Business Organisations and the Law - Essay Example

Business Organisations and the Law According to the work question, it is to be assessed whether the parent company is liable for its subsidiaries’ negligence in case of in – group companies. This requires discussion of the following issues. An important feature of corporate law is the concept of piercing the corporate veil. Among the capitalist economies, a major corporate entity is the limited liability corporation. A cardinal feature of this entity is that the liability of its shareholders is restricted to the extent of their investment in it.1 However, on occasion, the courts have regarded the debts of the corporation to be that of its shareholders, thereby piercing the corporate veil.2 The separate legal existence of a company was established by the court in the Salomon case. 3 As such, in Salomon v Salomon, 4 their Lordships created the rule that a company constitutes a separate legal entity that is distinct from its members. 5 This provided the direction to contemporary company law and the character of private limited companies. 6 European statutory provisions have incorporated this significant maxim. The objective behind providing for a separate legal persona and limited liability is to promote investment, foster trade and to furnish entrepreneurs with an incentive to commence new business. 7 In addition, in Adams v Cape Industries plc,8 a complete review of the Salomon ruling was achieved by the Court of Appeal. This case considered liability inside a group of companies. The claimant, moved the court to render the parent company liable for the obligations of the subsidiary company. The Court of Appeal lifted the corporate veil on the basis of the following considerations; namely, façade, agency and single economic unit. 9 In its judgment, the Court of Appeal declared that the corporate veil could be pierced if there was an express agency agreement between the subsidiary company and the parent company. The presumption of an agency relationship, strictly relied upon the presence of such an agreement. 10 The Court, also held that the veil could not be pierced, merely because the defendant company was a member of a group of companies and the corporate framework had been adopted to avert the liability of the defendant company. 11 GHI Ltd was working as a subsidiary of its parent company ABC Ltd. As such, GHI Ltd can be deemed an agent of its parent company ABC Ltd. Furthermore, in DHN Food Distributors Ltd v Tower Hamlets London Borough Council,12 Lord Denning of the Court of Appeal held that the group of companies, in question, were a single economic entity. Consequently, Lord Denning ordered compensation to be paid for the compulsory purchase of land. The importance of this decision lies in the fact that it constitutes a precursor to the proposition that the courts can ignore the Salomon principle, if doing so serves the ends of justice and equity. 13 ABC Ltd started a new subsidiary, as soon as the previous subsidiary, GHI Ltd underwent the process of liquidation. This action clearly indicates the malafide intention of ABC Ltd, to defraud the claimants and creditors of GHI Ltd. The majority of the issues relating to company law are governed by the Companies Act 2006.14 This Act comprises of 1300 sections and tends to be considerably elaborate. However, this Act has failed to make any provision with regard to the piercing of the corporate veil. The Companies Act 2006 does not render the shareholders personally liable. On the other hand, it expands the ambit of the rules that make directors and other officers of a company liable for their wrongful deeds. 15 While assessing the liability of ABC Ltd, with respect to the losses made by GHI, the relevant provisions of the Insolvency Act and Company Directors Disqualification Act have to be considered. The Insolvency Act 1986 and the Company Directors Disqualification Act 1986,16 impose liability upon the directors and other officials of a company, in which there had been fraudulent or wrongful trading or breach of a disqualification order. Contemporary company law in the UK, in the context of its application to companies, depicts a substantially deficient condition. 17 As such, the principle of piercing the corporate veil does not possess any statutory basis. At the same time, this doctrine cannot be evaluated on the basis of an established principle. The various related statutes have depicted scant regard for piercing the corporate veil and attaching the assets of the shareholders. Their remit is restricted to rendering directors and company officials liable. 18 Moreover, the UK Parliament has frequently enacted exceptions to the Salomon principle19. Such initiatives have been aimed at protecting creditors. Hence, the courts have to acknowledge that in the absence of legislation to the contrary, they should not interfere with the principle of separate legal entity.20 One such parliamentary initiative is provided by Section 213 of the Insolvency Act 1986.21 It secures the interests of creditors, whenever the company has functioned with the express intent of defrauding them. In such instances, the courts, during the winding up process have been empowered to pierce the corporate veil. 22 Consequently, it would not be incorrect to surmise that the courts will in all probability desist from piercing the corporate veil, with the intention of imposing liability upon a shareholder of a company for the debts of the latter. However, in exceptional cases, the courts will consider the substance and ignore the structure, thereby depriving a corporate entity of the benefits attendant upon such a status.23 Such rulings are dependent upon the presiding judge’s perception regarding fairness or policy. However, in Woolfson v Strathclyde Regional Council,24 the Law Lords referred to the Appellate Court’s decision in DHN Food Distributors Ltd v Tower Hamlets London Borough Council and expressed misgivings regarding the proper application of the principle that the corporate veil was to be pierced, only when there were circumstances signifying the presence of a façade that was obscuring the reality. 25 ABC Ltd adopted such tactics to deceive the claimants and creditors. Lord Keith, in Woolfson v Strathclyde Regional Council, noted that the corporate veil was to be pierced, only when special circumstances were in existence, which indicated that separate legal entity artifice was being employed as a mere façade to camouflage the truth. 26 Whenever the evidence disclosed that a company had been utilized as a means for receiving monies that had been wrongly paid out of a claimant company, in breach of the defendant’s duty towards the claimant company, it would be construed that the defendant had received the monies. 27 Nevertheless, the ruling in Trustor AB v Smallbone served to clarify that the courts would be intolerant of any further decline of the fundamental English Company Law principle.28 This principle required a company to be considered as a separate legal entity that was dissimilar to its members. Thus, English Company Law is devoid of any general power to pierce the corporate veil in the interests of justice.29 In this case, it was clearly established that the company constituted a mere façade, and its acts of impropriety were correlated to this stratagem. As it was demonstrated that the company was being employed to conceal facts and thereby circumvent personal liability, the corporate veil was pierced. 30 Very significantly, the court observed that an association between the impropriety and the façade was essential for piercing the corporate veil. 31 Furthermore, the situation is quite complex in English law, with respect to the piercing of the corporate veil. For instance in Ord v Belhaven Pubs Ltd,32 the Court of Appeal ruled that the defendant holding company had limited liability and could not be rendered liable for the debts of its subsidiary companies. In other words, the Court declined to pierce the corporate veil.33 The ruling in this case, depicted the penchant of the courts to support the separate legal persona notion of a company, and their inclination to pierce the corporate veil, only under some explicit circumstances. With regard to the GHI Ltd’s shareholders, it has to be borne in mind that these entities had a limited liability. Consequently, they cannot be rendered liable for the acts performed by the GHI Ltd. As the directors of this company, they can claim the remaining assets of the company and at the same time they cannot be made liable for its acts. The motives behind the formation of this company do not have a bearing, as long as they were not for fraudulent purposes. This was the gist of their Lordships ruling in Salomon. The GHI Ltd had carried out its business for the benefit of its shareholders. All the same, as had been opined by the Law Lords in Salomon, the mere fact that a company had been conducting business for the benefit of the shareholders or members, fails to generate a relationship of principal and agent betwixt theme. At the same time, it does not render these shareholders or members liable for the wrongful deeds of the company. The decision in Adams v Cape Industries plc, established that the courts examine the reason behind the creation of the company. If these intentions prove to be mala fide, the courts will pierce the corporate veil and affix liability upon the directors or shareholders of the company. This was illustrated in Guilford Motors Co Ltd v Horne.34 The intent behind forming the GHI Ltd was to reduce negligence and taxation liability, which constitutes a common and lawful business practice. Consequently, the directors of ABC Ltd cannot be deemed liable for the negligent acts of GHI Ltd. All subsidiary companies are not the agents of their principal company. Moreover, every company in a group of companies enjoys a distinct legal entity. This precludes the claimants from proceeding against the ABC Ltd for the damage caused to them by the subsidiary GHI Ltd. Along with the other two subsidiaries, the GHI Ltd constitutes a wholly owned subsidiary company of the ABC Ltd. Despite the fact that there is just one entity from the economic perspective, in law there are four distinct entities; namely, the ABC Ltd and its three subsidiary companies. As demonstrated in Macura v Northern Assurance Co Ltd,35 the courts discount the notion of separate legal persona and pierce the corporate veil, under certain circumstances. One such instance transpires, where the parent company functions as a shadow director, by exercising direct control upon the subsidiary’s board. This has been provided for under the Companies Act 2006. Consequently, if it can be established that ABC Ltd had acted as a shadow director of its subsidiary company GHI Ltd, then it will be rendered liable for the harm caused by the latter. The courts may pierce the corporate veil, if the GHI Ltd were to be a sham or mere façade. This was the outcome of Jones v Lipman.36 In the presence of circumstances that implied the deceitful nature of a subsidiary company, the courts may be induced to pierce the corporate veil and expose the true nature of the organisation. However, this does not depict the nature of the ABC Ltd and its subsidiaries, as the intention behind forming the latter was to legitimately reduce its tax burden and negligence liability. In Ord v Belhaven Pubs Ltd, the court made it very clear that the reorganisation of a group of companies with the intent of evading third party liability would result in the piercing of the corporate veil. Such lifting of the veil would ensure that the parent company could not avert liability for the harm caused. Consequently, there was nothing unlawful in the formation of another subsidiary by ABC Ltd, in order to supplant the GHI Ltd, which went into liquidation. Hence, the corporate veil cannot be pierced under these circumstances. Another consideration relates to establishing that GHI Ltd had functioned as the agent of ABC Ltd. As long as it cannot be established that the former had acted with the actual or apparent authority of the ABC Ltd, agency cannot be proved. Our problem does not indicate the presence of any such authority. Consequently, it cannot be claimed that there had been an agency relation between ABC Ltd and GHI Ltd. Hence, the corporate veil cannot be lifted by the court. Tortious liability is a major feature of limited liability. In the normal course of business, creditors assess the risks involved and take suitable steps to avert them. This does not extend to the employees of a limited company and the general public. These individuals cannot safeguard themselves from the injury caused to them by companies. In this manner, limited liability enables the transgressor company to evade liability for causing such harm. With regard to ABC Ltd, if can be established that it had consented to be responsible for the health and safety procedures of its subsidiaries, then it could be made to compensate the injured employees of its subsidiary. As the harm caused by GHI Ltd pertained to involuntary creditors it could prove to be onerous to establish a duty of care, under these circumstances. Thus, the parent company ABC Ltd would successfully escape any attempt to render it liable for the damage caused by its subsidiary. As long as the business activities of a company comply with the provisions of the law of the land and are legitimate, no liability can be attached. With regard to group of companies, limited liability facilitates significant reduction in taxation and negligence liability. When the parent company, scrupulously ensures that it does not undertake any procedure that establishes an agency relationship with its subsidiaries, and as long as the subsidiaries are not a mere sham or façade, the courts will allow the distinct legal identity of each of the companies in the group. This will effectively, disperse any liability that arises, on account of some wrongful act by one of its subsidiaries. Hence the involuntary creditors of the GHI Ltd cannot succeed in their claims against the parent company ABC Ltd, as per the above discussion and case law. BIBLIOGRAPHY Statutes 1. Companies Act 2006 2. Company Directors Disqualification Act 1986 3. Insolvency Act 1986 UK Cases 1. Adams v Cape Industries plc [1990] Ch 433 2. DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852 3. Guilford Motors Co Ltd v Horne [1933] Ch 935 4. Jones v Lipman [1962] 1 WLR 832 5. Macura v Northern Assurance Co Ltd [1925] AC 619 6. Ord v Belhaven Pubs Ltd [1998] 2 BCLC 447 7. Salomon v Salomon [1897] AC 22 8. Trustor AB v Smallbone [2001] 2 BCLC 436 9. Woolfson v Strathclyde Regional Council [1978] UKHL 5 Books 1. Anderson H, Directors Personal Liability for Corporate Fault: A Comparative Analysis (Kluwer Law International 2008) 2. Cassidy J, Concise Corporations Law (Federation Press 2006) 3. Hannigan B, Company Law (Oxford University Press 2012) 4. Jennings M, Cengage Advantage Books: Foundations of the Legal Environment of Business (Cengage Learning 2012) 5. Judge S, Q&A: Company Law 2008 and 2009 (Oxford University Press 2008) 6. Kershaw D, Company Law in Context: Text and Materials (Oxford University Press 2012) 7. Sealy L and Worthington S, Cases and Materials in Company Law (Oxford University Press 2007) Journals 1. 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