The Immense Diverse Nature of Company Law: the Concept of Corporate Personality - Research Paper Example

Introduction The concept that a company be a separate legal person from its members as decided in the landmark and relentlessly cited case of Salomon requires no detailed explanation; suffice it to say that from it was borne the concept of corporate personality. And suffice it further, in the interests of some detail, to acknowledge that Mr. Salomon’s circumstances indeed inspired such statements as ‘the company is ex hypothesi a distinct legal persona’ (Salomon v Salomon & Co. Ltd [1897] AC 22 HL, per Lord Herschell) and ‘the company is at law a different person altogether from the subscribers to the memorandum…nor are the members as subscribers liable…except to the extent and in the manner provided by the Act.’ (Salomon, per Lord Macnaghten). From the decision of Salomon came the potential for numerous far reaching consequences, and hence clarified was the reach and limit of the Companies Act 1862. Essentially, the House of Lords entrenched the practice of the separation of a corporate personality from its members, rendering it capable of entering into contracts in its own name (Lee v Lee’s Air farming Ltd [1961] AC 12 PC); of owning property, of suing and being sued and of making profits and losses in its own name (Macaura v Northern Assurance Co. [1925] AC 619 HL). More importantly was created the final principle of corporate personality, lest one forget the tremendous advantages of limited liability enjoyed by shareholders, limited only to the unpaid amount of their shares. Lord Templeman himself described the dicta in Salomon as an ‘unyielding rock’ (1990) and its application has been brought into the present by its placement in the Companies Act 2006, s.16(2). This paper will explore circumstances under which the veil is and can be lifted by the courts, and will ascertain how it tries, as far as possible to cause the director’s to act in the best interests of the company. Exceptions to the Corporate Veil Principle The principle of separate legal personality has not been without its problems, and as usual with the birth of a seemingly wonderful new legal concept is also borne the troubles that inevitably arise at it is applied to the various cases in the English courtroom. As is the case with most fundamental legal principles, the courts have been faced with circumstances in which exceptions to Salomon have been necessary and indeed permitted. And so began the slow and steady battle between the courts and the new cases which required that the Salomon decision should be applied carefully. The specifics of exactly which circumstances should allow a reasonable divergence from the Salomon principle are affected by the two different views surrounding the consequences of separate legal personality. The narrow view, as embodied in the Companies Acts holds that a company’s property, rights and liabilities belong to the company only. Yet, as is the case with many such legislative provisions, exceptions are inevitable, and the narrow view anticipated the coming of the wider view which holds that persons do not have any effect on and are not considered in relation to a company’s legal rights and obligations. The law reluctantly, but quite rightly acknowledges that exceptions exist, and both common law and statutory exceptions serve to treat ‘the rights or liabilities or activities of a company as the rights or liabilities or activities of its shareholders’ in certain circumstances. (Atlas Maritime Co. SA v Avalon Maritime Ltd (No. 1) [1991] 4 All ER 769 per Staughton LJ at 779). Yet, is there any systematic application of these exceptions? Is a systematic application indeed possible? One cannot help but notice the irony of the paradoxical term ‘systematic exception’, and perhaps to seek one is a futile exercise. This is especially so if one is to focus on the requirement that directors act in the best interests of the company: exactly what are – and what can be – the best interests of the company? Is this not simply a term laid open to definition at will? Limits to the Lifting of The Veil – Legislation & Parliamentary Intention On the other hand, it is not a novelty that the statutory exceptions to corporate personality are not easily successful; the Salomon principle is a fundamental one and is not to be easily set aside. Lord Diplock indeed highlighted the statutory basis of the corporate veil and stressed that ‘any Parliamentary intention to pierce the corporate veil would be expressed in clear and unequivocal language’ though the absence of such language could still allow for the veil to be pierced in special circumstances through a ‘purposive construction’ of Parliament’s intention (Dimbleby & Sons Ltd v National union of Journalists [1984] 1 WLR 427, p.435). Though, as was stressed in the case of Tunstall v Steigmann [1962] 2 QB 539, it is important to recognise that the ‘purposive construction’ be clear and it is also not easily implied. Various other statutory provisions provide for the lifting of the veil in specific circumstances, covering such aspects as taxation within group structures. It has been quite rightly suggested that such provisions do not exactly serve to lift the veil in the literal sense; rather they impose extra obligations on subsidiaries. Fraud also serves as a more definitive potential for the lifting of the veil – another common sense application of the principle. The Insolvency Act 1986 may also assign personal liability to directors or shareholders if it appears that the business was conducted for any fraudulent purpose (section 213), if there is evidence of director’s misconduct (section 212) or if the directors were negligent in not winding up the company if it had no reasonable prospect of surviving (section 214). Case Law & The Lifting of The Veil As a brief yet somewhat relevant opening, it is not far from the mark to state that the case law on lifting the veil is somewhat sporadic in nature and gives no clear or specific circumstances or principles as to when the veil will or will not be lifted. The timeline of cases shows the rather unsettled changes of the courts’ approach over the years. Circumstances where courts have previously lifted the veil include where the company is a façade, where groups of companies are formed, where an agency exists and where fraud has been committed. Each of these elements is relevant in relation to the directors of a company, and the requirement that they act in the best interests of the company – yet does the court’s lifting of the veil in these circumstances ensure that directors do indeed act in the best interests of the company, or are the circumstances so sporadic and unclear that directors are tempted to take chances nonetheless? An examination of each of the circumstances in turn will be assessed in an attempt to ascertain whether the court’s lifting of the veil is as effective in practice as it appears to be in its primary form. Façade as a Reason For Lifting The Veil Under the façade element, the court in Merchandise Transport v British Transport Commission (No.1) [1962] 2 QB 173 refused the separation of corporate personality where it was shown that the subsidiary company had been created as a device to avoid formalities when obtaining a favourable licence. A façade has also been found when a company has been created to avoid an employment covenant, as was the case in Creasey v Breachwood Motors Ltd [1993] 3 All ER 283, which held that the directors had purposely ignored the separate legal personalities of the two companies when transferring assets between them. Creasey was however overruled by Ord v Bellhaven Pubs Ltd [1998] 2 BCLC 447 on the basis that a reorganisation of the company group is legitimate although only in circumstances which the motive appears to be based on good faith. It is not difficult to see that the reason behind lifting the veil in these circumstances is because the company has been created to evade some form of legal obligation – the courts duly find it necessary to lift the veil and enforce the obligation. Mere unconscionable conduct will not however be enough – some form of dishonesty or fraudulent behaviour is required, and the test appears to be somewhat stringent. Only a company which appears to be ‘a device and a sham, a mask which he [the defendant] holds before his face in an attempt to avoid recognition by the eye of equity’ (Jones v Lipman [1962] 1 WLR 832, per Russell LJ) will risk its veil being lifted under the façade principle. This is an obvious attempt by the courts to take tentative steps when lifting the veil for suspected façade of a company – in the interests of maintaining the enshrined Salomon principle, caution is clear in the approach of the courts. Lifting The Veil in Grouped Companies Group-structure companies are often formed as a way of avoiding liabilities, obligations, tax and regulations. Wholly owned subsidiaries are formed by a parent company, who becomes a shareholder with limited liability should the subsidiary succumb to misfortune. Courts are often suspicious of group companies due to the fact that the lines often become blurred between groups in many ways. Lord Denning primarily held that a group of companies are a single entity and should be treated as thus (DHN Food Distributors Ltd v Tower Hamlet London Borough Council [1976] 1 WLR 852, at p.285). However, Lord Roskill held the opposing view that each company in a group ‘is a separate legal entity possessed of separate legal rights and liabilities so that the rights of one company in a group cannot be exercised by another company in that group’ (Albazero, The [1977] AC 774, per Roskill LJ at p.807). Similarly, the House of Lords in Woolfson v Strathclyde Regional Council [1978] SC HL 90 rejected Denning’s dicta and held that the veil would only be lifted if the group displayed an obvious façade. However, the Court of Appeal later favoured Denning, stating that the veil may be lifted ‘if it is necessary to achieve justice irrespective of the legal efficacy of the corporate structure under consideration’ (A Company, Re [1985] 1 WLR 281, at p.528). Of course, this concept is rather uncertain and open to potential weakening of the security the incorporation seeks to achieve, although the decisions are a clear conveyance of the struggle the courts have faced in trying to ascertain a set of principles whilst keeping them flexible enough to apply to varied circumstances. Subsequently, the judge in Adams v Cape Industries [1990] 2 WLR 657 criticised the Court of Appeal in Re a Company and narrowed the scope of the decision on the basis that the law should recognise the operation of subsidiary companies as legitimate in most circumstances. The lifting of the veil was consequently restricted to specific circumstances in which the court interprets a statute or legal document; where a mere façade is indicated (per Lord keith in Woolfson); or where an express or implied agency agreement is evident. The court also distinguished between moral approval and actual legality, stressing the irrelevance of the former, yet another attempt to keep the knot tight on the leash of the potentially uncontrollable beast. Whilst the decisions here leave much to be desired and are indeed fluctuant, the clearly constant attempt of the courts to arrive at a suitable set of boundaries in relation to when the veil will be lifted is present. Agency Relationships If an agency relationship exists, then it follows that the principal is responsible for the actions of the agent within the agency scope. Therefore, if a holding company is found to be the agent of the subsidiary company, the veil is justifiably lifted. It is important to state that the courts’ eagerness to find an agency is not overwhelming – some would even call it reluctant. The agency must be an express agreement although the courts have stressed that it is a question of fact, in which agency can be inferred from the surrounding circumstances (Garnac Grain Co. Inc v HMF Faure & Fairclough Ltd [1968] AC 1130). Again, Salomon establishes that mere membership of a company will not serve to make it an agent. Similarly, an agency cannot be inferred from its members’ exercisable control over it (British Thompson-Houston Co. v Sterling Accessories Ltd [1924] 2 Ch 33, per Tomlin J at p.38) and of course, an agency will not be found if the members did not consent to its creation (Yukong Line Ltd v Rendsburg Investments Corp (No.2) [1998] 1 WLR 94). So exactly how is an agency formed? The main characteristic of an agency is that its agent possesses the authority to form relations of a legal manner between the principal and third parties. However, it must be stressed that the general finding of agency within the veil lifting sector is rare because a business is normally intended to belong to the business, and not a member’s business. Case Law – Is There a General Principle For Lifting The veil? It is rather clear that there is no general principle in case law as to when the veil will be lifted. The situation is simply as thus: the courts will uphold Salomon….. and the courts will not uphold Salomon. There are no precise or indeed satisfactory explanations to predict with certainty when the veil is likely to be lifted and under which circumstances. But does this mean that it is not satisfactory? Although situations in which the veil has been lifted can be limited to a group of specific circumstances, the courts have also refused to lift the veil in the same circumstances. It simply depends on the individual case. It seems that the courts merely try to maintain a balance between the Salomon principle and the provision of justice, and leave themselves open to rule depending on the circumstances of the particular case. It is to be remembered the strength with which the Salomon principle burst onto the company law scene all those years ago; it is at least close to say that exceptions are rare and stringently decided, and more commonly activated under statutory authority. Conclusion But should we call for a clear principle here? We must keep in mind the immense diverse nature of company law – can one principle really cover it all? It seems that flexibility has been favoured over predictability, and why not? To say that the lifting of the veil is not specific enough is not to say that it renders the practice unsatisfactory – perhaps it causes members of a company to follow more stringently the rules. The whole reason for the existence of the courts’ ability to lift the veil is to prevent the abuse of the corporate personality. Those who intend to abuse the concept of corporate personality should not have the luxury of working their actions out so as to avoid liability. And those who have obviously abused the Salomon principle should not be able to avoid liability simply because a provision in the legislation has not provided for the circumstances under which they acted. Thus, it could be suggested, and quite strongly so, that the absence of rigid rules to state just when the veil can be lifted is an advantageous point in company law. CASELAW A Company, Re [1985] 1 WLR 281 Adams v Cape Industries [1990] 2 WLR 657 Albazero, The [1977] AC 774 Atlas Maritime Co. SA v Avalon Maritime Ltd (No. 1) [1991] 4 All ER 769 British Thompson-Houston Co. v Sterling Accessories Ltd [1924] 2 Ch 33 Creasey v Breachwood Motors Ltd [1993] DHN Food Distributors Ltd v Tower Hamlet London Borough Council [1976] 1 WLR 852 Dimbleby & Sons Ltd v National union of Journalists [1984] 1 WLR 427 Garnac Grain Co. Inc v HMF Faure & Fairclough Ltd [1968] AC 1130 Jones v Lipman [1962] 1 WLR 832 Lee v Lee’s Air farming Ltd [1961] AC 12 PC Macaura v Northern Assurance Co. [1925] AC 619 HL Merchandise Transport v British Transport Commission (No.1) [1962] 2 QB 173 Ord v Bellhaven Pubs Ltd Salomon v Salomon & Co. Ltd [1897] AC 22 HL Tunstall v Steigmann [1962] 2 QB 539 Woolfson v Strathclyde Regional Council [1978] SC HL 90 Yukong Line Ltd v Rendsburg Investments Corp (No.2) [1998] 1 WLR 94 BIBLIOGRAPHY Bainbridge, S.M. 2000. Abolishing Veil Piercing. 28 Harvard Law Review 32. Dignam, A. & Lowry, J. 2006. Company Law. 4th edition. New York: Oxford University Press. 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