC with two companies: CPC, a US (Illinois) company (100% owned by the former CEO of NAAC) and a Liechtenstein Company called AMC (100% owned by Cape).

North American Asbestos Corporation, 1953-1977

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Continental Products Corporation, 1977-81

Adams v Cape Industries Plc (1990)  Claimant’s arguments:

LW225- Company Law  Following DHN, companies in the group should be treated as one single economic entity.

 That the subsidiaries were used as a facade for Cape’s dealings.

 That the subsidiaries acted as Cape’s agent.

 Lord Justice Slade

 ‘Our law for better or worse, recognises 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’

 Conclusion

 The English courts are reluctant to lift the corporate veil

Veil-Lifting in UK

1. Salomon + CA 2006: Separate Legal Personality and Limited Liability. 2. Adams v Cape: Reluctance. 3. Consider traditional veil piercing grounds 4. Consider recent developments: Prest v Petrodel 5. Possible alternative liability in tort (if relevant!)

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Classic Veil Exceptions

 Single Economic Unit argument

 Facade/ Sham/ Fraud

 Agency

 Interests of justice

 Impropriety

Single Economic Unit Origin of Single Economic Unit  Lord Denning MR in Littlewoods Mail Order Stores Ltd v McGregor (Inspector of Taxes)

 ▪ “The doctrine laid down in Salomon v Salomon & Co ... has to be watched very carefully. 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”.

DHN v Tower Hamlets (1976)  Shaw:

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 ‘utter community of interest between DHN and Bronze’

 ▪ Goff:

 ‘look at the realities of the situation and to pierce the corporate veil’

 Denning:

 Should not be treated as different entities and thereby be defeated on a ‘technical point’

DHN- Lord Denning MR  “We all know that in many respects a group of companies are treated together for the purpose of general accounts, balance sheet, and profit and loss account. They are treated as one concern ... This is especially the case when a parent company owns all the shares of the subsidiaries — so much so that it can control every movement of the subsidiaries. These subsidiaries are bound hand and foot to the parent company and must do just what the parent company says”.

Single Economic Unit (Pre-Adams)  HL in Scottish case of Woolfson v Strathclyde Regional Council (1978) doubts Denning piercing of the veil in DHN although the case did not involve a wholly-owned subsidiary and so was distinguishable in any case.  Lord Keith: ‘appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere faZade concealing the true facts’  Classic statement by Goff LJ in Bank of Tokyo Ltd v Karoon (1987)  "[Counsel] suggested beguilingly that it would be technical for as to distinguish between parent and subsidiary company in this context; economically, he said, they

LW225- Company Law were one. But we are concerned not with economics but with law. The distinction between the two is, in H law, fundamental and cannot here be bridged.”

Single-Economic Unit (Adams)  In Adams (1990) the CA rejected this ground in this case but it could still be useful as an aid to the interpretation of specific statutes dealing with affairs of corporate groups. (Slade LJ).

 “save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon ... merely because it considers that justice so requires. Our law, for better or worse, recognises 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 normally attach to separate legal entities”

 But notice Slade LJ’s focus on the “day-to-day running” of NAAC. If Cape had been running NAAC, would the court have treated the two entities as one?

Single Economic Unit (Post-Adams)  Courts reluctant to recognise single economic unit since it was not recognised as a veil piercing exception in Adams v Cape.

 See Re: Polly Peck International Plc (1996) and Ord v Belhaven Pubs Ltd (1998).

 Some later cases on specific facts did find single economic entity:

 Samengo-Turner v J & H Marsh & McLennan (Services) Ltd (2008) - interpreting an EU Regulation.

LW225- Company Law  Beckett Investment Management Group Ltd. v Hall (2007) -clause in an employment contract.

 But rejected as a ground in a number of cases:

 Milliam v The Print Factory (2008); Ben Hashem v Ali Shayif (2008) and Linsen International Ltd v Humpuss Sea Transport Pte Ltd (2011).

Façade/ Sham/ Fraud

 As Lord Keith stated in Woolfson v Strathclyde Regional Council (HL) (1978)

 “it is appropriate to pierce the corporate veil only where special circumstances exist indicating it is a mere fa@ade concealing the true facts”.

 The veil was lifted on this ground in a number of cases:

 See: Re Darby, ex Brougham (1911); Gilford Motor Co. Ltd v Horne (1933); Re: Bugle Press Ltd (1961); Jones v Lipman (1962) Wallersteiner v Moir (1974); Aveling Barford Ltd v Perion Ltd (1989); Kensington International Ltd v Congo (2005).

Glford Motor Compnay v Horne [1933]  The court viewed H as the controller of the company, a company set up as a mere “cloak or sham” to allow H “to commit the breach of covenant that he entered into” (Romer LJ)

LW225- Company Law  “I am quite satisfied that this company was formed as a device, a stratagem, in order to mask the effective carrying on of a business of Mr E B Horne. The purpose of it was to try to enable him, under what is a cloak or sham ...” (Lord Hanworth)

Façade- Jones v Lipman [1962]  L entered into a contract to sell property to J. Shortly thereafter, L changed his mind. To avoid selling the property to J, L transferred the property to a company he owned and controlled and had set up to hold the property.

 If we follow Salomon, the new company has nothing to do with the agreement between L and J.  The High Court, however, did not follow Salomon. Unlike Horne in Gilford, Lipman was the controlling shareholder.

 “The defendant company is the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity” (Russell J).

Façade- Adams v Cape Industries  In Adams, although the court found AMC (the wholly owned Liechtenstein subsidiary of Cape) to be a faZade, the court also decided that AMC did not conduct any business in the USA. Consequently, lifting the veil to reveal Cape’s control over AMC could not be used as a basis for establishing the parent company’s presence in the USA.

 Crucially, the court found CPC (the Illinois registered company) to be an independent legal entity. The court held that there was nothing wrong with a parent company using a subsidiary company to limit or avoid future liability.

 An interest question is why those uses of incorporation, in the cases above, were deemed to be fraudulent, yet the restructuring in Adams v Cape Industries was acceptable to the court?

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Façade/ Sham/ Fraud- Summary  Comparing Adams v Cape Industries with Gilford Motor Co Ltd v Horne and Jones v Lipman leads to the following observations: 1. Adams v Cape concerned potential future liabilities rather than current liabilities that had already crystallised. 2. Veil piercing seems easier when dealing with a breach of a contractual obligations then a tortuous one. 3. The Controller (parent company or shareholder) only seems to be liable when its them who have commit the wrong rather than the subsidiary.

Veil-Lifting in UK  Fundamental Structure 1. Salomon + CA 2006: Separate Legal Personality and Limited Liability. Salomon reinforced both of these. 2. Adams v Cape: Reluctance. 3. Consider traditional veil piercing grounds 4. Consider recent developments: Prest v Petrodel. 5. Possible alternative liability in tort (if relevant!)

Classic Veil Exceptions  Single Economic Unit argument (DHN case)  Facade/ Sham/ Fraud  Agency- its own type of law  Interests of justice  Impropriety

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Façade/ Sham/ Fraud- Summary  Comparing Adams v Cape Industries with Gilford Motor Co Ltd v Horne and Jones v Lipman leads to the following observations: 1. Adams v Cape concerned potential future liabilities rather than current liabilities that had already crystallised. 2. Veil piercing seems easier when dealing with a breach of a contractual obligations then a tortuous one. 3. The Controller (parent company or shareholder) only seems to be liable when its them who have commit the wrong rather than the subsidiary.

Façade Since Adams  Creasy v Breachwood Motors Ltd [1993]: C claimed wrongful dismissal. BW (C’s employer) ceased trading and transferred its assets to BM leaving nothing with which to compensate C. C sought to lift corporate veil and bring action against BM (BM and BW shared the same directors).

 Decision: the corporate veil was lifted.

 Ord v Belhaven Pubs Ltd [1998] (questioning Creasy): O claimed misrepresentation against BelP. Defendant part of larger corporate group which had suffered due to a financial crisis. In response to that crisis, assets of group reorganised, leaving BelP without assets.

 Decision: Veil not lifted. Held this was a legitimate response to financial pressures.  Where the corporate veil was lifted:

LW225- Company Law  Kensington International Ltd v Congo [2005]

 Existing not future liabilities.

 Where the corporate veil was not lifted:

 Dadourian Group v Simms [2006], Millam v The Print Factory [2008], Ben Hashem v Ali Shayif [2008], VTB Capital v Nutritek [2013]

Becoming a Façade/ Sham/ Fraud  Can a company become a faZade despite being formed for legitimate purpose initially?

 Jones v Lipman and Ord v Belhaven suggest not but academic Png (1999) argued otherwise.

 CA in Raja v Van Hoogstraten (2006) found that the dishonest construction of a group of companies, may give rise to veil piercing even in relation to liabilities not originally envisioned by the creator of the sham companies.

 Note that, despite earlier authority, the veil cannot be pierced to allow the controllers of a company to be sued under the company’s contracts as if they were themselves a contracting party.

LW225- Company Law  Supreme Court in VTB Capital PLC v Nutrieck (2013). Authority for the idea you can’t use corporate veil to make contract now with parent company, you have to go with the party you sign with.

Agency Argument  The argument is that within a corporate group the subsidiary should be seen as an agent of the parent company.

 Everything is controlled by the parent company

 NB: think of the court of first instance in Salomon. Both the CA and the HoL rejected the claim that Salomon Ltd was an agent of Mr Salomon. The presumption is that there is no agency relationship between parent and subsidiary.

 The agency argument is technically not an example of lifting the corporate veil. Rather, it confirms the separate legal personality of principal and agent, but highlights the way the principal controls the agent.

 Has been successfully used in the case of Re FG (Films) Ltd (1953) where the judge held that the company had been incorporated simply to enable the film made by an American company to qualify as a “British Film”.

Agency in Adams v Cape Industries  The claimant argued that the subsidiary was an agent of Cape Industries, and that this agency relationship constituted the presence of the parent company in the US.

 The CA rejected this argument on the facts. The CA found that the subsidiary had not been given authority to act on behalf of or bind Cape Industries.

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 The CA makes it clear that any such relationship needs to be based upon specific evidence.

 Nonetheless this route remains theoretically available for claimants where evidence shows an agency agreement.

Smith, Stone & Knight Ltd v. Birmingham Corporat...