Lifting the Coporate Veil

LIFTING THE CORPORATE VEIL (i) Introduction (ii) Principles of unified Personality (iii)Statutory Exceptions (iv)Common Law and the Mere Facade Test (v) Agency and Groups (vi)Conclusions entryway 1. When a creditor discovers that a debtor come with is insolvent, the creditor will frequently insufficiency to find oneself the debt from a sh arholder, handler or associate of the insolvent ships attach to. in that respect exist miscellaneous statutory and familiar justness mechanisms by which the in bodied kill can be get up and liability imposed on idiosyncratics or differently companies.This lecture sets outs and discusses those mechanisms in the light of recent administration and of the Companies comport 2006. PRINCIPLES OF CORPORATE PERSONALITY 2. One of the fundamental precepts of compevery practice of legitimateity is that a corporation has somebodyality that is distinct from that of its shargonholders. This rule was laid mess by the crime syndicate of Lor ds in Salomon v. Salomon & Co1, in which it was held that even so if ace individual held closely all the sh atomic number 18s and debentures in a connection, and if the confronting shargons were held on dedicate for him, the association is non to be regarded as a guiltless butt of that individual.Lord MacNaughten verbalize2 The follow is at law a different person in all from the subscribers to the Memorandum and, although it whitethorn be that after incorporation the business is incisively the same as it was in advance, and the same persons argon managers, and the 1 1897 A. C. 22 2 Ibid, at p. 51 2 same hands receive the profits, the association is non in law the agent of the subscribers or the trustee for them. Nor are subscribers as members credible, in whatever shape or form, except to the finis and in the manner domiciliated by theAct3. The rule in Salomon lies at the stock ticker of corporate personality, and is the principal difference between companies and partnerships. However, on that point are situations in which the law acts look beyond that personality to the members or directors of the high society in doing so they are verbalize to abandon or pierce the corporate entomb. in that location is no single basis on which the veil whitethorn be elevate, rather the strips fall into several loose categories, which are examined below. STATUTORY EXCEPTIONS 3.There are certain statutory exceptions to the rule in Salomon which involve a director universe make nonresistant for debts of the tell because of breach of the companies or insolvency legislation. Eg (a) nonstarter to obtain a trading present 4. Where a public order fails to obtain a trading certificate in addition to its certificate of incorporation before trading, the directors will be liable to the other parties in any transactions entered into by the friendship to indemnify them against any release or damage suffered as a result of the friendships trouble to comply with its obligations.This provision Companies Act 1985, s. 117(8) has been retained in the 2006 Act. envision CA2006 s767(3). (b) Failure to use Companys public figure 5. Section 349(4) of the CA 1985 provided that if an officer of a phoner or a person performing on its behalf signs a bill of exchange, cheque or similar prick on behalf of the keep high society, in which the orders name is non mentioned4, that person will be personally liable to the holder of the instrument in forefront for the amount of it (unless it is duly 3 i. e. Companies Act 1862 4 thusly contravening s. 349 (1)(c) of CA 1985 3 aid by the fraternity). However, although CA2006 s. 84 imposes criminal penalties for failure to use the beau monde name on applicable documents, there is before long no equivalent provision in the 2006 Act imposing much(prenominal) a personal liability. (c) Disqualified Directors 6. Under s. 15 of the Company Directors Disqualification Act 1986, if a person who h as been disqualified from existence a director of, or involved in the management of a company acts in conflict of his disqualification he will be liable for all those debts of the company which were incurred when he was so acting.The same applies to a person who kat onceingly acts on the operating instructions of a disqualified person or an undischarged bankrupt. (d) Just and straightforward Winding Up 7. Under s. 122(1)(g) of the Insolvency Act 1986 a petition may be presented to wind up a company on the effort that it would be just and equitable to do so. This may involve lifting the veil of incorporation, for example to examine the basis on which the company was create5. (e) Fraudulent handicraft 8.Section 213 of the Insolvency Act 1986 deals with fraudulent trading. Under that section, if it appears to the act that any business of the company has been carried on with intent to defraud creditors of the company or of any other person, or for any fraudulent purpose, it may smart set that any persons who were k presentlyingly parties to the carrying on of the business in the manner above-mentioned are to be liable to ferment contributions (if any) to the companys assets as the court thinks proper. (f) Wrongful Trading 9.Section 214 of the Insolvency Act 1986 concerns wrongful trading, and enables the court to make a declaration, when a company has become gone into insolvent liquidation, that a former director is liable to make a contribution to the companys assets. Such a declaration can be make where the director in question knew or ought to fill concluded, 5 E. g. Ebrahimi v. Westbourne Galleries 1973 AC 360. 4 at some point before the commencement of the companys liquidation, that there was no reasonable prospect that the company would rescind going into insolvent litigation. By s. 214(7), the provisions of s. 214 also apply to hadow directors. (g) phoenix Companies 10. The Insolvency Act 1986 also allows the court to lift the corporate veil i n movements of socalled Phoenix Companies, in which a new company is created with the same or a similar name to an insolvent company. S. 216 of the Act makes it an offence for anyone who was a director of the insolvent company during the 12 months before liquidation to be associated with a company with the same name as the insolvent company or a name so similar as to refer an association6. S. 217 provides that where a person is involved in the management of a company in contravention of s. 16, or where he acts, or is willing to act, on instructions tending(p) by a person whom he knows to be in contravention of that section, he is himself jointly and severally liable with the company for all the relevant debts of that company. (h) Unfair Prejudice 11. The lawcourts powers under s. 459 of the 1985 Act (the provisions of which are duplicated in s. 994 of the 2006 Act) apply where the companys affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of its members generally or of some part of its members (including at least himself). The general proposition that the conduct of a enhance company in restrict of a subsidiary can be relevant where a s. 459 petition is presented by shareholders of a subsidiary is unsurprising7. It has also been held by the apostrophize of speak to8 that directors unfairly prejudicial conduct of a subsidiary may be actionable by shareholders of the name under s. 459 if the parent and subsidiary have directors in common. (i) Third Party Costs Orders 6 Unless that person is given leave by the court so to act s. 216 (3) 7 affect Nicholas v Soundcraft 1993 BCLC 360 Citybranch Ltd v Rackind 2004 EWCA Civ 815 5 12. The court has jurisdiction to make a cost value against a ships company to the proceedings in privilege of a non-party (including the directors or shareholders of a litigant company) by virtue of s. 51 Supreme Court Act 1981 and CPR 48. 2. This has recently been applied by the Court of collection in the character of Alan Phillips Associates Ltd v Terence Edward Dowling9. A prune was accepted by a company on headed paper almost identical to that of a business run by Mr Phillips prior to incorporation.Mr Phillips falsely issued proceedings in his own name and the company was indeed ersatzd as Claimant. The companys claim was dismissed and a third party costs order was made against Mr Phillips. 13. More typical circumstances for a third party costs order arose in Goodwood Recoveries Ltd v Breen10 which held that where a non-party director could be described as the real party desire his own benefit and controlling and/or funding the litigation, then even where he had acted in good faith or without any autonomy justice might demand that he be liable in costs. 4. Similarly in CIBC Mellon Trust Co v Stolzenberg11 when the court held that there was no reason in principle why, if a shareholder (not being a director or other person duly authorised, appoi nted and legally obliged to act in the best interests of the company) funded, controlled and directed litigation by the company in order to promote or hold dear his own financial interest, the court should not make a costs order against him. COMMON LAW AND THE MERE FACADE TEST engine of Fraud 15.It has long been completed that the Courts will not allow the Salomon principle to be used as an engine of fraud, or to vitiate pre living legal obligations. Probably the bestknown example of this rule is Gilford Motor Company Ltd v. Horne12, in which the suspect had been managing director of a the Claimant company, and had entered into a 9 2007 EWCA Civ 64 10 2005 EWCA Civ 414 11 2005 EWCA Civ 628 12 1933 Ch. 935 6 covenant not to solicit customers from his employers when he ceased to be diligent by them.On leaving the companys employment, Horne formed a company to carry on a competing business, the shares in which were held by his wife and a friend, and he thereby solicited the Claim ants customers. The Court of Appeal held that this company was a mere window dressing or fraudulence to enclothe his breach, and granted an injunction to enforce the covenant against both Horne and the company. 16. Similarly, in Jones v. Lipman13 the Defendant had entered into a contract to sell property, but then sought-after(a) to avoid the sale by transferring the property to a company which he controlled.Russell J held that specific performance could be ordered against the company, which he described as the creature of the First Defendant, a device and a sham, a block out which he holds before his face in an attempt to avoid intuition by the eye of equity14. 17. A recent example of the industriousness of the principle is Kensington International Ltd v Congo15. The Claimant had obtained various sound judgments against the Republic of Congo which it sought to enforce by way of third party debt order against bills makeable to a company called Sphynx who had sold a cargo of fossil oil.Sphynx had bought the oil from Africa Oil. Africa Oil had bought the oil from the Congolese state possess oil company (SNPC). Sphynx and Africa Oil were both controlled by the president and director general of SNPC. The court held that the various transactions and company organizes were a sham or facade and had no legal substance, and were set up with a view to defeating live claims of creditors against the Congo. SNPC and Sphynx were simply part of the Congolese state and had no existence relegate from the state.It was not necessary for there to be a divestment of assets at an depreciate to liberate the court penetrative the corporate veil in similarity to the event transactions. 13 1962 1 WLR 832 14 ibid, p. 836 15 2005 EWHC 2684 (Comm) 7 18. It should be noted that the mere detail that there is fraudulent legal action does not necessarily justify the piercing of the corporate veil. In Dadourian Group v Simms16 individuals who had fraudulently misrepresented that one of them was a mere intermediary when in item he was a co-owner and ontroller of a contracting company was liable for deceit but the veil was not lifted so the individuals were not found liable for the companys breach of contract to vitiate equipment. In this case there was no conspiracy to injure the Claimant and there had been a genuine intention that the company would buy the equipment. The now inoperative Interests of Justice Test 19. In Creasey v. Breachwood Motors Ltd17 the facts were slightly different from those of Gilford v. Horne and Jones v. Lipman.Creasey had been the manager of a garage possess by Breachwood Welwyn Ltd (Welwyn), but was dismissed from his post and mean to sue for wrongful dismissal. In anticipation of his claim, and wanting to avoid having to pay him damages, the proprietors of Welwyn formed another company, named Breachwood Motors Ltd (Motors), and transferred the entire business of the old company to it. Creasey obtained judgment in defa ult against Welwyn, which was then struck off of the register of companies. Creasey obtained an order substituting Motors as defendants, against which Motors appealed. Richard Southwell Q.C. , sitting as a judge of the powers Bench Division, held that Motors could be counterchanged as defendants, and that the veil could be lifted because Welwyns assets had been purposely transferred to Motors in full knowledge of Creaseys claim18. Richard Southwell Q. C. specifically unyielding that it was right to allow the veil to be lifted as regards Motors, rather than force Creasey to apply to have Welwyn restored to the register and apply for an order that its assets be restored to it under s. 423 of the Insolvency Act 1986 (an alternative which the judge described as a procedural minefield). 0. In Ord & Anor v. Belhaven Pubs Ltd19 the Court of Appeal has however decided that the conclusion in Creasey was wrong. In Ord the defendant company had made various 16 2006 EWHC 2973 (Ch) 17 1992 B CC 638 18 Ibid, p. 648 B 19 1998 BCC 607 8 misrepresentations to the claimant. By the time these came to light, the company had all but ceased trading, and had negligible assets. The claimant sought to substitute the defendant companys guardianship company, and the judge at offshoot instance followed Creasey and allowed the substitution.The Court of Appeal decided that this was incorrect, as the original company had not been a mere facade for the attribute company, nor vice versa. unlike the new company in Creasey, neither company had not been created as a sham to avoid some liability, there had been no particle of asset stripping and so the veil should not be lifted. Hobhouse LJ, enceinte the judgment of the court, stated There may have been elements in that case i. e. Creasey of asset stripping. I do not so read the piece of Richard Southwell QCs judgment But it planms to me to be inescapable that the case in Creasey v.Breachwood as it appears to the court cannot be sustai ned. It represents a wrong adoption of the principle of piercing the corporate veil and an issue of the power granted by the rules to substitute one party for the other following death or succession. and so in my judgment the case of Creasey v. Breachwood should no longer be hardened as authoritative. 20 The Current State of the Law 21. The courts are now increasingly reluctant to lift the veil in the absence of a sham. In position, it is clear that the veil will not be lifted simply because it would be in the interests of justice.In Adams v. Cape Industries plc21 the Court of Appeal was unambiguous on this point. Slade LJ said22 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. Salomon & Co Ltd 1897 AC 22 merely because it considers that justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the 20 Ibid, p. 616 B 1 1990 Ch 433 9 general law fall to be treat as screen entities with all the rights and liabilities which would normally attach to separate legal entities. 22. That the courts are now less willing to lift the corporate veil than was once the case is also indicated by the judgment of the House of Lords in Williams v. Natural look Health Foods Ltd23. The defendant company was effectively run by one man, a Mr Mistlin, and had given negligent advice to the claimant regarding the profitability of a franchise.On the company being wound up the claimant joined Mr Mistlin as a defendant on the basis that he had delusive personal responsibility. The House of Lords unanimously jilted the Court of Appeals determination that Mr Mistlin had assumed responsibility to the Claimant, holding that in order for a director to be personally liable for negligent advice given by the company, it had to be shown both that the director had assum ed personal responsibility for that advice and that the claimant had reasonably relied on that assumption of responsibility.As there had been no personal dealings between Mr Mistlin and the claimant, these tests were not met, and the corporate veil should remain intact24. 23. A court will also be justified in disregarding a companys personality so as to prevent the corporate form being used as a medium through which to lawfully carry out an activity which would otherwise be a wrongdoing. In Trustor AB v.Smallbone25 the defendant Smallbone had effected the fee of considerable sums of money from Trustor AB, a company of which he was managing director, to a company called Introcom, which he controlled. Sir Andrew Morritt V-C found that Introcom was simply a vehicle for receiving the money, and that the payments were made in breach of Smallbones duty to Trustor. Summary judgment was ordered against Smallbone and Introcom. 24. What then is the law following the decisions in Ord and Will iams?Neither case, of course, involved findings that the relevant company had been a facade. Ord should not be 22 Ibid p. 536. 23 1998 2 any ER 577 24 The Court of Appeal has held that the principles identified by the House of Lords in Williams are equally applicable to torts other than negligence, although this decision has been criticised see Standard Chartered Bank v. Pakistan National Shipping Corp. (No 2) 2000 1 Lloyds Rep 218 25 2001 1 WLR 1177 10 thought to prevent the veil being lifted in cases where there is a sham or facade.Subsequent authorities, as well as the House of Lords decisions prior to Ord26, show that the law is soothe that the courts will be willing to lift the veil in cases where there is a sham and that principle is still at the stub of the test to be applied. AGENCY AND GROUPS 25. Although Salomon made it clear that a company is not automatically the agent of its shareholders, in exceptional cases such a relationship can exist, and it will be a question o f fact whether there is a relationship of agency in any particular case, so that it is appropriate to pierce the veil.Questions of agency most often swipe in the context of associated or group companies, and so the two areas are here considered together. Statute 26. Companies Act 1985 ss. 227-231 (and CA 2006 s. 399 et seq) provide that groups of companies must attain group accounts, which must comprise consolidated balance sheets and profit and privation accounts for the parent company and its subsidiary undertakings.The aim of the accounts is to give a uncoiled and fair picture of the state of the undertakings included in the consolidation as a whole, which are treated for the purposes of the accounts as an frugal unit. The process course requires that the corporate veil be lifted in order to depict which companies form the group. The courts are also sometimes willing to treat a group of companies as a unit for other purposes, and have tended to justify the decision to pierc e the veil by analogy with the legislation, or by finding that one group company was the agent of another.Case Law 27. The learning of the courts attitude to agency in a company context has tended not to produce clear rules, perhaps until recently, and so the historical case law is summarised below. The principles leading to a finding of agency were considered by Atkinson J in 26 E. g. Woolfson v. Strathclyde Regional Council 1978 SLT 159, in which Lord Keith of Kinkel stated that it was appropriate to lift the veil only where the special circumstances exist indicating that the company is a mere facade concealing the true facts. 1 Smith, Stone & Knight Ltd v. Birmingham Corporation27, in the context of whether a subsidiary company was the agent of its holding company. That was a case where agency was established and the veil lifted the parent company had full and exclusive access to the subsidiarys books, the subsidiary had no employees other than a manager, it occupied the parent s premises for no consideration and the only evidence of its purportedly independent existence was its name on the stationery.Atkinson J said that the question of whether a company was carrying on its own business or its parents was a question of fact, and identified six questions which he considered determinative (i) Were the profits of the subsidiary those of the parent company? (ii) Were the persons conducting the business of the subsidiary appointed by the parent company? (iii) Was the parent company the head and brains of the venture? (iv) Did the parent company curb the venture? v) Were the profits made by the subsidiary company made by the skill and direction of the parent company? (vi) Was the parent company in effective and constant control of the subsidiary? These questions, while still relevant, can no longer be viewed as a everlasting(a) statement of the law. As will be discussed below, the trend of the authorities has been away from findings of agency unless particul ar circumstances dictate that such a finding should be made. 28. It is relevant to consider the purpose for which the relevant company organise was created. In Re F. G. Films) Ltd28 an American holding company set up a British subsidiary to produce a film, in order that it might be classified as a British film. The age of Trade refused to register it as such, and the matter came to court. It was held that the British companys participation in the making of the film was so small as to be practically negligible, and that it had been brought into existence for the sole purpose of being enjoin forward as having made the film, and for thus enabling it to qualify as a British film, and that therefore there was a relationship of agency. 2 29. In Littlewoods Mail Order Stores Ltd v. McGregor29 Lord Denning warned that the Salomon doctrine had to be cautiously watched, and said that Parliament had shown the way as regards the scrutiny of groups of companies, and that the courts should fol low suit. 30. An influential case in this area was DHN Food Distributors Ltd v. Tower Hamlets London Borough Council30, which touch on compulsory purchase one company in the group owned the freehold of premises, from which another group company interchanged and which it occupied as bare licensee.The Court of Appeal stressed the significance of the existence of a single economic unit and recognised the group as a single entity, allowing it to recover compensation, but the exact reasons behind the decision are unclear, as the members of the court were each apparently influenced by different factors. Lord Denning MR noted that the subsidiaries were totally owned, Shaw LJ pointed out that the companies had common directors, shareholdings and interests, and Goff LJ referred to ownership and the fact that the companies had no business trading operations outside the group.Goff LJ also stated that not all groups would be treated in this way, and there have been cases since DHN Food Dist ributors in which wholly owned subsidiaries have not been identified as a unit with their holding companies31. 31. To further confuse the position, DHN Food Distributors was not followed by the House of Lords in the Scottish appeal of Woolfson v. Strathclyde Regional Council32, and also runs counter to many decisions of courts in Australia and New Zealand. In Industrial Equity Ltd v.Blackburn33 the High Court of Australia said that the group accounts legislation did not operate to deny the separate legal personality of the company. In Re Securitibank Ltd (No. 2)34 the New Zealand Court of Appeal considered the decision in Littlewoods Mail Order Stores and thought that the approach in that case was the wrong way around the court considered that the Salomon principal should be the outset point 13 for any examination of a group of companies, and any departure from it should be considered carefully.In the New South Wales case of Pioneer cover Services v. Yelnah Pty Ltd35 Young J consid ered the authorities and held that the veil should only be lifted where there was in law or in fact a partnership between the companies, or where there was a sham or facade36. 32. The English position was again considered by the Court of Appeal in Adams v. Cape Industries plc37, in which the Claimants with default judgments obtained in Texas against a company sought to enforce those judgments against an its ultimate holding company in the joined Kingdom.The Court of Appeal held that although a parent company exercised supervision and control over its subsidiary in a foreign country, the parent company was not present in that country, and did not submit to that jurisdiction, by a subsidiary which did business in its own right. In the passage quoted above, Slade LJ stated that the Salomon principle will not be disregarded simply because justice so requires, and that subsidiary companies should be considered as individuals unless special circumstances situated otherwise.Members of a c orporate group were perfectly entitled to use the corporate structure even if the consequence was that only lowly capitalised subsidiaries were exposed to potentially harmful asbestos claims. 33. It is suggested, therefore, that the present position is that the courts are likely to be indisposed to lift the veil as against groups of companies in the absence of some proportionateness of agency, and that Littlewoods Mail Order Stores and DHN Food Distributors cannot any longer be considered authoritative. CONCLUSIONS sure Ultimate Purpose- An alternative test? 4. Some shams or facades may be obvious, but many others will not. The courts are reluctant to provide precise guidelines so as to define what constitutes a sham preferring the tractability of a case by case approach. Useful tests to be employed when trying to identify a sham are * Are the relevant entities in common ownership? * Are the relevant entities in common control? * Was the company structure was put in place before or after a particular liability (or serious risk) arose, and if the latter(prenominal) then to what extent was he liability or risk a motivating factor for those who set up the structure? * Was the company structure put in place in an attempt to allow an activity which would be unlawful if carried out personally? 35. It has been suggested by some commentators38 that a genuine ultimate purpose test should replace the traditional established sham or facade test. However, this novel approach may visualise up as many problems as the traditional test.Further, it seems to strike at the heart of the concept of the limited liability company since a patriarchal (and often sole) purpose of incorporation is to reduce personal exposure to trade creditors, a motive that has been held to be acceptable since the concept of the limited company first became part of the legislative framework. Parliament, when passing the Companies Act 2006, had ample opportunity to conduct a wholesale revision of this principle but deliberately left the topic well alone. There currently appears to be half-size judicial enthusiasm for such revision either. DOV OHRENSTEIN RADCLIFFE CHAMBERS LINCOLNS INN