Thu, 27 Jan 2011
PIERCING THE CORPORATE VEIL
The Companies Act 2006 by section 16(2) and (3) recognises an incorporated company as having a personality such as to distinguish it from those separate personalities of its members. It reiterates and emphasises the principle identified in company legislation since 1862, and further illustrated in the well known case of Salomon v Salomon and Co Ltd [1867] AC 22(HL).
This separate existence has several important consequences. It provides a company with:
- The right to sue and to be sued in their own name
- Retain and enjoy its profits
- Have the capacity to contract with anybody including their only shareholder.
It further benefits and protects shareholders who are not in that capacity liable for the debts of their company and cannot be held liable for any wrongdoings.
The court faces balancing these fundamental principles which in turn restricts the application of the piercing of the corporate veil. Only in exceptional circumstances will the court look beyond and thereby override the company’s legal personality in order to examine and ascertain the true state of affairs. Fraud is of course the most obvious of those exceptional circumstances, either in establishing the business or in conducting the business. Where an individual creates or runs a company to act as a shield for fraudulent purposes that veil will be lifted, if not ripped or rudely torn away, Jennings v CPS [2008] 4 ALL ER 113(HL) to expose the true perpetrators.
When analysing the judicial decisions on lifting the veil it is crucial to distinguish between those situations where the court applies statute (other than the Companies Act) or, less frequently, a contract from those where, as a matter of common law, the veil is lifted.
Directors are shielded from responsibility of their company’s shortcomings and failure where such companies are “limited.” In these troubled times, however, greater efforts are being made to lift, or pierce, that “corporate veil” in an attempt to place blame on an individual in an attempt to recover some of the monies owed to them by a flailing company. The question is how and when such efforts will be successful.
Challenges to the doctrines of separate legal personality and limited liability at common law tend to raise more fundamental challenges to these doctrines, largely due to the fact they are formulated on the basis of general reasons for not applying them, such as fraud, the company being a “sham” or “façade,” that the company is the agent of a shareholder, that the parties are part of a ‘single economic unit’ or event that the ‘interests of justice’ require this result.
It would seem, however, the courts are if anything more reluctant to accept such general arguments against the doctrines that arguments based on particular statues or the terms of particular contracts.
Adams v Cape Industries Plc [1990] 2 WLR 786 HL sheds light on the courts approach. It concerned liability within a group of companies and the purpose of the claim to ignore the separate legal personality of the subsidiary was to make the parent liable for the obligations of the subsidiary towards involuntary tort victims. Cape was an English Registered Company whose business was mining asbestos in South Africa and marketing it worldwide. The question for the courts was whether judgment obtained against Cape in the USA would be recognised and enforced in the English courts. The court rejected all arguments by which it was sought to make Cape liable. The single economic argument proceeded in an effort to persuade the court that although each company in a group of companies is a separate legal entity possessed of separate rights and liabilities the court should in appropriate circumstances ignore the distinction between them and treat them as one. The argument failed. The court accepted that the wording of a particular statue or document may justify their in interpreting it so that a parent and subsidiary are treated as one unit at any rate for some purposes but the message conveyed was clearly that the courts are reluctant to pierce the veil in the absence of such statutory or contractual provisions. They recognised, inevitably, the “one well-recognised exception to the rule prohibiting the piercing of the veil,” namely when the corporate structure is a “mere façade concealing the true facts.” The difficulty is in knowing what may make a company a “mere façade.”
The agency argument
Where a parent company permits its subsidiary to act as its agent it may so act if they have authority to do so. In those circumstances, the parent company will be bound by the acts of its agent, provided the acts concerned are within the actual or apparent scope of the authority. But, it is important to note that there is no presumption of such an agency relationship. In the absence of an express agreement between the two corporate personalities it will be very difficult to establish one.
The Interests of Justice
The term is inherently vague providing no clarification as to when the veil may be pierced. It may well provide a policy impetus for creating an exception to the doctrine but is insufficient in its own right. It remains a simple catch all term to refer to all of the identified and established grounds. Absent the presence of dishonesty the court should not attempt to pierce the veil, Ord v Belhaven Pubs Ltd [1998] BCC 607 at 615F.
The Court of Appeal has considered whether the exception to the rule would relate to fiduciary relationships. They expressed the view it was a powerful argument of principle in the intensely personal context of trust, confidence and loyalty but did not, however, elevate the argument into legal precedent, Ratiu v Conway [2006] 1 ALL ER 571.
Impropriety
More recently, parties have endeavoured to persuade the court that the veil should be set aside on the grounds the company has been used to carry out an unlawful activity or in order to avoid the impact of a court order. Ordinarily, where the veil is pierced in such cases the principle of successful shareholders limited liability is not affected. Rather it is the company which is being made liable for the obligations of the shareholder. In Re H [1996] 2 ALL ER 291 CA, restraint orders were made under the Criminal Justice Act 1988 regarding assets held by companies completely owned and controlled by individual defendants who had been convicted of excise duty fraud. The companies however were not convicted and were not deemed to be a façade in the Cape sense of the word, since they carried on individual businesses of their own, albeit partially unlawful businesses. The case is explicable however on the grounds that ignoring the companies’ separate legal entity was necessary for the implementation of the statutory policy underlying the 1988 Act.
Directors have also sought to avoid liability by allocating their assets to companies they control. In those circumstances, where a director has misappropriated corporate assets or opportunities but those assets had been taken by a company owned or controlled by the director rather than the director personally, the court preferred to hold the company liable for knowing receipt of the corporate assets on the grounds hat the director in question was a façade, Gencor ACP Ltd v Dalby [2000] 2 BCLC 734. It is not however obvious that a director should escape liability to account simply due to the company carrying on an independent business as well as receiving the assets misappropriated by the director, CMS Dolphin Ltd v Simonet [2001] 2 BCLC 704 at 736. In fact it may be possible to analyse such cases without recourse to the doctrine of lifting the veil on the grounds that the common rule about misappropriation of corporate assets by directors encompasses both assets taken personally and those taken through entities which they control.
In essence, impropriety seems no more established than “interests of justice” as a ground for piercing the veil though courts have secured just results by and large through recourse to other rules, often from outside company law. It may be the courts, as with “interests of justice”, are unclear where the boundaries of an ‘impropriety’ lie.
Conclusion
Corporations exist in part to shield the personal assets of shareholders from personal liability for the debts or actions of a corporation. Unlike a general partnership or sole proprietorship in which the owner could be held responsible for all the debts of the corporation, a corporation traditionally limited the personal liability of the shareholders. The limits of this protection have narrowed in recent years. Shareholders are increasingly personally liable.
Piercing the corporate veil typically is most effective with smaller privately held business entities (close corporations) in which the corporation has a small number of shareholders, limited assets, and recognition of separateness of the corporation from its shareholders would promote fraud or an inequitable result.
Directors would do well to abide by the mantra: “He that respects himself is safe from others. He wears a coat of mail that none can pierce,” Henry Wadsworth Longfellow [1807-1882]
Olivia Chaffin-Laird
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