The Fundamental Concept of the Veil of Incorporation - Essay Example

Introduction The unique and distinct element of corporate entities is the fact that they have a separate existence from their owners. This is an advantage companies have over other business forms like partnerships and sole proprietorships. This paper examines the legal situations in which the concept of separate existences could be limited in the English legaly system. To this end, the paper examines the doctrine of the “piercing of the veil of incorporation” by reviewing and evaluating elements from case law. The Fundamental Concept of the Veil of Incorporation The central case in English law that provides an explanation of the concept of the “veil of incorporation” is the case of Salomon1 in which Aron Salomon transferred his business into a limited company in which six other members of his family subscribed to the company memorandum2. The purchase price of the shares of the new company was £38,782 and Salomon took 20,000 shares whilst his six other family members took one share each. Salomon took Debentures (loan stock) of £10,000 and £8,877 cash which ware paid to Salomon on the balance of the purchase price. The business floundered and was wound up with liabilities in excess of its assets by £7,7333. The companys liquidator claimed that the companys business was still Solomons because the company was a “sham”. Thus, in the preliminary court hearing, the liquidator won and was given the right to sue for Salomon to pay for the loss. The Court of Appeal also held in favour of the liquidator. The Court of Appeal state that based on the Companies Act, they had to hold Salomon liable because he was “one substantial person running the business with six mere dummies”4. However, the matter was presented to the House of Lords who reversed the decision of the court of first instance and the court of appeal. They ruled in favour of Salomon and stated that one share is enough to render an organisation a corporate entity and hence, the veil of incorporation could be applied to such an entity to prevent the liability of the entity to spread to the owners. Therefore, this creates a fundamental doctrine in English law that holds the right to the separation of business resources from owners resources sacred. Qualification of the Veil of Incorporation “Limited Liability, introduced in 1855 to allow people to trade without committing their personal fortune to a venture requires in time, legislative balance. The limited company is in danger of being too wide a protection for free enterprises and of providing a veil for the unscrupulous”5. This statement indicates that there is the need for a balance to be created between the need to keep businesses in operation and other parties who might abuse this position. Thus, in a situation where keeping the Salomon principle is unjust, the court may intervene and try to find a way of dealing with the issues and problems that come with it6. However, in cases where it will be unjust for the Salomon principle to be upheld, the court might have to act or intervene to prevent abuse and misuse of the idea and concept. This is because the limited liability concept cannot be opened to abuse and misuse by malicious parties in organisations. Thus, there have been various levels and various processes in which the Salomon principle was compromised. However, since the Salomon decision, the courts have been called upon to apply the principle of separate legal personality as a mainstream and fundamental process within which corporate entities must be viewed7. Landmark Cases There have been some cases in English law that have laid the foundations for the development of the law relating to the veil of incorporation. In Guilford Motor Co Ltd V Horne8 a person who was bonded by his employers never to divert customers from his employers formed a company and sought to attract customers from his former employers. When his former employers sued for an injunction, he argued that the company was separate from him. It was held that the veil of incorporation could be pierced in such a situation because the deliberate formation of an organisation for a purpose that contravenes the fundamental purpose of a previous agreement could not be defended by the veil of incorporation principle. In the case of Jones V Lipman9, the two parties entered a contract for the transfer of land. Lipman did not want to honour the terms of the contract. He therefore formed a company and transferred the land to the company. The courts held that it is necessary to pierce the veil of incorporation because the companys formation and the subsequent transfer of land to that company was not done in good faith. Hence, it was held that the veil of incorporation could not be used as a defence against such situations and contexts. “The courts can and often do pull off the mask. They look to see what really lies behind. The legislature has shown the way with group accounts at the best. And the courts should follow”10. This means that the courts will always want to examine transactions and processes in order to come up with a decision on how to evaluate and classify a given situation relating to an organisation. This is classified by some authorities as an interventionist approach and method that provides some kind of limitation against the abuse and misuse of the doctrine of the veil of incorporation11. Statute The UK after 1997 became a relatively more regulated nation than it was previously. There were numerous laws and regulations that came to force throughout the country and this covered so many issues including corporation law. Prior to that, the Insolvency laws had provided the impetus for dealing with directors responsibility for illegalities and misapplication of shareholders funds. The Companies Act 2006 provides some important sections that deal with directors obligations and roles. Section 213 of the Companies Act of 2006 provide preliminary discussions on how the veil of incorporation can be lifted. This indicates clearly that there is no unfettered and unlimited usage of the veil of incorporation principle. Hence, organisations and businesses will have to be careful and sensitive to what they do in executive positions. Thus, where there is a dishonest intent, there could be a lifting of the veil of incorporation so that the directors or managers involved can be given the appropriate punishment. Section 214 goes on to give details of the situations in which the Veil of Incorporation could be called to quest. It states that: Where a transaction or arrangement is entered into by a company in contravention of section 197, 198, 200, 201 or 203 (requirement of members approval for loans etc) but, within a reasonable period, it is affirmed— (a)in the case of a contravention of the requirement for a resolution of the members of the company, by a resolution of the members of the company, and (b)in the case of a contravention of the requirement for a resolution of the members of the companys holding company, by a resolution of the members of the holding company, the transaction or arrangement may no longer be avoided under section 21312. Thus, where the contravention was in line with the mainstream rules and regulations and there was a corresponding resolution to back it up, then the whole process can be viewed as an appropriate one and the veil may not be lifted. Section 214 of the Insolvency Act 1986 states that in cases where there is a major problem or issue with “wrongful trading”, an individual manager or director could be held responsible for his actions. This implies that this could also be a situation where the veil could be lifted where a director contravenes the memorandum of association and accepts a different approach to trading. In such a case, the manager or individual in question might be held liable for the issues and dealt with on that basis. Situations in which the Veil of Incorporation May be Lifted Dingman and Lowry identify some cases within which courts will typically have to qualify the veil of incorporation doctrine. This include: 1. Where a company is an agent of another: In this situation, there is the need for the linkage and connection to be examined and if it is seen to be malicious or inappropriate, a court of competent judicature might need to disregard the veil of incorporation principle and view the managers and members of the company as separate entities. 2. Issues of Fraud: Where there is a malicious intent of the directors or top members to perpetuate fraud, there is the need for the veil of incorporation to be disregarded because the directors must be deemed as individuals and charged in their individual or collective capacity. 3. Tax Issues: In instances where the parties or members of an organisation seek to use a malicious approach or method to evade taxes, the authorities will need to apply to the court to ensure that the veil of incorporation is not abused in this situation and context. 4. Employment issues: Where there are employment limitations and related issues, there could be the qualification of the veil of incorporation principle to ensure that there are proper attributions to ensure fairness and justice. 5. Group issues: In instances where the groups of companies are operating in a way and manner that is not consistent with the principle of good faith, the rules and regulations could be reviewed in order to ensure that the right approaches and methods are put together to preserve justice and fairness. Forms of Qualification of the Veil of Incorporation Ottolenghi and other writers classify four types of the qualification of the veil of incorporation. The first type is peeping and this involves a situation where the veil is lifted to get a members information13. This is a situation where the various kinds of privileges a director enjoys in an organisation is limited because of various reasons that will be necessary to get the court to gain some kind of information in order to hold a director responsible. Penetrating involves a situation where the veil of incorporation is disregarded and liability is attributed to the members14. The penetration is put on a scale which could include either enterprise liability or business participant liability in which various persons within the leadership structures or all the directors can be held liable for an issue attributed to the company15. Extending involves a situation where groups of companies are treated as one entity to prevent them from abusing their rights and authorities in a given situation or context. This is often utilised in the cases of tax fraud and related matters where companies must be treated individually rather than a group of separate entities and organisations. Ignoring is where a company in a given situation is not recognised at all. This might be necessary to disregard an organisation and prevent it from carrying out certain activities that it desires to carry out if it is seen to be in bad faith. Adam V Cape Industries The case of Adam V Cape Industries16 indicated that there are three main situations and contexts within which the corporate veil could be lifted. The first instance is where the court has the need to interpret a given statute or document. In such a situation, there is the need for some kind of clarity to exist and where upholding the veil of incorporation will affect the clarity of the statute, then the veil of incorporation might be pierced to ensure that the law in question is implemented appropriately and in the rightful context. The second instance of a case where the veil of incorporation could be lifted is in the special circumstances where there is evidence to believe that the veil of incorporation is being invoked to create a false facade of the realities of transactions the members of the business are involved in. This involve situations where there is the need to hold the companies for moral culpability. The third context in which the Adam V Cape Industries rule can be applied is in situations where there is an express agency agreement. Where there are agreements and views in relation to a given matter, one party cannot use the veil of incorporation as a sword to deprive the other party or parties of their rights and privileges. Conclusion The veil of incorporation is a central doctrine of the English legal system. It involves the principle that a corporate entity is different from the owners and managers of the entity. This was instituted in the Salomon case. However, in UK case law, there is evidence that the veil of incorporation, although upheld to be sacred in English commercial law can be pierced. There could be several instances where the veil will have to be literally torn down because of immoral acts of the managers, dishonest trading and abuse of power. In such cases, there will be the need for the veil of incorporation to be torn down to provide an avenue to hold the directors and managers responsible. In other cases, where the veil of incorporation doctrine is used as a sword rather than a shield, the courts or aggrieved parties can sue for injunctions to prevent them from abusing the doctrine. This occurs in cases where the doctrine is used to cause some kind of dishonest dealings in cases relating to civil transactions. In other situations, it could be used to make certain claims or avoid certain obligations like tax obligations. In such cases, the court might have to disregard the veil of incorporation altogether. Bibliography Books Bourne Nicholas. Bourne on Company Law London: Routledge. 2010 Davies, Paul. Gower and Davies: The Principles of Modern Company Law London: Sweet and Maxwell. 2012 Digman Alan. Hicks and Goos Case and Materials on Company Law Oxford: Oxford University Press. 2011. Dingman Alan and Lowry John. Company Law Oxford: Oxford University Press. 2012 Lowry John and Reisberg Arad. Pettets Company Law London: Longman. 2009 Orts Eric. Business Persons: A Legal Theory of the Firm. Oxford: Oxford University Press. 2012. Journal Ottolenghi, Simon. “From Peeping Behind the Corporate Veil to Ignoring it Completely” The Modern Law Review 53(3) pp338 – 353 Cases Adams v Cape Industries plc [1990] Ch 433 Gilford Motor Co Ltd v Horne [1933] Ch 935 Jones v Lipman [1962] 1 WLR 832 Littlewoods Mail Order Stores v IRC [1969] 1 WLR 1214 Salomon V A Salomon & Co Ltd [1897] AC 22 Read More