Limited Liability & \'Piercing the Corporate Veil\' - Revision PDF

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Introduction to Company Law (1) Constitution and Incorporation: o Hickman v Kent or Romney Sheep Breeders [1915] – generally established rule that the Articles evidence a contract between the company and its members, in their capacity as members and with respect to their rights and obligations as m...

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COL Revision Summary

Antonia Szapary

Introduction to Company Law (1) 

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Constitution and Incorporation: o Hickman v Kent or Romney Sheep Breeders [1915] – generally established rule that the Articles evidence a contract between the company and its members, in their capacity as members and with respect to their rights and obligations as members. o Companies may have the standard Model Articles under CA 2006 or these may be amended; the Articles must always be interpreted alongside CA 2006. o Can be incorporated from scratch with Companies House, or converted from Shelf Company. o Incorporation requires two documents – the memorandum, and the articles of association. o Conflicting authority as to whether one member may enforce the Articles against another member directly (Rayfield v Hands [1960]), or only through the company itself: enforcing provisions in Articles against the member (Welton v Saffery [1897]). Resolutions: o Directors – make decisions by passing Board Resolutions in Board Meetings. o Shareholders – make decisions by passing Shareholder Resolutions (Ordinary & Special) in general Meetings, or by Written Resolution.  Voting – (a) show of hands (one per person), (b) poll vote (one vote per share held).  Ordinary Resolution – passed by simple majority: more than 50%.  Special Resolution – passed by 75% or more shareholders voting in favour.

Legal Personality and Limited Liability (2) 

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s74 Insolvency Act 1986: o Enshrines concept of limited liability – confirming that shareholders of a company (generally speaking) are not liable to a liquidator in the event of the company’s insolvency. If company has insufficient funds to meet its liabilities, creditors can’t pursue claims against shareholders. Legal Personality – Company is a separate legal ‘person’: continues to exist even if tis shareholders and directors change, and personal assets are entirely separate from the assets of the company. o Current Position:  s16 CA 2006 establishes that a Company becomes a ‘body corporate’ (legal person) capable of exercising the functions of an incorporated company from the date of incorporation (date registrar issues certificate of incorporation).  Private Limited Company (plc) can be formed with just 1 director and 1 shareholder.  Shareholders – “own” the company: pay for their shares and are entitled to dividends (profits), but have no entitlement to company’s property.  Directors – day to day control over company under MA3; as a company is inanimate it must act through human beings. Salomon v Salomon & Co [1897]: o High Court – the company was Mr Salomon’s agent and he was the principal. The business belonged to Mr Salomon, and thus he was required to indemnify the company. o Court of Appeal – no agency but was evidence of fraud, because company was made for an illegitimate purpose (applying purposive rule), and was overvalued. Was a one man company controlled by Mr Salomon, who was liable for its debts. o House of Lords – agency argument flawed, a company is a different legal person from its members through incorporation, and is separately liable for the debts it incurs. In absence of fraud, motive of the incorporators in irrelevant: HL takes a literal approach to statute. A company is validly incorporated once the formalities have been complied with. The shareholders need not have an interest in the business. One-man companies can benefit from limited liability. o HELD: reversed Appeal Courts ruling in favour of Salomon, creating the legal concept of “corporate veil” between the company and its owners/controllers. Consequences of Separate Legal Personality: 1. Company owns its own property

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Antonia Szapary

Macaura v Northern Assurance [1925] – Lords held the timber belonged to the company and not Macaura, and therefore he was not able to claim on the insurance policy despite owning almost all the shares in the company. 2. Company enters into contracts on its own behalf – benefits and liabilities under the contract belong to the company (even if between company and its sole director/shareholder).  Lee v Lee’s Air Farming [1961] – PC held Lee and the Company were distinct legal entities, and so Lee under his contract of employment was a ‘worker’. Widow was therefore entitled to compensation and is irrelevant that Lee was a majority shareholder and sole director. 3. Company sues and is sued on its own liabilities  Adams v Cape Industries [1990] – claimants argued (a) Cape and its subsidiaries should be treated as a single economic unit; (b) the subsidiaries were used as a façade concealing the true facts; (c) an agency relationship existed between Cape and NAAC. o HELD: AC rejected all these arguments; nothing could be enforced against Cape. Limited Liability: o Justification – encourages businesses taking risks and investment, which generates money and benefits the wider community.  Shareholders have limited liability – liability is limited to the amount of their shares even when a shareholder is the ‘controlling mind’ of the company (sole shareholder/director).  Creditors are aware that they are contracting with a limited company – s59 & 60 CA 2006 requires that all company names contain ‘Ltd’ or ‘Plc’. o Issues – creditors of companies and claimants in court risk being unable to receive monies due to them as the concept prevents them from going behind the corporate structure to seek monies from those controlling the company (piercing the corporate veil). 

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Piercing the Corporate Veil (2) Refers to 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 (exception to Salomon).  Current Position – court may pierce the corporate veil only where a person under an existing legal obligation or restriction deliberately evades or frustrates this by setting up a company. o Shareholders or parent companies may incur liability arising out of the acts of the company but this liability arises under a specific statute, in tort or under the law of agency and not from the piercing of the corporate veil. 1. Façade or Sham – cases in which the Court has “lifted the veil” o Gilford Motor Co v Horne [1933] – former employee bound by a restrictive covenant not to solicit customers from his former employers, set up a company to do so. HELD: the company was merely a front or sham and issued an injunction to prevent trading. o Jones v Lipman [1962] – L formed a company to evade a contract with J for sale of land, and transferred land to company claiming he was no longer the owner. HELD: court found the company to be merely a façade and granted an order for specific performance. o Trustor AB v Smallbone [2002] – T asked court to pierce the corporate veil and treat receipt by the second company as receipt by S on grounds that the company was a sham created to facilitate transfer of money in breach of duty. HELD: company was indeed a sham and the device through which the impropriety was conducted, and because of this improper motive the court could lift the veil and find S liable. 2. Single Economic Entity – parent companies are NOT liable for their subsidiaries other than in specific statutory circumstances. o DHN Food Distributors v Tower Hamlets [1976] – Denning LJ: HELD that groups of companies is a single economic unit and should be treated as such. o Woolfson v Strathclyde Regional Council [1978] – Lords doubted Denning’s decision in DHN, HELD the veil of incorporation will be upheld unless it is a sham or façade created specifically for the purposes of avoiding liability (confirming each company in a group is a distinct entity). o Adams v Cape Industries [1990] – AC refused to allow the corporate veil to be lifted to allow the judgement to be enforced against the parent company. Consequence of separate legal identity is 

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enterprises can use company group structures to pursue more risky ventures which remain removed from the parent company’s liability. 3. Agency – liability based on agency does NOT lift the corporate veil o Company has power to act as an agent for its parent company/individual shareholders if authorised. o BUT, there is no presumption that this is the case and in the absence of express agreement, it is very difficult to establish the liability of shareholders/parent companies on this basis. o Even when agency is established, argument is based on law of agency and is not an example of lifting the corporate veil – Lords decision in Salomon considered and established this view. 4. TORT – liability based on tortious activity does NOT lift the corporate veil o VTB Capital v Nutritek [2013] – HELD: court left open the question of whether there exists any principled basis on which the corporate veil can be pierced. Found VTB could claim damages on basis of the tort of ‘fraudulent misrepresentation’ (alternative remedy). o Prest v Petrodel Resources [2013] – family law case concerning distribution of assets in a divorce.  HELD: Lord Sumption – affirmed key principles in Salomon, setting out two principles: (1) Concealment principle: doesn’t involve piercing CV (corporate structure conceals real actors and courts look beyond to discover real facts); (2) Evasion principle: courts piece CV if person deliberately attempts to evade an existing legal obligation he is under by interposing a company which he controls.  CV can only be pierced to prevent the abuse of corporate legal personality where someone deliberately frustrates the enforcement of an alternative remedy (otherwise not necessary).  In Prest, no impropriety in company holding the properties for tax purposes, so piercing the corporate veil was not necessary.  Husband’s attempt to transfer the properties to a separate company had failed, so the property reverted back to him and was up for distribution – no need to pierce CV because an alternative was found through Trust Law.  Following Prest v Petrodel, does the Doctrine have any real application? o SC confirmed piercing the veil may exist as a matter of law, but would be extremely rare that the principle would be invoked. o SC reviewed historic cases where CV was pierced, and stated liability could have been established in each under general principles without the need for lifting the CV. o Summary – where other routes to infer liability are available which do not ignore separate legal personality, the courts will infer liability on these principles. o ‘Specific Performance’ (Jones v Lipman) – specific act by an individual can resolve an issue instead of piercing CV.

Corporate Activity (3) 

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In what circumstances are decisions taken by those persons treated as decisions of the company? When do the acts of (human) directors or employees bind the (inanimate) company to obligations to third parties, and does the company have the capacity to be bound? Contractual Liability – power of a company to enter into a transaction is limited in two ways: 1. Capacity – was the act within the power of the company?  Necessary to check the ‘objects clause’ in the memorandum to check which acts/business the company is empowered to participate in.  If the transaction is outside company’s powers, it is consequentially void and unenforceable (ultra vires) against the company even if the shareholders attempted to ratify the act. This is because the company was not incorporated with the requisite capacity (Ashbury v Riche).  ‘Capacity’ not as relevant to companies incorporated under CA 2006, because memorandum no longer contains an objects clause – under s31 CA 2006 a company’s objects are unrestricted (subject to its articles).  BUT, will encounter companies incorporated under previous Companies Acts which may have their capacity restricted by their objects clauses.

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Antonia Szapary

2. Authority – if company DOES have capacity, must ask whether the individual who contracted on the company’s behalf had the authority to do so. If yes then transaction is valid, but if not the transaction is voidable at the instance of the company.

The Doctrine of Ultra Vires (3) Companies are not allowed to act outside of their objects clause, and if unable to achieve stated object it was vulnerable to be wound up by the court (German Date Coffee [1882]).  Problems Resulting from the Doctrine of Ultra Vires: o Objects clause was not originally permitted to be altered. Later legislation allowed alteration but only in very limited circumstances until 1991, when amendments to CA 1985 came into force. o Inhibits Diversification – companies often diversify and change their business, which is often key to businesses to protect for the future. o Doctrine of Constructive Notice – combined with UV this caused problem for third parties seeking to enforce contracts against companies (particularly regarding objects clauses).  Applies to all publicly available documents (memorandum & articles), and deems anyone dealing with registered companies to have notice of the contents of their public documents.  Therefore, one is unable to argue that one was not aware that the company lacked capacity to enter into a transaction that fell outside the scope of its objects clause.  Resultingly, companies incorporated from 1960s until 1991 usually had very long objects clause setting out all the possible types of businesses they may engage, to avoid the effects of the UV rule and provide the company with sufficient capacity for its trading.  REFORM of Ultra Vires: o CA 1985 (amendments in 1991) introduced changes – introduction of a provision in s35 CA 1985 removing the doctrine of constructive notice in relation to a company’s memorandum & articles. o CA 2006: enshrined the above changes in s39(1): “the validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the company’s constitution”.  Requirement for an objects clause in the memorandum was completely removed.  s31 states that the default position is now that all companies have unrestricted objects (but can still choose to insert one if they wish). o Companies formed prior to CA 2006 – objects clauses are treated as a provision of the articles (s28(1)) and will continue to bind the company unless altered by special resolution. If company adopts new articles then this treats the objects clause as being removed.  It is therefore necessary to check the position, but any issues of ultra vires are rare.  Agency and Authority: o An agent is appointed by a principal to act on their behalf – the contract will be entered into between the principal and the third party, not the agent, who merely represents the principal. o In order to validly represent the principal an agent needs authority – this can be actual (express or implied) or deemed (either by statute, or under common law: ostensible or turquand’s rule). 1. ACTUAL Authority – authority that has been actually conferred on them by the principal. o Freeman & Lockyer v Buckhurst Park [1964] – Diplock LJ: “an ‘actual’ authority is a legal relationship between principal and agent created by a consensual agreement to which they alone are parties. Its scope is to be ascertained by applying ordinary principles of construction of contracts”. a) Express Authority – MA 3 ‘Directors’ general (express) authority: subject to the articles the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company.  MA 5 and 6 also gives Directors authority to delegate any of their powers to others. b) Implied Authority :  Appointment to a specific role – can be distinguished from ostensible/apparent authority because it is only the relationship between the principal and agent which is relevant to determining whether the implied authority exists (e.g. appointment of MD carries power to do all such acts necessary to manage the company, include those not expressly stated). 

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Smith v Butler [2012] – HELD that implied powers of a MD are those that would ordinarily be exercisable by a MD in his position, subject to company’s articles and anything parties expressly agreed.  Course of dealing – e.g. when a director/agent continually enters into specific transactions, and the board of directors either acquiesce or agree to this. o Hely-Hutchinson v Brayhead [1968] – despite having no express authority, Court HELD that he had implied actual authority from a course of dealing due to his conduct over many months of entering into similar contracts and later notifying the board, who never objected. 2. DEEMED Authority – situations where the agent has no actual authority, yet can still bind the principal. a) Statutory authority under s40 CA 2006 – parties who deal with a company in good faith are entitled to assume that directors’ powers are free of any constitutional limitations.  Means that the company cannot claim not to be bound by the acts of its directors by asserting these acts are unconstitutional – applies even when the articles require specific shareholder/board approval for a particular act.  Threshold for proving a third party has acted in ‘bad faith’ is high.  Only protects third parties, not directors – if director acts ultra vires the company can sue them and recover compensation for any consequential losses caused. b) Ostensible (apparent) authority under common law – determined by looking at the relationship between the principal and third party: authority of the agent as it APPEARS to the third party.  Freeman & Lockyer v Buckhurst Park [1964] – AC upheld claim on basis of ostensible authority: although K had no actual authority, the board had held K out as the MD, allowing him to act in this way, and therefore K has ostensible authority to bind the company. c) ‘Indoor management’ rule in Turquand’s case – less significant now due to s40 CA 2006, but still applies in certain situations: in particular where the third party has not dealt directly with the board, or a question of whether the agent was authorised by the board.  Royal British Bank v Turquand [1856] – Court held that as public documents would only reveal that a resolution was required and not whether such a resolution has been passed, the loan was valid. The principle stated was that outsiders are entitled to assume that the company’s internal procedures have been complied with (known as the ‘indoor management’ rule).  NOTE: rule will not apply when third party has actual notice of the irregularity, is not acting in good faith, or where the third party is an insider (e.g. director’s contract with company).  Ratification – company is able to ratify acts that are beyond the actual authority of its agents, provided that the act is within the authority of the appropriate organ of the company who are looking to ratify it (board or shareholders). o Involves passing a resolution to approve the act and agree company will be bound by it. o New Falmouth Resorts v International Hotels Jamaica [2013] – court stated “the acts of an agent on behalf of the principal outside his actual authority may be adopted and ratified” [and] “if there is ratification it has retrospective effect i.e. it renders the transaction with the company binding on it from the time it was entered into by the agent”. o

Pre-Incorporation Contracts (3) 

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Company comes into existence at the time of issue of the certificate of incorporation by the Registrar of Companies (s15 CA 2006) – until then it is not a legal person and therefore has no capacity to enter into contracts (Rover International v Cannon Film Sales [1987]). If a contract was entered into before the company is incorporated, then as the company did not exist at that point as a legal person, it is not possible for it to have legal rights/duties under the contract (did not have legal capacity at that point). C...