Piercing the Corporate Veil - Essay Example

?Piercing the Corporate Veil A company is vested with limited liability upon incorporation. This is also known as the principle of corporate veil. This stratagem protects the interests of investors in such companies. A major benefit provided by it relates to the making available of capital for major industrial developments. In the absence of such protection, investors are at risk of being subjected to unlimited personal liability(Muchlinski, 2010, p. 917). The provision of limited liability to incorporated companies enhanced investments from a large number of small and large investors. It would not be far from the truth to assert that the growth of the modern economy and industrial development can be attributed to this principle of limited liability. Investors are no longer required to harbour apprehensions regarding their investments and from being held accountable for the liabilities of the company in which they had invested (Muchlinski, 2010, p. 917). It has been contended by the majority that the proper functioning and growth of stock markets has been effected by limited liability. Moreover, it has simplified the task of evaluating the assets of companies. Furthermore, limited liability has excised the uncertainties, risks, and liabilities experienced by investors in the past. Shareholders can monitor the behaviour of their company to a much greater extent than in the past. Modern economic development requires large – scale capital inflow (Muchlinski, 2010, p. 917). The limited liability effectively ensures the availability of capital from investors. The House of Lords established the doctrine of corporate personality in Salomon v Salomon. Under this principle, private investors and shareholders of companies were permitted to organise their business, via the corporate legal form. It also allowed entrepreneurs and institutional investors to monitor their investment strategies. In the absence of the legal form of the company, shareholders and investors were at the risk of being personally held liable to the creditors of the company (Muchlinski, 2010, p. 918). It has been perceived that this doctrine has increased the influence of shareholders and investors in the functioning of the company and in its business strategies. However, the majority of the people have welcomed the doctrine of limited liability, as it eliminates the direct responsibility of shareholders in the management of the company (Muchlinski, 2010, p. 918). The process of globalisation has substantially increased business activity and the operations of multinational corporations (MNC) at the global level. The separation of legal form of the company from its shareholders and investors has brought about several jurisdictional problems and the domination of MNCs in business (Muchlinski, 2010, p. 920). These problems have come to the fore due to different legal systems in the world. In addition, the state regulatory mechanisms that pertain to the MNCs differ from each other. The limited liability concept externalises the risk from group of investors. Ultimately, it transforms global legal order into national and sub-national jurisdictions. Thus, the corporate veil has assumed the garb of a jurisdictional veil, and the MNCs are using this veil to limit risk of liability (Muchlinski, 2010, p. 920). Moreover, Jurisdiction has emerged as an important aspect of international commercial transactions. The MNCs have established a parent – subsidiary culture in international business, which creates ambiguity in determining the appropriate jurisdiction for disputes. The difficulty chiefly arises because the jurisdiction of the parent company and that of its subsidiary are different. Consequently, disputes with a subsidiary cannot be addressed by the legal system of the parent company’s host country, in order to determine liability (Muchlinski, 2010, p. 920). InAdams v Cape Industries, a UK based parent company exported asbestos from its mines in South Africa. It had conducted this export via a sales subsidiary and thereafter through an independent sales agent. These exports were sent to its customers in the USA. In this case, the plaintiffs who were employees of the US customers brought an action against Cape Industries (Muchlinski, 2010, p. 920). This action related to the illness suffered by them due to exposure to asbestos. The court in Texas held Cape liable. However, Cape ignored these developments as it did not have any assets in the US. Subsequently, the plaintiffs approached the English courts, so as to enforce the judgment of the Texas court (Muchlinski, 2010, p. 920). The defendant Cape Industries argued that since it had no existence in the US, the jurisdiction of the Texas had been incorrectly asserted. The Court of Appeal in the UK accepted the contention of Cape Industries and rejected the claims made by the plaintiffs. It also refused to consider Cape Industries’ sales agent and sales subsidiary in the US, as an integral part of Cape Industries. The Court was of the opinion that it could not pierce the corporate veil, merely on the grounds that the Cape Industries had employed the corporate structure to evade liability for the harm caused to the plaintiffs by exposure to asbestos(Muchlinski, 2010, p. 921). The principle of separate corporate personality and limited liability plays an important role in English company law. This principle was firmly established by the House of Lords’ decision in Salomon v Salomon. This principle had been developed prior to the decision in Salomon v Salomon. The British Parliament granted limited liability to all English companies upon their incorporation, by means of the Limited Liability Act of 1855. The House of Lords fortified this in its judgment in the Salomon case (Cheng, 2011, p. 335). The provision of limited liability to companies through the Act has faced substantial resistance and criticism from the beginning. In Salomon, the Court of Appeal had unanimously imposed personal liability on Salomon for the debts of his company. The House of Lords set aside this ruling and clearly established that companies have a separate legal personality. However, the Law Lords failed to clarify the scope and application of this principle (Cheng, 2011, p. 335). Subsequently, English courts commenced to pierce the corporate veil. The courts not only pierce the veil of single – shareholder companies, but also with regard to large companies. Some of the notable instances of such veil piercing include, Apthorpe v Peter Schoenhofen Brewing, St Louis Breweries v Apthorpe, Gilford Motor v Horne andRainham Chemical Works, Ltd v Belvedere Fish Guano Co(Cheng, 2011, p. 336). The doctrine of corporate veil gained popularity after the Second World War. There were several instances, in which the courts acknowledged the separate legal personality of limited companies and the existence of the corporate veil. Nevertheless, there were some notable cases, wherein the courts lifted the corporate veil. These included ReFG (Films), Jones v Lipman, Firestone Tyre and Rubber v Lewellin, and Merchandise Transport v British Transport Commission. The chief proponent of piercing the corporate veil was Lord Denning, who spared no effort in exposing the persona lying in concealment behind the safety of the corporate veil. This redoubtable legal luminary and jurist par excellence ceaselessly warned against blind adherence to the doctrine established in Salomon (Cheng, 2011, p. 338). Moreover, reliance on the doctrine of agency caused the court to pierce the corporate veil in Firestone Tyre and Rubber Co Ltd v Lewellin. The defendant who manufactured tyres for the parent plaintiff company was deemed by the court to be the agent of the plaintiff company. Similarly, the court pierced the corporate veil in Re FG (Films) Ltd and determined the existence of an agency. The court also held that the film was an American film. With this decision, the court found the occurrence of fraud in the subsidiary company, by lifting the corporate veil. It is commonplace for businesses to circumvent liability by incorporating themselves as limited liability entities. The courts have been seized with this inequitable behaviour and have pierced the corporate veil in several instances. Such intervention by the courts has the effect of rendering the true controllers of a company liable. As such, courts pierce the corporate veil; while interpreting a statute, contract or other document; whenever the company proves to be a mare facade that fails to disclose the facts; and when it is possible to establish that the company is an authorised agent of its members or controllers(Mantysaari , 2005, p. 237). Companies were provided with a legal existence that was independent of their shareholders, by the Limited Liability Act. This was established by the decision in Salomon v Salomon. The creation of such separate legal entity enables individuals to engage in trading without bearing the risk of personal insolvency if the business were to fail. As such, the distinct character of a corporation from that of its members was recognised with the decision in Foss v Harbottle. This decision renders the company itself as the proper claimant with regard to a wrong done to the company (Judge, 2008, p. 13). This implies the independent legal nature of a company. As such, with the decision in Salomon v Salomon, private companies gained recognition. As regards a group of companies, the rule in Salomon, established that the individual companies in the group were distinct legal entities. Consequently, the insolvency of a company in the group did not attach liability to any of the other companies in that group. This important outcome was brought to the fore in the ruling in Re Southard Ltd(Judge, 2008, p. 13). The presiding judge opined that several subsidiary companies could be brought into being by a parent company. Such companies would under the direct or indirect control of the shareholders of the parent company. Consequently, if one of these companies were to decline into insolvency, then the other subsidiary companies and the parent company would not be made liable for the debts of the insolvent subsidiary(Judge, 2008, p. 13). Nevertheless, the courts do not hesitate to pierce the corporate veil, under certain circumstances. This was illustrated by the decision in Re Darby ex p Brougham. In this case the veil was pierce by the High Court and the fraudsters who had formed the company as an alias for themselves were exposed(Judge, 2008, p. 13). Furthermore, in Diamler Co Ltd V Continental Tyre and Rubber Co (Great Britain) Ltd, the corporate veil was pierced, in order to establish the nationality of a company registered in the UK. Moreover, in DHN Food Distributors Ltd v Tower Hamlets London Borough Council, the Court of Appeal considered the three companies in a group as a single entity(Judge, 2008, p. 13). In Adams v Cape Industries the Court of Appeal rejected the claim that the subsidiary of the respondent had been constituted with the express objective of evading liability. Whilst doing so, the court opined that a group of companies would be deemed to be a single economic unit only under certain circumstances. This exception related to the interpretation of contracts, statutes and other documents(Judge, 2008, p. 14). Another reason cited by the claimants for the court to pierce the corporate veil related to their claim that the subsidiary had acted as the authorised agent of the parent company. This was rejected by the Court of Appeal, which ruled that agency could not be presumed, solely due to the proximity of operations. This was affirmed in Yukong Line Ltd of Korea v Rendsburg Investments Corpn of Liberia (No 2)(Judge, 2008, p. 14). In addition, some of the statutory provisions for piercing the corporate veil are to be found in the Insolvency Act 1986. For instance, section 213 of this Act makes it an offence to conduct fraudulent trading. As a consequence, individuals who had acted in a manner that was aimed at defrauding the creditors of the company, have to contribute to the assets of the company at the time of its dissolution. The quantum of such contribution is to be decided by the court(Judge, 2008, p. 15). Similarly, a director of a company who persists in trading despite being aware that the company is to be subjected to insolvent liquidation, can be ordered by the court, under section 214 of the Insolvency Act 1986 to contribute to the assets of that company. The company directors are duty bound towards the company and its creditors, at the time of insolvency or when the company is on the verge of insolvency(Judge, 2008, p. 15). This duty requires them to prevent the dissipation or exploitation of the company’s property, in a manner that benefits the company’s directors to the detriment of its creditors. This was clearly held in Winkworth v Edward Baron Development Co Ltd.If trading continues under these circumstances, constitutes breach of duty of care(Judge, 2008, p. 15). As such, the concept of corporate veil plays an important role in company law. Moreover, the courts attach great significance to the principle established via the ruling in the Salomon case, which has now come to be known as the Salomon principle. The courts in the UK apply this principle to the cases dealing with the corporate veil, which are referred to them for hearing. The unprecedented emergence of corporate groups has shown a marked increase in the employment of this principle by the courts (Prentice , 1996, p. 483). Under this concept, a company will have a separate legal personality and it can enjoy benefits, such as the transfer of risk from the parent company to one of its subsidiaries. The English case law demonstrates the stance of its courts on the use of the corporate personality by companies. For instance, in re Baglan Hall Colliery Ltd, the court had recognised this corporate personality and allowed the owners of the company to register the latter as a limited liability company. The intention of these owners was to avoid liability. The Court of Appeal held that the owners could convert their colliery into a limited liability company. It held that the provisions of the Companies Act could be invoked for such change, in order to evade liability (Re Baglan Hall Colliery Co, 1870). In Jones v Lipman, there was a contract between the defendant and the plaintiff with regard to the sale of a house of the defendant. However, the defendant had transferred the house to his company. The plaintiffbrought legal action against Lipman. It was held by the court that the defendant had used the company as a facade, in order to evade the sale of his house (Jones v Lipman , 1962). Accordingly, the court ordered specific performance of the contract. In Giford Motor Co Ltd v Horne, the defendant an employee of the plaintiff company, was under a restrictive covenant that required him to abstain from soliciting the customers of the company, subsequent to the discontinuance of employment with the plaintiff company. Horne disregarded this obligation and violated the covenant, subsequent to tendering his resignation to the plaintiff company. Horne formed a company and commenced to solicit the customers of his erstwhile employer Giford Motors. He attempted to defend his actions by resorting to the corporate veil provided by his company. It was held by the court that the corporate veil had been utilised as a mask by Horne (Giford Motor Co Ltd v Horne , 1933). Moreover, in Trustor AB v Smallbone, a director of the company had transferred money from the company to his account and another account. This company was under his control and he utilised these transferred amounts for his personal requirements. In this case, the court pierced the corporate veil, with a view to rendering justice (Trustor AB v Smallbone , 2001). Furthermore, in Kensington International Ltd, the court lifted the corporate veil. This case established that the corporate veil could be pierced on various grounds. Thus, fraudulent activity is not the sole criterion for the courts to pierce the corporate veil of a company (Kensington International Ltd v Congo , 2005). In Gencor v Dalby, the court lifted the corporate veil of the company and held that the defendant had created the company to avoid liability. The court also held that the company was nothing other than the alter ego of the defendant (Gencor v Dalby , 2000). The lifting of corporate veil is not confined to companies. In several agency cases, the courts have lifted the corporate veil to expose fraudsters (Re: F.G. Films Ltd , 1953). Moreover, in DHN Food Distributors the court pierced the corporate veil of a group of companies. This was done, in order to expose a specific company in that group(DHN Food Distributors Ltd v Tower Hamlets London Borough Council, 1976). Finally, the court ruled in Briggs v James Hardie& Co Pty Ltd, that the principle established in Salomon lacked commercial reality (Briggs v James Hardie & Co Pty Ltd , 1989). It also held that this principle failed the test of practical applicability to commercial disputes. Under the concept of corporate veil, a limited company obtains an independent legal personality that protects its investors and shareholders. However, in some cases, the courts have not baulked at piercing the corporate veil, in order to expose the mala fide transactions of the company. As such, the courts are empowered to pierce the corporate veil, if corporate fraud has been perpetrated by its directors or managers. List of References Adams v Cape Industries plc (1990) Ch 433. Apthorpe v Peter Schoenhofen Brewing (1899) 15 TFR 245. Briggs v James Hardie & Co Pty Ltd (1989) 16 NSWLR 549. Cheng, T. K., 2011. The Corporate Veil Doctrine Revisited: A Comparative Study of the English and the US Corporate Veil Doctrines. Boston College International and Comparative Law Review, 34(2), p. 329 – 412. Daimler Co Ltd v Continental Tyre and Rubber Co (Great Britain) Ltd (1916) 2 AC 307 . DHN Food Distributors Ltd v Tower Hamlets London Borough Council (1976) 1 WLR 852. Firestone Tyre and Rubber Co Ltd v Lewellin (1957) 1 WLR 352. Foss v Harbottle (1843) 67 ER 189. Gencor v Dalby (2000) 2 BCLC 734. Gilford Motors Co Ltd v Horne (1933) 1 Ch D 935. Insolvency Act c. 45. 1986.Crown copyright. Jones v Lipman (1962) 1 WLR 832. Judge, S., 2008. Q & A: Company Law 2008 and 2009. Oxford University Press. Kensington International Ltd v Congo (2005) EWHC 2684. Limited Liability Act 1855 (18 & 19 Vict c 133).Crown Copyright. Mantysaari , P., 2005. Comparative corporate governance: shareholders as a rule-maker. Springer. Merchandise Transport v British Transport Commission (1962) 2 QB at 173. Muchlinski, P., 2010. Limited Liability and Multinational Enterprises: A Case for Reform?. Cambridge Journal of Economics, 34(5), p. 915 – 928. Prentice , D. D., 1996. Veil Piercing and Successor Liability in the United Kingdom. Florida Journal of International Law, Volume 10, p. 469 – 485. Rainham Chemical Works, Ltd v Belvedere Fish Guano Co (1921) 2 AC 465. Re Baglan Hall Colliery Co (1870) 5 Ch App 346. Re Darby ex. p. Brougham (1911). Re FG (Films) Ltd (1953) 1 WLR 483. Re Southard Ltd (1979) 1 WLR 1198. Salomon v Salomon & Co Ltd (1897) AC 22. St. Louis Breweries v Apthorpe (1898) 15 TLR 112. Trustor AB v Smallbone (2001) 2 BCLC 436 Chancery Division. Winkworth v Edward Baron Development Co Ltd (1987) 1 All ER 114. Yukong Line Ltd of Korea v Rendsburg Investments Corpn of Liberia (No 2) (1998) 1 WLR 294. Read More