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A company once incorporated becomes a legal personality, a juristic entity, separate and distinct from its members and shareholders and capable of having its own rights, duties and obligation and can sue or be sued in its own name. This is commonly referred to as the doctrine or principle of corporate personality and it carries with it the concept of limited liability which ordinarily flows from the aforementioned doctrine of corporate personality. No case illustrated the above principles better than the noted House of Lords decision in Salomon v. Salomon. However, in some circumstances, the courts have intervened to disregard or ignore the doctrine of corporate personality and limited liability especially in dealing with group companies and subsidiaries and where the corporate form is being used as a vehicle to perpetrate fraud or as a "mere façade concealing the true facts." In this article, we will examine the concept of lifting the veil and the circumstances where the court may "pierce" or "lift" the veil of incorporation.
Despite numerous sophisticated attempts in recent years at providing theories which explain company law, it is noteworthy that we have not yet fully understood the essence of the corporate being. It will, suffice to say, that if three persons incorporate a company, the company will become a fourth person separate and different from these three persons individually or collectively. However when the company or corporate form is a sham or a ‘mere façade concealing the true facts,’ the veil of corporate personality can be torn aside.
Thus against the backdrop of the possibility of that limited liability (which protects investors, shareholders) can be a vehicle for facilitating fraud, parliament via statutory legislations and judiciary via decided cases have sometimes intervened to mitigate the harsher effect of corporate personality and limited liability but this does not mean that the two doctrines are no respected or recognized by the courts as holding sway as rigid construct of English company law.
However it is in dealing with companies operating as group structures and their subsidiaries that we have witness intensive statutory and judicial intervention/watchdog in the core area of company law. As corporate affairs became more complex and group structures emerge, the Companies Act began to recognize that treating each company in a group as separate was misleading. Overtime a number of provisions were introduced to recognize this fact. For instance, the English Companies Act 1985, section 227 provides that parent companies have a duty to produce a group accounts and section 231 also requires that parent companies to provide details of the names of subsidiaries country of activity/operation and the shares it holds in the subsidiary.
As for group structures, we are referring to the complex situation where a parent company organizes it businesses through a number of subsidiary companies in which it is usually the sole shareholder. This is usually for amelioration of tax liability/burden or other potential or likely liability making effective use of transfer pricing i.e. allocation of profits in transactions between entities, which are legally separate but under common control. The issue of transfer pricing used to be regarded as primarily one countering international tax avoidance through the abusive setting of prices to allocate profits to the jurisdiction with the lowest tax rates. However, developments have now made it more clearly an issue of the correct allocation of taxable profits to different jurisdictions. Transfer pricing thus impacts all multi-national enterprises, whether they seek to avoid tax by adjusting their pricing for tax purposes or not albeit international tax avoidance having also become an issue of concern to the global community. See Article 9 of the OECD model tax convention.
It was the possibility of using the corporate form to commit fraud that actually prompted t he introduction of a number of civil and criminal provisions that operate to disregard or negate the effect of corporate personality and limited personality in most Companies Act (legislations in common law jurisdictions. See for instance Section 459 of the Companies Act 1985 UK and Section 213-215 of the Insolvency Act 1986 (English). Section 213 of the Insolvency Act 1986 known as "Fraudulent Trading" states:
If in the case of the winding up of a company, it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditor of any other person, or for any fraudulent purpose, the following has effect:-
The court on application of the liquidator may declare that any person who were knowingly parties to carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper.
This section did not achieve the desired effect as the courts set the standard for intent fairly high because of the possibility of a criminal charge also arising under Section 458 of the Companies Act 1985. Achieving this high standard proved very difficult and so a provision was introduced in Section 214 of the Insolvency Act 1986 to deal with situations where negligence rather than fraud was involved. Section 214 known as "Wrongful Trading" states:
If in the course of the winding up a company, it appears that Subsection 2 of this section applies in relation to a person who is or has been a director of the company, the court on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper.
The subsection applies in relation to a person if:
The company has gone into insolvent liquidation
At sometime before the commence of the winding up of the company, that person knew or ought to have concluded that here was no reasonable prospect that the company would go into insolvent liquidation, and
That person was a director of the company at the time.
This section operates on the principle that a reasonable director will realize that the point of no return has come and stop trading at this point if (s)he does not do so, (s)he risks having to contribute to the debts of the company.
As in most medium-sized companies, directors will also be shareholders, and the section therefore operates to tangentially negate limited liability.
Corporate veil lifting by the courts
Following the Salomon decision, the courts have tried to uphold separate corporate personality as a position of normality while also maintaining a watchful eye on any misuse of the corporate form. However sometimes the courts have been more watchful than others. Judicial approach as exemplified by some cases is quite interesting.
In the case of James v. Lipman (1962) 1 WLR 382, for instance, Mr. Lipman entered into a contract for the sale of land. However, Mr. Lipman changed his mind and did not want to complete the sale. He formed a company in order to avoid the transaction and conveyed the land to the company instead. He then claimed that he no longer owned the land and could not comply with the contract. The Court found that the company was but a façade for Mr. Lipman to hide behind and granted an order for specific performance.
Note however that it will be difficult for the Court to have found as they did if Mr. Lipman has conveyed this land to another company of which he had no interest and which has no knowledge of his contract to sell the land to Mr. Jones. The reason for the above is that in real property transaction, a contract/agreement for the sale of the land will, upon exchange of contract create or vest in the prospective buyer an equitable/beneficial interest and since equitable interests are remedies in peronam (affecting the parties involved), and as such the company will acquire the legal interest in the property (legal rights are rights in rem – i.e. good against the whole world), and as such Mr. Jones cannot disturb the conveyance to the company and his remedies may only attach the purchase price in the hands of Mr. Lipman.
In Littlewoods Stores v. IRC (1969) 3 ALLER. 855 Lord Denning in his usually epigrammatic language considered in relation to the concept of veil lifting that:
The doctrine laid down in Salomon’s case 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 court can and often do, pull off the mark. 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…
By early 1990s however, the Courts where indicating that the veil was to be rigidly maintained. Thus in the complex case of Adams v. Cape Industries P/C (1990) ch. 433, the Court of Appeal firmly emphasized that he circumstances when the courts could lift the veil were very limited. The case is complex but broadly the following were the facts and circumstances of the case:
Until 1979, Cape, an English Company, mined and marketed asbestos. Its worldwide marketing subsidiary was another English company, named Capasco. It also had a US marketing subsidiary incorporated in Illinois, named NAAC. IN 1974 some 462 people sued Cape, Capasco NAAC and other s in Texas for personal injuries arising from the inhalation of asbestos in a factory.
Cape protested at the time that the Texas Court had no jurisdiction over it, but in the end it settled the action. In 1978 NAAC was closed down by Cape and other subsidiaries were formed with the express purpose o reorganizing the business in the US to minimize cape’s presence there for taxation and other liability issue.
Remember what we said earlier on, on how in the context of the problems associated with transfer pricing how subsidiary corporations, particularly foreign subsidiaries are sometimes employed to milk the parent corporation, or otherwise improperly manipulate the financial accounts of the parent company e.g. by shifting of profits, the making of fallacious sales, and other methods frequently adopted for the purpose of milking the parent company or mitigating their true tax liability.
Back to Adams v. Cape case; between 1978 and 1979, a further 206 similar actions were commenced and default judgment were entered against Cape and Capasco (who again denied they were subject to the jurisdiction of the court, but this time did not settle). In 1979 Cape sold its asbestos mining and marketing business and therefore had no assets in the US. Adams sought the enforcement of the US default judgment in England.
The key issues was whether Cape was present within the US jurisdiction through its subsidiaries or had somehow submitted to such jurisdiction. The only way that could be the case was if the court lifted the veil of incorporation either treating the Cape group as one single entity or finding the subsidiaries were a façade, or that the subsidiaries were agents for Cape.
The Court found that in cases where the courts had treated a group as a "single economic unit" thus disregarding the separateness of each company in the group, the Court was involved in interpreting a statute or document. This exception to maintaining corporate personality is qualified by the fact that there has to first be some lack of clarity about a statute or document which would allow the Court to treat a group as a single entity. The Court concluded that:
Save in cases which turn on the wording of particular statutes or contracts, the Court is not free to disregard the principle of Salomon v. A. Salomon & Co Ltd. (1889) AC 22 merely because it considers that justice so requires.
Our law, for better, or worse, recognizes the creation of subsidiary companies, which though in one sense the creatures of their parent companies will nevertheless under the general law fail to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities. The Court of Appeal recognize the "mere façade concerning the true facts" as being a well-established exception to the Salomon principle. The case of Jones v. Lipman (1962) being the classic example. There Mr. Lipman’s sole motive in creating the company was to avoid the transaction. In determining whether the company is a mere façade the motive of those behind the alleged façade may be relevant. The Court of Appeal looked at the motives of Cape in structuring its US business through its various subsidiaries. It found that although Cape’s motive was to try to minimize its presence in the US for tax and other liabilities (and that might make the company morally culpable) there was nothing legally wrong with this.
The Court then finally considered the "agency" argument. This was a straightforward application of agency principle. If the subsidiary was Cape’s agent and acting within its actual or apparent authority, then the actions of the subsidiary would bind the parent. But generally speaking a subsidiary is not an agent of a parent. The Court found that the subsidiaries were independent businesses free from the day-to-day control of Cape with no general power to bind the parent. Therefore Cape would not be present in the US through its subsidiary agent. See also the case of Creasy v. Breachwood Motors Ltd.(1992) BCC 638.
Note that the decision in Cape has dominated the case law since. See also the case of Ord v. Bellhaven Pubs Ltd. (1998) 2 BCCC 447. A scholarly contrasting of the case of Adams v. Cape with Jones v. Lipman will show that in Adams v. Cape the court indicates that moral culpability on the part of Cape in arranging its affairs to deliberately avoid liability was irrelevant. There was nothing illegal in doing this and therefore the "mere façade" exception would not apply.
However, in Jones v. Lipman there was similarly no illegality, rather it was Mr. Libman’s motive of trying to avoid liability by using the corporate form that led to the court’s view that it was a mere façade. Note that in neither case is illegality involved but in Jones v. Lipman’s case, the deliberate avoidance motive appears crucial and in the other it is not. |
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