The Advantages and Disadvantages of Lifting the Corporate Veil - Research Paper Example

The advantages and disadvantages of lifting the corporate veil Introduction The registration of business organisations is governed by different corporate laws worldwide varying from one country to the other, and statute established which result into entities that are independent from the owners. Piercing or lifting the corporate veils are the legal decisions made which determines whether to regard the rights and duties of corporation in a similar manner as those of the corporates shareholders. In law, the incorporation of an organization results into the gaining of the legal ability to be treated as an independent individual or entity, separate from the owners. Though considered as a way of protecting the private properties of an individual in case the organization falters, the veil of incorporation has been considered as a shield of protecting rogue managers from protection (Daniel, 2007). This is due to the legal fact that the company, as an entity becomes responsible for the any wrongdoing committed by any of its employees and should therefore be sued instead of the shareholders. The benefits of the piercing the corporate veils have been discussed in equal measures as some of the disadvantages of the principle (Allen, 2012). Piercing or lifting the corporate veil is a term used to describe the decisions made by courts to remove the protection clause which makes shareholders in an organization different from the organization itself. In the case of a court piercing the corporate veil, any complaint against the company can be directed to individual managers as opposed to the company as an independent entity. In this paper, legal jurisprudence and other cases demonstrating the benefits and demerits of the lifting the corporate veil will be discussed to provide a basis for the entire arguments (Kryvoi, 2012). Advantages of lifting the corporate veil In the event that the court pierce the corporate veil, the individual assets of individuals will be targeted to help offsets some of the liabilities facing the organization. Courts have lifted the corporate veil in a number of instances and this has demonstrated the benefits of this provision of the law. The piercing of corporate veil, a literal term to mean the removal of the protection joined by shareholders has a number of advantages that have been demonstrated by court rulings across the business sphere. In a number of cases, business management misuse organizational assets and funds and this result into an organization that lacks in liquidity and the ability to offset its debts (Allen, 2012). In the event that the court can be convinced that the actions of the managers and the key stakeholders in the organization played a role in reducing the liquidity of the company, the corporate veil can be lifted to offset the debts owed by the company. This has occurred in a number of instances in which the court has been convinced that the company’s finances were misused managers for private and selfish needs of their own (Ramsey & David, 2005). The application of the lifting of the corporate veil doctrine has enabled the courts to protect individuals from fraudulent transaction with a corporation, which may have led to loss of many. Many a cases, the managers and directors of an organization may misuse the resources of the organization or the resources of the third party dealing with the corporation and hide behind the veil. In such instances, the courts have failed to apply the Solomon rule in protecting the people in the organization especially if it is demonstrated that the corporation is not in a position to shoulder the liabilities of the director’s actions. Several cases have been litigated in the United Kingdom in which a company’s directors have been accused of fraud and using the incorporation principle as a protection (Rudorfer, 2009). For example, in the Gilford motor company limited v Horne, in which Horne was employed with a contract that did not extend to customer solicitation. Due to such actions, which were seen to contravene his contracts, the company brought a lawsuit against him to answer to his fraudulent actions before the law. In the court of appeal ruling, it was established that the main reasons for incorporating the company under his wife’s name was to perpetuate fraud. The company thus acted as a device or stratagem to cover up for his business which involved soliciting the company’s customers while still working with them (Gower, 2003). The veil of incorporation was lifted in this case and Horne was made accountable and directed to pay the company in person for the losses his action caused the company and its employees. Another case that demonstrates the benefits of lifting the veil of incorporation in fighting fraud is the Jones v Lipman case. In this case, a man was contracted to sell his land but changed his intention along the way and decided to transfer the ownership of the land to a company. When making the ruling in this case, the judge referred to the Gilford v Home case and established that the transfer of the land in the name of the company was a mask for committing fraud (Bainbridge, 2001). By using the company, Lipman intended to cover his face to avoid being recognized by eye of equity and be held accountable for his actions which were guided by fraud. The two cases demonstrate that despite the presence of the incorporation doctrine, the court cannot be used to allow for fraudulent transaction under the cover of the company being an independent entity. In the event that it is proved before the court that such a misuse of the principle occurred, the corporate veil will be lifted to protect the innocent citizens from fraud (Rudorfer, 2009). Group enterprises are at times operated by the incorporation rule that makes the action of the group members seen in isolation to the group itself. However, this has been abused in a number of instances and the lifting of the corporate veil used as a weapon to protect innocent members. For example, the case of D.H.N. Food products ltd v Tower Hamlets London Borough Council provided the precedent for disregarding the Solomon principle to protect specific interest groups. These companies operate as a subsidiary, which the court rules to act like an economic entity that was entitled to legal compensation (Gobert & Punch, 2003). Despite the fact that groups of companies are most of the time treated as one in the case of doing the financial accounting, the shareholding nature however determines the extent of responsibility in the time of a dispute. The court thus established the group enterprise cannot be a ground for protecting individual companies against their actions and holding the entire unit accountable. The court thus lifted the corporate veil in the case and this created a room for the complainant to face the individual enterprise as opposed to the incorporated group as the defendant may have wished (Bourne, 2013). Most companies contract agent companies to act in their behalf in almost every transaction including interacting and negotiating a contract with the customer. Such agents may be incorporate companies in the face of the law, which have independent legal responsibilities and boundaries in their actions. In the case the agent acts in a manner that the parent company’s character is in question, the nature of the agency contract between the two companies makes it possible for the corporate veil to be lifted and the parent company made to indemnify the actions of the agent. In the case of Bodrip v Solomon, the court established that the agent was a mere instrument under the instructions of Solomon and that the businesses transacted by Solomon’s company were his business and no one else could be held accountable for the actions of his agents (Miller & Jentz, 2011). At times, the incorporation of a company is done for the purpose of fleecing the public, engaging in illegal businesses like arm trade among others. Such kind of businesses has occurred before the eyes of the law due to the incorporation law that protects the individual shareholders of the company from being held responsible. In most cases, the courts have lifted the veil of incorporation to study the character of shareholders and establish whether the incorporation doctrine is being misused (Elkin, 2012). This was done in the case of Abbey and Planning in which the court was convinced to lift the corporate veil of a school that was being operated as a company with main share held as trustees. The piercing enabled the court to establish the terms under which these trustees were holding the shares of the company and to what extent it shielded them from being held liable for the actions of the company (Hannigan, 2012). Despite the benefits of applying this principle, the English law has often failed to apply the principle and obeyed the incorporation rule. The arguments given for such actions have cited the weaknesses of the lifting of the corporate principle in determining the extent of liability for individual shareholders. This has provided some light on the weaknesses of this principle especially before the English law as most appeals before the House of Lords have been successfully executed. The incorporation of companies act has acted to shield individuals from being held liable for prosecution for the decisions they make for the company, which may affect the business partners of the company (Miller & Jentz, 2011). Disadvantages of the lifting the corporate veil One major problem that arises from continuous use of the lifting of the corporate veil principle is the insubordination of the independent corporate existence principle. A company upon registration is deemed to have gained a personality that enables it to act, sue and be sued, actions that are independent of the people within. This was strengthened when the House of Lords disregarded an appeal ruling in the Salomon v Salomon & Co ltd case in which the company was being forced to take responsibility for the actions of the agents. Through the revocation of the decision, the House of Lords established that the principle of incorporation takes precedence over any law and thus protects the members of a company from being held personally liable for the actions of the company itself (Vanderkerckhove, 2007). The application of the piercing the corporate veil principle also eliminates the possibility of the company enjoying the perpetual existence that is common in the event that any member of the company cease to exist. By holding the members personally responsible for their actions, no other individual may be willing to be readily associated with the company for fear of being made to indemnify the company’s stakeholders in case of a problem (Hawke, 2000). Conclusion The application of the lifting of the corporate veil principle has continued to create room for heated debate among company law professionals with some supporting while others opposing it. At times however, the actions of the members of the organization cannot be legalized by the incorporation act and this gives them the room to continue engaging in fraudulent deals. The application of the lifting the corporate veil doctrines makes it possible for individual members of the company to be held accountable for the actions they committed in their own best interest and not that of the company (Lacy, 2002). Despite the massive benefits of applying this principle, cases that have been reversed by the House of Lords have emphasised the need for respecting the incorporation and ensuring continuity of the company by not targeting individual members of the company. References Allen, N 2012, Reverse piercing of the corporate veil: a straightforward path to justice, Business law journal, 16(1), 25-40. Kryvoi, Y 2012, Piercing the corporate veil in international arbitration, global business law review, 1(169), 169-187. Daniel J 2007, Piercing All the Veils: Applying an Established Doctrine to a New Business Order, Iowa Journal of corporate law, 529. Elkin, J 2012, lifting the veil and finding the port of golf: piercing the corporate veil and substantive consolidation in the United States, dispute resolution international, 6(2), 131-148. Ramsey M. & David B 2005, Piercing the Corporate Veil in Australia, Melbourne University Press. 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