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Lifting The Corporate Veil - Corporate law

Written By: Anusuya Sadhu
Copyright Law in India
Legal Service
  • Incorporation by registration was introduced in 1844 and the doctrine of limited liability followed in 1855. Subsequently in 1897 in Solomon v. Solomon & Company the House of Lords effected these enactments and cemented into English law the twin concepts of corporate entity and limited liability. In that case the apex court simply laid down that a company is a distinct legal person entirely different from the members of that company.

    What this means is that the company has life of it's own, can own property, can sue and be sued in it's own name, has perpetual life and existence to name a few of the benefits of incorporation. It is a trite law that a rather hefty veil is drawn between these two that can be lifted only in a limited number of circumstances that seem to be fluctuating according to current judicial thinking.

    However the courts have not always applied the principal laid down in Solomon v. Solomon & Co. In a number of circumstances, the court will pierce the corporate veil or will ignore the corporate veil to reach the person behind the veil or reveal the true form and character of the concerned company. The rationale behind this is probably that the law will not allow the corporate form to be misused or for the purposes which is set out in the statute. In those circumstances in which the court feels that the corporate forms is being misused it will rip through the corporate veil and expose its true character and nature disregarding the Solomon principal as laid down by the house of lords.

    When the veil is lifted:
    The courts have been more that prepared to pierce the corporate veil when it fells that fraud is or could be perpetrated behind the veil. The courts will not allow the Solomon principal to be used as an engine of fraud. The two classic cases of the fraud exception are Gilford motor company ltd v. Horne and Jones v. Lipman.

    In the first case, Mr. Horne was an ex-employee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company. In order to defeat this he incorporated a limited company in his wife's name and solicited the customers of the company. The company brought an action against him. The Court of appeal was of the view that "the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne" in this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud. Thus the court of appeal regarded it as a mere sham to cloak his wrongdoings

    In the second case of Jones v. Lipman a man contracted to sell his land and thereafter changed his mind in order to avoid an order of specific performance he transferred his property to a company. russel judge specifically referred to the judgments in Gilford v. Horne and held that the company here was " a mask which (Mr. Lipman) holds before his face in an attempt to avoid recognition by the eye of equity" he awarded specific performance both against Mr.Lipman and the company. Under no circumstances will the court allow the ant form of abuse of the corporate form and when such abuse occurs the courts will step in and Jennifer Payne in her article lists three aspects of fraud, which needs to be looked at before the corporate veil can be lifted which are

    A) What are the motives of the fraudulent person relevant-
    Whether some level of deception is necessary needs to be determined. In the case of Hilton v.plustile ltd the plaintiff and the defendant agreed to use a medium of a company in a tenancy arrangement in order to evade the application of the rent act 1977.The court of Appeal held that the plaintiff was not entitled to lift the veil since he had full knowledge of the matter at all times. However another interesting question that arises is what is the effect of deception on the other party. The issue came up for discussion in the case of Adams V.Cape industries plc.In considering whether the corporate form has been used in such a way as to justify the lifting of the corporate veil, the court stated that the correct test in relation to groups of companies was whether the company had been used as a "mere fašade concealing the true facts" applying this test Slade J. said that the "motives of the perpetrator may be highly material" in both the classic cases intention to deceive the plaintiff was very much present how ever it was not so in Adams V. Cape industries. So the point that needs to be determined is whether motive is necessary for the fraud exemption to exist. However to get any answer it is also important to find out the nature of legal right that is being denied to the plaintiff

    b) Is the character of the legal obligation being evaded relevant?
    What the court wants is to prevent limited companies from using the corporate form to evade a contractual or legal obligation. However one needs to question whether the nature of this obligation will affect the ability of the court to lift the corporate veil. In the classic cases the defendants sought to avoid the legal obligations that existed prior to their incorporation, the main motive of incorporation was to avoid the performance of the legal obligation in Adams v. Cape there was some discussion about the need to allow the veil to be lifted in order to prevent Cape avoiding publicity as to its involvement in the sale of asbestos to America and to prevent cape from having any practical benefit of the group's asbestos trade in the states without the attendant risks of tortuous liability. However the tortuous liability was purely speculative. For the fraud exception to exist the defendant must deny the plaintiff some preexisting legal right. In case no legal right is existent the intention on part of the defendant to deceive the plaintiff must be speculative and hence less substantial in nature. if the legal right crystallizes before the incorporation of the company then the mental element is satisfied if however the reverse then question arises if whether in such circumstances the mental element can be satisfied. A suitable answer to this is if the legal right crystallizes after the incorporation but before the use of the corporate form to evade the legal right, the fraud exception should be satisfied

    C) Is the timing of the incorporation of the device company relevant?

    In Creasey v. Breachwood Motors Limited, the reason for the failure of the fraud exception was the timing of incorporation of the sham company. Here Mr. Creasey brought an action against wrongful dismissal against his employers BW. BW served a defence but four months later he was served a notice saying that the company was insolvent .BM took over all the business except the plaintiff's claim. The plaintiff obtained an order for damages and interest however before he received anything BW went was dissolved without going into liquidation. The plaintiff sought an order substituting BM for BW on the grounds of justice. In this case the facts may look similar to Adams v. Cape Industries however Richard Southwell sitting as distinguished Gilford and Horne and Jones v. Lipman on the basis that in those cases the sham companies are had been formed with the view to carry out the fraud .in the present case the device company BM was already in business and caring on it's own business. This a very controversial case and should have been decided on the basis of the classic cases as it should not matter whether device companies were created to avoid the legal obligation or whether they were in existence. Creasey should have been otherwise decided maybe on the grounds of justice.

    2. Group Enterprises
    Sometimes in the case of group of enterprises the Solomon principal may not be adhered to and the court may lift the veil in order to look at the economic realities of the group itself. In the case of products Ltd. V. Tower Hamlets it has been said that the courts may disregard Solomon's case whenever it is just and equitable to do so. In the above-mentioned case the court of appeal thought that the present case where it was one suitable for lifting the corporate veil. Here the three subsidiary companies were treated as a part of the same economic entity or group and were entitled to compensation.

    Lord Denning has remarked that 'we know that in many respects a group of companies are treated together for the purpose of accounts, balance sheet, and profit and loss accounts. Gower too in his book says, "There is evidence of a general tendency to ignore the separate legal group" however whether the court will pierce the corporate veil depends on the facts of the case. The nature of shareholding and control would be indicators whether the court would pierce the corporate veil. In the case of Woolfson the house of lords held that there was "no basis consonant with the principle upon which on the facts of this case the corporate veil can be pierced to the effect of holding Woolfson to be the true owner of Campbell's business or the assets of solfred "the two subsidiary companies that were jointly claiming compensation for the value of the land and disturbance of business. The House of Lords in the above mentioned case had remarked "properly applied the principle that it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere fašade concealing the true facts" In the figurative sense fašade denotes outward appearance especially one that is false or deceptive and imports pretence and concealment. That the corporator has complete control of the company is not enough to constitute the company as a mere fašade rather that term suggests in the context the deliberate concealment of the identity and activities of the corporator.

    The separate legal personality of the company, although a "technical point" is no matter of form it is a matter of substance and reality and the corporator ought not, on every occasion, to be relieved of the disadvantageous consequences of an arrangement voluntarily entered into by the corporator for reasons considered by the corporator to be of advantage to him. In particular "the group enterprise" concept must obviously be carefully limited so that companies who seek the advantages of separate corporate personality must generally accept the corresponding burdens and limitations

    In some cases the corporate veil has not been lifted prime examples of that are Adams V. Cape Industries. This was a case involving a foreign judgment against a company. the court in this case held that each company in the group is a separate entity. However one area where the courts have been particularly reluctant to recognize the concept of group entity is with relation with corporate debts. Though it is not possible to in absence of agency or trust to hold one group liable for the debts of another in America equitable doctrines are applied and in New Zealand as well as Ireland there are statutory provisions for pooling of assets.

    3. Agency
    In the case of Bodrip v. Solomon Justice Vaughan Williams expressed that the company was nothing but an agent of Solomon " That this business was Mr. Solomon's business and no one else's; that he chose to employ as agent a limited company; that he is bound to indemnify that agent the company and that this agent, the company has lien on the assets..." however on appeal to the house of lords it was held that a company did not automatically become an agent of the shareholder even if it was a one man company and they other shareholders were dummies.

    A company having power to act as an agent may do so as an agent for its parent company or indeed for all or any of the individual members if it or they authorize it to do so. If so the parent company or the members will be bound by the acts of its agent so long as those acts are within actual or apparent scope of the authority. But there is no presumption of any such relationship in the absence of an express agreement between the parties it will be difficult to establish one. In cape attempt to do so failed. Incases where the agency agreement holds good and the parties concerned have expressly agreed to such a agreement them the corporate veil shall be lifted and the principal shall be liable for the a acts of the agent.

    4. Trust
    The courts may pierce the corporate veil to look at the characteristics of the shareholders. In the case of Abbey and Planning the court lifted the corporate veil. In this case a school was run life a company but the shares were held by trustees on educational charitable trusts. They pierced the veil in order to look into the terms on which the trustee held the shares.

    5. Tort
    Usually the English courts have not lifted the veil on the ground of tort it is a phenomenon not witnessed in most common law jurisdictions apart from Canada

    6. Enemy character-
    In times of war the court is prepared to lift the corporate veil and determine the nature of shareholding as it did in the Daimler case where germen shareholders held the shares of an English company during the time of world war 1.

    7. Tax-
    At times tax legislations warrant the lifting of the corporate veil. The courts are prepared to disregard the separate legal personality of companies in case of tax evasions or liberal schemes of tax avoidance without any necessary legislative authority.

    Statutory support of lifting the veil ( English law)

    1) Reduction of number of members

    Under section 24 of the companies act if a public company carries on business for more than six months may become liable jointly and severally with the company for the payment of debts the right that this section confers on creditors is limited. it is only that member who remains after 6 months that can be sued. The anomaly of this section is that the liability attaches to a member and not a director unless the director also happens to be a director as well. This section has very little practical utility because of the limitation.

    2) Fraudulent or wrongful trading: -
    a) Criminal liability: -
    If any business of a company is carried on with the intend to defraud creditors of the company or creditors of any other person or for any fraudulent purpose who was knowingly a party to the carrying on of the business in that manner is liable to imprisonment or fine or both
    This applies whether or not the company has been or is in the course of being wound up.
    The civil liability for the same offence in now a part of the Insolvency Act

    b) Sections 213-
    (1) If in the course of winding up of a company it appears that any business of the company has been carried on with the intend to defraud creditors of the company or creditors of any other person or for any fraudulent purpose...then

    (2) The court on application of the liquidator may declare that person in who were knowingly parties to the carrying on of business in that manner are liable to make such contributions (if any) as the court thinks proper.

    Wrongful trading is dealt with in section 214 of the insolvency act and has similar provisions to section 213.however this section operates only in cases of insolvent liquidation and the declaration can be made only against a person who at some time before the commencement of winding up, was a director of the company and knew or ought to have concluded at that time that there was no reasonable prospect that the company would avoid going into liquidation.
    No such declaration will take place is the court is satisfied that the person took all the possible steps to minimize the losses.
    These sections have been considered to be opposed to the Solomon principle: -

    3) Abuse of company names or employment of disqualified directors

    Section 216 of the Insolvency Act now makes it an offence for anyone who was a director or a shadow director of the original company at any time during the 12 months preceding its going into insolvent liquidation to be in any way concerned (except with leave of court) during the next five years in the formation, management, of a company or business with a name by which the original company was known or one so similar as to suggest an association with that company.

    A person acting in violation of 216 is under 217 personally liable, jointly and severally with that company and any other person so liable, for the debts and other liabilities of that company and any other person so liable, for the debts and liabilities of that company incurred while he was concerned in its management n breach of section 216.

    d) Misdescription of the company
    Section 349(4) of the companies act provides that if any officer of the company or other person acting on its behalf
    Signs or authorizes to be signed on behalf of the company any bill of exchange, promissory note, endorsement, cheque or order for money or goods in which the companies name is not mentioned in legible letters..He is liable to a fine and he is personally liable to the holder of such as mentioned above.

    e) Premature trading.
    Another example of personal liability is section 117 (8). Under this section a public limited company newly incorporated as such must not "do business or exercise any borrowing power" until it has obtained from the registrar of companies a certificate that has complied with the provisions of the act relating to the raising of the prescribed share capital or until it has re-registered as a private company. if it enters into any transaction contrary to this provision not only are the company and it's officers in default ,liable to pay fines but it the company fails to comply with its obligations in that connection within 21 days of being called upon to do so, the directors of the company are jointly and severally liable to indemnify the other party in respect of any loss or damage suffered by reason of the company's failure.

    The Judgment of the Court Of Appeal in the Adams case is the current law, which is nothing more than a reiteration of the law laid down by the House of Lords in Solomon's case. The bottom line being only the court will lift the veil in the face of grave abuse of the corporate form not otherwise.

    The author can be reached at: [email protected] / Print This Article

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