The Veil of Incorporation - Assignment Example

The Veil of Incorporation Introduction Veil of incorporation can be defined as the legal provision in which a company or incorporation is made a separate legal body from its shareholders and directors. As a result of this provision, company directors and shareholders are protected from taking responsibility for the mistakes committed by the company under their jurisdiction. As such, the assets of company directors, investors and shareholders are protected from lawsuits that directly involve a corporation or company. In the event that a company incorporates, it therefore becomes a single legal body and is distinct from the persons who formed it or invested in it (Sealy, 2011, p. 72). In the same way someone cannot be held liable for the misbehavior of another person, except for when they implicitly or expressly assumed liability, directors and other shareholders of a company can never be bound by the duties and rights of the company. It is important to note that the incorporation of corporations through registration was first introduced in 1844. This was followed by the principle of limited liability in 1855. This assignment therefore provides a detailed discussion of the veil of incorporation and gives an in-depth analysis of the circumstances in with the incorporation is upheld (Anderson, 2008, p. 87). With specific case examples, the paper discusses the instances in which the veil can be lifted. Acts of parliament have also lifted the veil in a number of circumstances. The paper therefore provides information on how acts of parliament can be able to lift the veil. Discussion Companies or corporations are meant to be independent entities. It is for this reason that the veil of incorporation identifies companies as independent bodies whose liabilities are not shared by neither their owners nor people employed to run them. One ought to note that the main advantage of the veil of incorporation is the fact that owners’ and employees’ assets are protected from repossession in the event that the company or corporation they are in charge of is in debt. For this reason, the entire law of incorporations is based on the principle of corporate entity. The inception of the veil of incorporation The veil of incorporation was first ruled in the UK in 1897 in a court case that involved Salomon and Salomon and Co. LTD. This court ruling forms the basis of the veil. The case has since been a point of reference when it comes to the veil of incorporation. The following is an in-depth description of the Case 3: Salomon v/s Salomon and Co. LTD. (1897) The principle of a distinct legal entity arose from the case of Salomon versus Salomon & Co. LTD in which Salomon had a company with all its shareholders being his family members. The business became a failure and it is here that a number of issues arose. Total value of the company’s assets was insufficient to compensate the company’s creditors and Mr. Salomon. Another concern was raised by the creditors concerning Mr. Salomon’s compensation. They argued that the level of control that Salomon had exercised over the company could not allow him receive compensation. Solomon then decided to sell his prosperous shoe business to Salomon and Co. for a sum of 30,000 Pounds. The company was made of Salomon, his wife, daughter and four sons. Salomon’s debenture in the company was a total of $10,000 while the unsecured creditors claimed a total of $7,000. During a court petition, the creditors had a claim over the debenture holder. These claims were on the ground that Salomon and company were to be considered as one. However, the House of Lords ruled that the existence of Salomon’s company should be considered independent from its members. As a result, the company’s assets were to be utilized to compensate the debentures first before the unsecured creditors. The House of Lords held that even though Salomon had all the shares of the company, he was the secured creditor and for this reason he was entitled to compensation before the unsecured creditors were compensated. This then formed the basis of then veil of incorporation. Practical consequences of veil of corporation and case examples to illustrate it One of the practical consequences of the veil of corporation is that company owners and employees are restricted from blanketing their fraudulent acts with the company name. On some occasions, company directors or even employees may be tempted to engage in fraudulent deals with the purpose of pinning the blame on the company. It is for this reason that the veil can be uplifted in order to address such issues (Maisto, 2007, p.98). A classical example of a court ruling in which the veil of incorporation came in handy was Prest v/s Petrodel Resources Ltd (2013) UKSC 34. Mr. Prest was a business person who owned numerous offshore companies that he managed almost single handedly. These companies were majorly focused on owning residential properties, alongside the matrimonial home him and his wife lived in. A moment came when their marriage ended. Mrs. Prest then claimed huge financial assistance based on the value of the companies and real estate businesses. The Matrimonial Causes Act did not have a provision for treating assets not belonging to a party to the marriage. All the companies and their assets were treated as independent entities. However, the judge ruled that Mr. Prest was using the veil of incorporation to evade his legal responsibilities especially for compensating his ex-wife after a divorce. Instances where the veil of incorporation is legally lifted The veil of incorporation was playing a significant role in sorting issues regarding companies and their directors until people began using the veil as a cloak for their fraudulent deals. They began using the veil to deliberately frustrate and evade legal obligations and liabilities. It is for this reason that the courts came up with a provision of lifting the veil and looking at the sole beneficiaries of what would best be termed as corporate fiction (Wallace, 2002, p. 119). Lifting the veil of incorporation simply means paying no attention to the corporate personality and scrutinizing persons in control of the company or corporation. There are a number of instances when the veil can be lifted by the courts. These circumstances include: Improper conduct or fraud For the promotion of revenue When a company assumes and enemy character During instances when the corporation is a sham When the company avoids welfare legislations For public interest purposes a) Improper conduct or fraud In the event that fraud is committed behind the veil then the courts have all the reasons to lift it. This is an indication that the law does not give room for the use of the Salomon principle as an instigator of fraud (Mead, Sagar, Bampton, & Foster, 2006, p. 46). A classical example of when the veil can be lifted in such instances is in the case of Gilford Motor Company Ltd v/s Horne. Mr. Horne was a former employee of Gilford Motor Company and his contract had stated that he could not poach customers from the company to another company. As a way of overcoming this clause, he formed a company under his wife’s name and poached customers from his initial employer. When Gilford Company sued Mr. Horne, the courts ruled that Horne had incorporated the new company with the purpose of committing fraud. b) For the promotion of revenue The courts have the jurisdiction to ignore the veil of incorporation when it is used as a tool for tax evasion. Additionally, the courts have the power to overlook the veil if it is used to circumvent tax responsibilities (Anderson, 2008, p. 118). c) When a company assumes and enemy character A company is said to have assumed an enemy character in the event that its directors or persons who exercise full control on it are found to be citizens or residents of an enemy country. In such instances, the courts examine the traits and behaviors of those in real control of the corporation as opposed to treating the company as an independent legal entity (Wallace, 2002, p. 89). d) During instances when the corporation is a sham The courts also have the jurisdiction to lift the veil of incorporation in the event that a company or corporation is proven to be a mere sham or cloak. e) When the company avoids welfare legislations All companies are obliged to take part in welfare legislations. Avoidance of welfare legislations is treated in the same way as evasion of tax. Therefore, the courts may lift the veil if a company is guilty of avoiding welfare legislations (Maisto, 2007, p.98). f) For public interest purposes Some companies may be involved in transactions that neither favors public policies nor interests. In such instances, courts are allowed to ignore the veil of incorporations. Ways in which acts of parliament lift the veil There are a number of ways through which the veil of corporations can be lifted through acts of parliament. These provisions are enshrined in the Companies Act of 1985. For instance, a company ought to have at least two members. In the event that a company has a single member for a period of more than six months, the member is held liable for any sort of debts that were incurred during that time (Pathak, 2013, p. 78). The Transfer of Undertakings Regulations of 2006 stipulates that if a company is transferred from one corporation to a sister corporation then the employment period of that particular employee is considered continuous (Wallace, 2002, p. 80). There are also other instances when the employees or owners of a company may be held liable according to acts of parliament. For example, all public corporations are required to have an S117 certificate failure to which the director become personally liable for debts accumulated by the company (Sealy, 2011, p. 67). A company cheque must be written in the name of the company exactly. Failure to do so, the person who signs it becomes liable in the event that it is not cleared. According to the Company Directors Disqualification Act 1986, a director who has been disqualified as one of the directors of a company is personally liable if they perform the duties of directors during the disqualification period. In the event that a director knows that his or her company is nearing insolvency and continues to transact businesses, they are held liable. A case example of this scenario is Courts Furniture Ltd that continued taking new orders in spite of the fact that its directors were aware of its nearing closure (Mead, Sagar, Bampton, & Foster, 2006, p. 76). In my opinion, it is absolutely fair for courts to lift the veil of incorporations if it is abused or if the law is not observed. However, it is not true to say that courts always lift the veil even in circumstances that the lift is totally unnecessary. The lift only happens in cases where directors or employees fail to uphold the law or are trying to evade their legal responsibilities. References Anderson, H. (2008). Directors personal liability for corporate fault: A comparative analysis. Alphen aan den Rijn: Kluwer Law International. Gilford Motor Co Ltd v Horne. (1933) Ch 935. Maisto, G. (2007). Courts and tax treaty law. Amsterdam: IBFD. Mead, L., Sagar, D., Bampton, K., & Foster, B. P. (2006). CIMA Certificate in Business Accounting: Paper C05. Oxford: Elsevier. Pathak, A. (2013). Legal aspects of business. New Delhi: Tata McGraw-Hill. Petrodel v Prest. (2013) UKSC 34. Salomon v A Salomon & Co Ltd. (1897) AC 22. Sealy, L. S. (2011). Sealy & Milman: Annotated guide to insolvency legislation 2011. London: Sweet & Maxwell. Wallace, C. D. (2002). The multinational enterprise and legal control: Host State sovereignty in an era of economic globalization. The Hague: M. Nijhoff. Read More