Company Law: The Judiciary Should be Prepared to 'Lift the Corporate Veil' in the Interests of Justice - Essay Example

Company Law: The Judiciary Should be Prepared to 'Lift the Corporate Veil' in the Interests of Justice 1. Introduction This paper seeks to discuss the conflict between corporate veil and the interests of justice. It starts with understanding of the concept and purpose of the veil of incorporation and develops into arguments when the veil of incorporation may not be applicable in the interest of justice. Decided cases by the judiciary are used as spring board of discussion for the resolution of the issues. 1.1 Definition and purpose of the veil of incorporation A state understood in political science has the so called police power as one of its inherent power, which allows it to enact legislations to promote its very survival. It has thus to enact laws via legislature for the survival of society. Pursuant to this there is society’s need to promote the economy by encouraging people to engage in business. One economic tool is through the company law. Under said law is doctrine of veil of incorporation. In the old case of Salomon v. Salomon & Co. Ltd [1897] A.C. 22, there is that maxim that a company is a legal person in the eyes of the law having a personality separate and distinct from the individuals who are its members or owners. According to Howell, “A separate corporate legal entity is seen as a desirable foundation for company law, inducing investment, encouraging trade and therefore stimulating wealth creation.”1 It is on this premise that the veil finds its significant meaning in promoting the economy. Entrepreneurs will find their solace with this provision since it allows them to avoid the consequences of unlimited liability in case they engage into partnership business. The veil therefore serves as a protection of the company owner or stockholder from creditors who may want to run after said owners separate property in case of insolvency of the corporation. As to extent of the protection given the veil is subject to exceptions through judicial restraint and legislation. The first means that the court may pierce or disregard the veil “if, however, the veil of incorporation is used to facilitate wrongdoing, this behaviour will not result in a benefit for society.”2 . On the other hand, the state through legislation has allowed the lifting or piercing of the veil under has Sections 17 and 213-215 of Insolvency Act 1986.3 2. Analysis 2.1. When should the veil be lifted? Although there is a possibility of lifting the veil in certain statues, the power to lift the same is best appreciated in the cases decided by the courts under the concept of “interest of justice”. Hence, we would see more the wisdom of judiciary in going over the decided cases. It would seem that although the rule approximates that of role of a public policy, interest of justice is paramount over said rule. It is therefore the judiciary that would create the exception to the rule on veil on incorporation and as to what constitute interest of justice is a question of facts in relation to jurisprudence relating to the rule. 3. What are the cases where the veil is lifted? 3.1 Case of Bottrill4 In the case of Bottrill, the Salomon principle was acknowledged to be in existence but ‘its consequences were ignored’.5 This was the conclusion because it was held that the company was acting through its directors and officers and hence ‘principal can issue orders which its agents carry out, and the status of shareholder is separate from that of agent of the company.6 Lord Woolf had the occasion to recognise that payments to National Insurance Contributions have been paid and that he said “to deprive an individual of his claims under the [Employment Rights Act 1996] could be to deprive unjustly that individual of the benefits to which he could properly expect to be entitled after he and his employer had made the appropriate contributions."7 The reason for applying the lifting in case of Bottrill appears to have been caused by the possible deprivation of an individual’s claims under the Employment Right act 1996 and considering that the circumstances of Bottrill was really different from previous cases of shareholders who happened to be also employees. 8 3.1.2 What other cases involve a shareholder and at the same time an employee? In a 1997 case, prior to Bottrill decided in 2000, the court decided against Buchan, “a 50 per cent shareholder working under a valid contract of employment, eligible for redundancy payments on the insolvency of his company?”9 Howell argued that Buchan was apparently denied of his claim under the employment law because of the issue of intention and control which she explained saying there was in fact an intension between Mr. Buchan and the company as per employment contract, which the tribunal rejected that ‘this intention was good evidence of his status as an employee.’10 While discussing Buchan’s case, Lawson L.J, in Calder v. Kitson Vickers (Engineers)11, said: "If the law allows a man to claim that he is a self-employed person in order to obtain tax advantages for himself and then allows him to deny that he is a self-employed person so that he can claim compensation, then, in my judgment the union between fairness, common sense and the law is strained almost to breaking point." Tackled in the same case, Employment Appeal Tribunal (EAT) addressed the issue of control with the argument that as a controlling shareholder he could prevent his own dismissal and was therefore outside the class of persons intended to be protected by the Act.12 How to reconcile the conflicting cases then? The court had the opportunity to sensibly recognize ‘faults in the reasoning of the Buchan case and concluded that Mr Bottrill, who had a three-year contract and owned the only share in Magnatech U.K. Ltd, was an employee of the company’13. Concerned about the consequences of the decision, which could result in large numbers of successful applications for payment from others in similar positions, the Department of Trade and Industry had appealed and relied with case of Buchan.14 In the same case EAT decided on appeal “that Mr Bottrill's control was only temporary and theoretical and that he was indeed an employee of Magnatech having a contract of employment under which he paid National Insurance contributions and tax as an employee.”15 The Court of Appeal affirmed the decision of the EAT. Agreeing with EAT, Lord Woolf, pointed out that to imply tests into the statute that do not actually exist would cause confusion.”16 3.2 Other cases applying the denying the veil of incorporation 3.2.1. Trustor AB v Smallbone The court held in Trustor AB v Smallbone ‘that although T's submissions were too wide in principle, it was appropriate to pierce the corporate veil in the circumstances of the instant case since (1) the company had been shown to be a facade or sham in which there were no third parties involved as I only had nominee directors and was controlled by a company of which S was a beneficiary, citing the cases Gencor ACP Ltd v Dalby 17 and Adams v Cape Industries Plc.18 It was also held in Trustor AB v Smallbone19, citing Salomon v Salomon & Co Ltd [1897] A.C. 22 that ‘I's acts of impropriety were linked to the use of the company structure as a device to conceal the facts so as to seek to evade any personal liability on the part of individuals’. It was also in the same case that the court found the change to apply the principle of interest of justice as something above the doctrine of the veil of corporate entity ‘since I had been used solely as a vehicle of the receipt of monies from T’20 It must be noted in the case of Trustor AB that there is a requirement of the link between a company being a façade and the use of the company structure as device to conceal the facts so as to evade any personal liability on the part of the individuals. The decision confirms that the parties may not unjustly from benefit of being separately legal entities. The owners or directors cannot use the mantle of the principle to hide their wrong doings. 3.2.2. Cases of Creasey v Breachwood Motors Ltd and Ord v Belhaven Pubs Ltd In the case of Creasey v Breachwood Motors Ltd21, the court lifted the veil ‘when directors of Motors had deliberately ignored the separate legal personalities of the two companies, transferring Welwyn's assets and business to Motors without regard to their duties as directors and shareholders.’ It is in the interest of justice to treat Motors as liable for Welwyn's liability to C and the court have done the same. On the other hand, in the case of Ord v Belhaven Pubs Ltd,22 the court held that allowing the ‘appeal on the substitution as defendant of either a company in the same ownership as, or a company which was a shareholder in, the defendant company, did not fall within the scope of RSC Ord. 15 r. 7(2).’ It was also established in the case of Ord that ‘O apparently issued the application after realising BP no longer had sufficient assets.’ Comparing the two cases would tell us that the judiciary treated the two cases differently. Under the first there was a deliberate disregard of the duty23 while in the case of second24 , the court allowed the exercise of discretion to suffer its consequence and the court deemed that lifting the veil under such case would be improper. 3.3.0 Inapplicability of lifting of veil 3.3.1 Case of DHN Food Distributors Ltd v Tower Hamlets In the case of DHN Food Distributors Ltd v Tower Hamlets25, the issue whether the veil could be lifted between a Holding company and its subsidiary companies. In the same case there was the sub-issue of whether lifting the veil is justified only if the company is a mere ‘façade’. As to the main issued Rixon opined the corporator cannot belong to both worlds that is to be ‘to be relieved of the disadvantageous consequences of an arrangement voluntarily entered into by the corporator for reasons considered by the corporator to be of advantage to him’26 Rixon was very emphatic in concluding: “The group enterprise’ concept must obviously be are fully limited so that companies who seek the advantages of separate corporate personality must generally accept the corresponding burdens and limitations” 27 As to the sub-issue on lifting only on the basis of façade, the words of Lord Keith in a decided case will have to be considered in interpreting the same. In the case of Woolfson28, using Ormerod’s29 judgment in Tunstall’s decision, Lord Keith appeared to have affirmed such proposition. It was however found in said decisions that there was no clear definition of ‘façade’. This leads someone therefore to speculate what is the meaning of the word. The New Lexicon Webster’s Enclopedic Dictionary of the English Language, 1992, (Lexicon Publications, USA) defines it as ‘an appearance or manner intended as pretense or mask. It is not therefore enough that the person involved has ‘complete control for the company’30 for a company to be a façade. It is the concealment of the identity and the activities of the corporator that is controlling. This concept of concealment as an element of the company being a ‘façade’ could be deemed to be consistent with the ruling in the following cases: Darby. Ex parte Broughman,31 Gilford Motor Company, Limited v. Horne32, where Lord Hanworth at 956 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" and Jones and Another v. Lipman and Another, where Russell J. at 836 said: "The defendant company is ... a mask which he holds before his face in an attempt to avoid recognition by the eye of equity”33. In said cases, Rixon said that there was lifting of the veil because ‘the company was formed in order to enable the corporator to do through, and under cover of, the company what he might not do openly and in person.’34 The House of Lords had also spoken that any contention that the court may "disregard Salomon's case whenever it is just and equitable to do so" is without basis.35 The judiciary then applied the doctrine of separate legal personality of a company, by deciding that the doctrine in is "no matter of form” but “it is a matter of substance and reality" 36 3.3.2 Williams v. Natural Life Health Foods Ltd (1998) 2 ALL ER 577 In the case of Williams v. Natural Life Health Foods Ltd (1998) 2 ALL ER 577, where the franchiser of health of shop was effectively a one man company and never met the franchisee on many of the negotiations. Cases of misrepresentations happened and the franchise did not work out as it had been promised. Misrepresentations came to light and the franchiser company was in liquidation. The issue was whether the franchisee could bring proceedings directly against the one man behind the franchiser company. Court of Appeal’ s decision was for lifting but the House of Lords held that this approach was wrong by reasoning that the veil of incorporation was sacrosanct and should only be lifted in the most exceptional circumstances. The court held that in the absence of any personal contact resulting in a specific reliance by the franchisee on the representations made on behalf of the franchisor company, the corporate veil of the franchisor company should not be lifted.37 (Paraphrasing made) 4. Conclusion and Recommendation 4.1 Conclusion: The court appears to be consistent in applying the veil of incorporation and in lifting the same based on the cases we have analyzed. The Salomon case is still applicable and the application was also still grounded on the misuse of the benefit of the veil in incorporation. The veil was created for the purpose of attaining a social objective; the concept is still a social objective. There is thus basis to uphold the majesty of the law in upholding the rule on veil of incorporation but the state through the court is empowered to check abuses of the same in the interest of justice. 4.2 Recommendation It is recommended that those who opt to choose the benefit of veil of incorporation may not at the middle of the game and say that they are exempted and therefore must also be treated as one. On the other hand, those who believe that the veil of incorporation does protect them from their wrong doing from the risk of having to be liable beyond their capital contribution in their business may not altogether be mislead because the judiciary, in the interest of justice, may always lift the veil and treat what supposed to be separate entities as one. Bibliography 1. Concise Oxford Dictionary(1982), Seventh Edition 2. Griffiths, M. (2000), Lifting the corporate veil revisited, {www document} URL , www.accaglobal.com/publications/studentaccountant/36826 accessed Aril 5,2006 3. Howell (2000), Salomon Under Attack, Company Lawyer, Sweet & Maxwell Limited and Contributors 4. Rixon, F.G. (1986) Lifting The Veil Between Holding And Subsidiary Companies, Law Quarterly Review, 1986, Cases: 1. Adams v Cape Industries Plc. [1990] Ch. 433 2. Calder v. Kitson Vickers (Engineers), [1998] 1 W.L.R. 830; [1998] 2 All E.R. 577; [1998] 1 B.C.L.C. 689; [1998] B.C.C. 428 3. Canadian Meat Processing Corp. et al. (1983) 147 D.L.R. (3d) 81, 83) 4. Creasey v Breachwood Motors Ltd, (QBD) Queen's Bench Division, 10 July 1992 5. Darby. Ex parte Broughman [1911] 1 K.B. 95, per Phillimore J. at 101 6. DHN Food Distributors Ltd v Tower Hamlets L.B.C. [1976] 1 W.L.R. 852Gencor ACP Ltd v Dalby [2000] 2 B.C.L.C. 734) 7. Gilford Motor Company, Limited v. Horne [1933] 8. In Buchan v. Secretary of State for Employment, [1997] B.C.C. 145; [1997] I.R.L.R. 80 [1988] I.C.R. 232. 9. Jones and Another v. Lipman and Another, [FN88] FN88. [1962] 1 W.L.R. 832 10. Limited v. Horne [1933] 1 Ch. 935 11. Ord v Belhaven Pubs Ltd , (CA (Civ Div)) Court of Appeal (Civil Division), 13 February 1998 12. Ormerod L.J. in Tunstall v. Steigmann, [1962] 2 Q.B. 593, 602. 13. Salomon v. Salomon & Co. Ltd [1897] A.C. 22. 14. Secretary of State for Trade and Industry v Bottrill [2000] 1 All E.R. 915 (CA) 15. Trustor AB v Smallbone (No.3), (Ch D) Chancery Division, 16 March 2001 16. Tunstall v. Steigmann [1962] 2 Q.B. 593, per Ormerod L.J. at 602 17. Woolfson v. Strathclyde Regional Council 1978 S.C. (H.L.) 90, 96. Laws Cited: .1 Insolvency Act 1986, Sections 17 and 213-215 .2 Employment Rights Act 1996, Sections 166 and 182 Read More