Lifting the Veil of Incorporation - Case Study Example

"Lifting the Veil of Incorporation" The doctrine of separate personality of a corporation engendered by the sheer act of incorporation is a well entrenched principle in English law. The doctrine simply states that once a company is formally incorporated in accordance with law, it starts to possess a personality of its own, one distinct from its members and stockholders. This distinct personality, by fiction of law, protects a corporation from the consequences of the individual acts of its members and stockholders. The principle had its beginnings in the Roman law and was officially adopted by English law in the early case of Salmon v The Hamborough Co (1671) 1 Ch Cas 2041. Unfortunately, this principle had been, time and again, employed as a vehicle to evade individual liabilities and responsibilities that the courts were compelled to 'lift the veil,' so to speak, that separates corporations from their stockholders. Recent developments in the corporate world, however, had made it difficult to anticipate when judicial interference will be exercised to lift or pierce the veil of incorporation as courts have exhibited equivocations in handling 'lifting-the-veil" cases in the past. The case of Adams, however, seemed to have narrowed down the principles when judicial interference may be exercised in such cases. The Case of Salomon v Salomon In the early days before the advent of complex corporate structures, there was not much question about the application of the corporate separate personality or the "lifting of the" veil cases. The courts were adamant in subscribing to the separate personality doctrine as held in the landmark case of Salomon v Salomon & Co Ltd [1897] AC 22, which upheld the sanctity of the doctrine. The Salomon case is the classic separate corporate personality upon which the courts looked to for guidance in deciding corporation cases even to this day. It involved a prosperous boot-making business owned by Salomon Sr. which later incorporated it to Salomon Ltd. to accommodate members of his family who wanted to be in the business. His wife and five children took one share each whilst he held on to 20,001 shares. For the sale of the boot and leather-making business, Salomon was paid '39,000, '20,000 in cash, '10,000 in debentures and the rest as payment for debts. The economy soon turned bad which affected Salomon Ltd's business, forcing it to seek loans from outside creditors among which was a Mr. Broderip. The company, however, failed to revive itself and paying the loans became difficult. Broderip sued to obtain payment for his secured loan and the company went into liquidation. 2 The liquidator, subsequently handling the company's winding up, argued that the corporation was a fraud and that therefore Salomon's debentures should be made to apply as payments to the company's creditors. The decision was debunked by the House of Lords which sustained the separate nature of the company's personality from that of Mr. Salomon. The HL held that, on its face, the incorporation was valid and in accordance with the formalities of law and therefore the court is precluded from reading meaning or inserting their own version of the law into its incorporation. There was nothing unlawful about Salomon holding ownership of more than half of the company's shares or of the fact that the subscribers or incorporators were all members of his family to which he wielded great influence upon. 3 Judicial Interference Although the Salomon principle had since been held the classic view, court decisions have swung from one side to another that it became difficult to anticipate whether they would adhere to the Salomon principle or not in every case. The basic presumption is that the court will lift the veil of incorporation in instances when "equity demands that justice be dispensed." Yet, court decisions have shown that there was no clear-cut rule as to what constitutes injustice that would merit court intervention and disregarding the principle held in the Salomon case. 4 This equivocation is illustrated in the case of Adams v Cape Industries plc [1990] Ch 433 and Woolfson v Strathclyde RC [1978] SLT 159 which contradicted the cases of Gilford Motor Company Ltd. v Horne [1933] Ch 935, Jones v Lipman [1962] 1WLR 832 and DHN Food Distributors Ltd v Tower Hamlets LBC [1976] 1 WLR 852. In the case, for example, of Gilford, the court declared a company a mere front for respondent Horne so he could engage in activities, which he was proscribed from doing as an individual. Horne was an employee of Gilford Motor Company and at the time he joined it, he signed a contract which explicitly prohibited him from engaging, ever, in a business that would involve solicitation from Gilford's clients. To get around this trade covenant, Horne had his wife set up a company called J.M. Horne & Co Ltd, which solicited from Gilford's clients. The Court of Appeal declared the company a sham created simply to make Horne circumvent the prohibition in the contract. Lord Hanworth said: "'this company was formed as a device, a stratagem, in order to mask the effective carrying on of a business of Mr. E B Horne. The purpose of it was to try to enable him to, under what is a cloak or sham, to engage in business which ['] was a business in respect of which he had a fear that the plaintiffs might intervene or object." 5 In Jones, the court likewise declared a company a "sham" created only to protect the defendant from performing an obligation he willingly entered into in the first place. In this case, the defendant agreed with another to sell his house. Before the transaction could be completed, the defendant created a company of which he was the shareholder, with another person, and the director and sold the property to. The court referred to the incorporated company as "' the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity." 6 The court "lifted the veil" of incorporation and ordered specific performance against the defendant. The courts have also "lifted the veil' of separate corporate entity in cases of group companies, all of which are separately incorporated in accordance with law. Such is the case of DH. This case involves three companies: the DHN Food Distributors Ltd., the parent company; the Bronze Investment Ltd., a subsidiary company which owned the land under which the DHN business was conducted, and; the DNH Transport Ltd., which owned the vehicles used in the conduct of the DHN business. DHN is an East End firm involved in the groceries-and-provisions and cash-and-carry businesses. It owned all shares in all three companies and directorship was common in all three. When the local council expropriated the land, the DHN sustained losses as all three were tied up in the same business. The Land Compensation Act of 1961 obliged the government to pay losses as a consequence to expropriation but in the present case, it refused to award the same to DNH as it was not the legal owner of the land but Bronze Investment Ltd., which was only entitled to an award of loss of land but not loss of business. Clearly, compensation for loss of business can only be granted if the three companies were declared a single unit, which is likely only if the court "lifted the veil" of incorporation. Fortunately for DNH, the court did just that when it declared that not to do so would constitute a deprivation, on a mere technicality, of the companies of what was justly theirs.7 In the above-cited cases, the courts illustrated that they were willing to depart from the principle of separation of corporate personality held in the Salomon case when justice and equity demand. The courts exercised their prerogative to look beyond legal formalities to weigh the basis of the formation of the corporations something which the HL refused to do in the case of Salomon. There are cases, however, which clearly contradicted the above-cited cases such as Woolfson v Strathclyde RC 8 and Adams v Cape Industries plc.9 The Woolfson case also involved governmental expropriation but was entirely contradictory to the earlier case of DHN as the HL here reiterated that the veil of separate personality should not be lifted unless there was a finding that it was just merely used as a fa'ade by another. It also involved three entities, one of which is a real person and the other juridical entities. All three occupied one floor area and were engaged in the business of bridal clothing retail when the government expropriated the building. It turned out that one single person and his wife was behind all the two companies, which was obviously set-up for their convenience. When the case went up to the HL, it refused, unlike in the DHN case, to lift the veil of incorporation. 10 The Adams case is very significant case in corporation law because it is deemed to have narrowed down the instances of judicial interference in the legal fiction of separate corporate personality. It also involved a group of companies: Cape Industries plc, an English company engaged in mining and marketing asbestos; Capasco, an English company, which is Cape's worldwide marketing subsidiary, and; NAAC, Cape's marketing subsidiary incorporated in the US. In 1978, the three companies were sued in the US due to personal injuries sustained from asbestos installed in a factory. Cape agreed to settle (although it demurred to the legality of the US jurisdiction over it) and subsequently, sold all its assets in the US. One plaintiff, Adams, sought the reinforcement of the US judgment in England. The Court of Appeal ruled against Adam's claim on the ground that there was no basis or reason for the Court to lift the veil of separate corporate personality and regard the three companies as a single entity because there was no showing that Cape used the other two as a mere fa'ade to conceal its real activities nor were the two other companies acting as mere agents of Cape as they were independent companies free from its control and supervision. 11 Conclusion Since the Salomon case, the courts have been vacillating in exercising their prerogative to "lift the veil" of incorporation to dispense justice. Although the courts have not set aside the holding in the Salomon case, they had, nevertheless, established various doctrines through several decisions which allowed them to set aside the sanctity of the separate corporate personality. But even the courts, however, seemed to be divided as when justice, if justice is indeed the underpinning factor of judicial intervention, should be dispensed or how much of it is to be dispensed. Thus, cases seemed to be contradicting each other. Whilst the Gilford, Lipman and DHN cases showed that the courts would interfere when they believed the corporate doctrine is being used to conceal the true nature of a corporation's activities, cases like Woolfson and Adams surprisingly showed that they are willing to turn their backs even when justice is clearly denied. Happily, however, the court seemed to have made a clear and decisive holding in the Adams case that hopefully settle the issue as to when judicial interference in cases like it could be had. References Adams v Cape Industries plc [1990] Ch 433. DHN Food Distributors Ltd v Tower Hamlets LBC [1976] 1 WLR 852. Gilford Motor Company Ltd. v Horne [1933] Ch 935. Hicks, A & Goo, S H 2008, Cases and Materials on Company Law, Oxford University Press, 115. Kelly, D & Holmes, A & Hayward, R 2005, Business Law, Routledge Cavendish, 310. Salomon v Salomon & Co Ltd [1897] AC 22 (Kelly et al 310). Smith, D 1999, Company Law, Gulf Professional Publishing, 27. Woolfson v Strathclyde RC [1978] SLT 159. Read More