Piercing the Corporate Veil

Piercing the Corporate Veil

  

 

Identify and evaluate the circumstances in which the courts will consider piercing the corporate veil. Refer to relevant decided cases.

Introduction

            The principle of piercing or lifting the corporate veil under English law is mired by confusion and misconception. While the courts have shown an understanding to treat the corporation as a legal entity separate from its owners, and hence the need to exercise caution and equitable authority while piercing the corporate veil, courts are also cognizant of the fact that the directors of a company may establish a limited liability corporation based on the understanding that this vehicle could allow them to escape debts incurred by it in the event that it goes bankrupt.  The ‘veil of incorporation’ principle as laid down in Salomon v Salomon. forms the basis of the entire law of corporations. The main benefit of incorporating a company is to ensure that it remains a separate legal entity from the individuals who formed it. Some individuals, however, through their own ingenuity, tend to utilise the corporate veil unabashedly with the understanding that they could hide behind the corporate cloak. In such instances, the courts have deemed it necessary to lift the corporate veil in order to examine the individuals behind these corporations. In this way, the people who have dishonesty or fraudulently used the legal entity are exposed. The premise of the current essay is to use relevant cases to identify circumstances in which Court would be inclined to pierce the corporate veil.

Circumstances in which the courts can lift the corporate veil

            The doctrine of piercing the corporate veil has found wide application in corporate law in enabling Courts to establish whether a shareholder should be held liable for the obligations of a company. This limits the likelihood that company directors could be held personally liable for the activities of the corporation. In this case, courts endeavour to balance two competing interests: ensure economic and democratic justification by promoting limited liability while also protecting society and creditors from harm caused by shareholders and corporations[5]. However, in instances when the Court chooses to ignore the corporation and looks directly at the individual directors or members of a company we talk of the corporate veil as having been pierced or lifted. The court retains the discretion to decide whether to pierce the corporate veil, or not, based on the underlying economic, moral, and social factors that operate through and in the corporation.

The courts have identified fraud as a primary reason for piercing the corporate veil. Where the court has reasons to believe that the company directors have been involved in improper business conduct or fraud, it has shown a willingness to pierce the corporate veil in an attempt to reveal such developments being carried out behind the veil. This is an attempt by the Courts not to let directors of a corporation use the Salomon principle as a tool to commit fraud. These two classic cases in which the Courts have endeavoured to lift the veil on grounds of fraud on the part of the company directors. In Gilford Motor v. Horne, the defendant, Mr. Horne, was a former employee of the plaintiff (Gilford Motor Company). According to his employment contract, he was not allowed to solicit the company's customers. In a bid to circumvent this limitation, Mr. Horne incorporated a limited company under the name of his wife and proceeded to solicit the customers of the plaintiff. Consequently, the company sued him. In its ruling, the Court of Appeal held that Mr Horne had formed the company as a tool to conceal the effective conduction of his business, and with a clear motive to perpetrate fraud. Accordingly, the Court viewed the action by Mr Horne in forming the company as just a pretence to cover his wrongdoings.

In Jones v. Lipman, a landowner entered into a contract to sell his land but later change his mind before the contract could be completed. He then formed a company and transferred ownership of the land to it as a means of evading paying for specific performances pertaining to this property. The Court cited the ruling given in Gilford v. Horne and held that Mr Lipman was using the company as a cloak to avoid the application of an equitable remedy against him. Accordingly, the court ruled that both the company and Mr Lipman were to be awarded specific performance.  

            If the Court is satisfied that a company is a mere sham or cloak, it could be compelled to lift the veil. In Wooffson v Strathclyde, the House of Lords held that there were no grounds for ruling that the corporation's structure was a mere sham or facade and as such, there was no legal statute that could be summoned to aid in piercing the corporate veil. In Adams v Cape Industries, the Court of Appeal relied on the same principle and identified two grounds under which the court may lift the company vein: by establishing an agency relationship between the subsidiary and the parent company; and by establishing that the company structure is a mere sham or facade aimed at masking the true facts that apply to Woolfson v Strathclyde. 

            A company veil may also be pierced in case the court is convinced that a defendant has used a corporate structure to avoid settling rights of relief owed to third parties. For instance, in Re a Company, the defendant created several English and foreign trusts and companies to enable him to dispose of his English assets. The court further established that following the occurrence of the alleged fraud and when it was clear that the plaintiffs would become insolvent, the defendant proceeded to dispose of his English assets. In light of the prevailing circumstances, the court felt compelled to pierce the corporate veil as a means of realising justice.  

            In Gencor v Dalby, the court held the director of the company liable for having diverted the commission accruing from the company’s revenue to an offshore company that he individually controlled. The court held the director needed to account for the money that he diverted to the offshore company in his sole custody.

            In Trustor v Smallbone, the plaintiff (Trustor) sought a court order to have the plaintiff (Smallbone) who was a director of the company held to account for the appropriation of the company’s funds paid to a second company (Introcom) that was under his control. The plaintiff argued that Introcom received the money under the principle of knowing receipt and knowing pay. However, the court declined to pierce the corporate veil based on the argument that there was no involvement of an unconnected third party; the company structure had not been abused to conceal or avoid liability or doing so for purposes of achieving justice.

            This is a clear indication of the court’s unwillingness to withstand additional erosion of the basic rules of the English Company Law namely, that a company should be treated as a “distinct legal entity” that is separate from its directors. In Trustor v Smallbone, the court is cognizant of the fact that it lacks the general power to lift the corporate veil with the goal of attending to an injustice. While the court revealed that the company was a sham or facade as evidenced by its acts of impropriety, the court lifted the veil because the director was using the company to conceal facts and escape personal liabilities. Therefore, the court held that lifting the corporate veil required there be a relationship between facade and impropriety.

            The court may also pierce the corporate veil in the case of group enterprises as it may be hard to adhere to the Salomon principle. In such a case, they may be compelled to pierce the veil with a view to scrutinising the group's economic realities. For example, in D.H.N Food v Tower, the Court of Appeal deemed it necessary to disregard the Salomon principle on equitable and just grounds. The court treated the three subsidiaries as part of a group enterprise and hence subject to the same economic entity. Lord Denning in his ruling held that the three subsidiaries were entitled to compensation. The idea of a corporation as a separate, legal entity was treated as a matter of reality and substance, as opposed to a matter of form. However, there is a need for courts to tread carefully while dealing with "the group enterprise" principle in order that corporations that might be inclined to take advantage of separate corporate personalities also accept the ensuing limitations and burdens.   

            It may also be necessary to pierce the corporate agency on agency grounds. In Salomon v Salomon, Justice Williams held that Solomon had treated the company as his agency.  However, the House of Lords overruled his judgement following an appeal to the case in which it was held that a corporation did not automatically turn into an agency for its shareholders even though it was under the sole control of one man. It may be necessary for courts to lift the corporate veil and examine the characteristics of the shareholders of a company as happened in Abbey v Planning where the court lifted the corporate veil to enable them to examine the conditions under which the trustees of an educational charitable trust held shares and operated it as a company.

            At times, a party may endeavour to have the corporate veil lifted based on the argument that this will lead to a just and fair outcome. RMS Glazing v Strata Plan is one such case where piercing the veil was sought in the interest of justice.  Here, the plaintiff and Mr Lo Surdo (both a shareholder and director of the plaintiff) were sued by a corporate body for losses it had incurred after the plaintiff had entered into contracts with the corporation. While the corporation was successful on some of the claims it had raised, when it came to the issue of costs, noted that the corporation was a mere 'body of straw' and hence sought to have Lo Surdo held personally liable on grounds that he was actively involved, not to mention that he also had a stake in the results. However, Cole J ruled against the claim that the company was a mere 'body of straw', noting that Body Corporate had transacted business with the company as opposed to Mr Lo Surdo for over a decade.  

Conclusion

            The Salomon case acts as the basis for the identification of the corporation as a separate legal entity from its shareholders. Accordingly, the company shareholders cannot be held liable for the company's liabilities that exceed their shares, in the event that the company goes bankrupt. This is known as the veil principle. However, the court may exercise its discretion and lift the corporate veil in case of fraud, if the corporation has been established to cover impropriety or is a sham, and where group enterprise hinders the application of the Salomon principle. 

 

Bibliography

Books

Bevan, Neal R, Business Organizations and Corporate Law (Cengage Learning 2006) 275.

Rudorfer, Michala, Piercing the Corporate (Veil GRIN Verlag 2009) 2.

Case Laws

Adams v Cape Industries plc [1990] Ch 433

Abbey Malvern Wells Ltd v Ministry of Local Government and Planning [1951] 2 All ER 154

DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852 

Gencor ACP Ltd v Dalby [2000] EWHC 1560 (Ch)

Gilford Motor Co Ltd v Horne [1933] Ch 935 

Jones v Lipman [1962] 1 WLR 832

Re a Company (No 001418 of 1988) [1990] BCC 526

RMS Glazing Pty Ltd v The Proprietors of Strata Plan No 14442

Salomon v Salomon & Co Ltd [1896] UKHL 1 

Trustor AB v Smallbone (No 2) [2001] EWHC 703 (Ch)

Woolfson v Strathclyde Regional Council [1978] UKHL 5 

Article Journal

Ramsay, Ian M,’ Piercing the Corporation Veil in Australia’ (2001) 19 Company and Securities Law Journal 250.

Online articles

Cornell University Law School,’ Piercing the corporate veil’ (n.d.)

Macey, Jonathan R,’ The Three Justifications for Piercing the Corporate Veil’ (2014)