Lifting of Corporate Veil - Essay Example

? The various ways by which the court has lifted the veil of incorporation and disregarded the corporate entity are so varied as to strongly suggest that the court is guided above all by the principle that it will do so when fairness and justice require it.-Discuss. Table of Cases Adams v Cape Industries Plc Connelly v RTZ Corp Plc Conway v Ratiu Dimbleby & Sons Ltd v National Union of Journalists Gilford Motor Co v Horne Jones v. Lipman Rachel Lubbe v Cape Plc Salomon v Salomon & Co Ltd Smith, Stone and Knight Ltd v Birmingham Corporation Tate Access Floors Inc V Boswell Introduction One of the main aims of the company law is to safeguard the shareholders’ from being subject to personal accountability for the risks of managing a business. The intention of the law makers is to establish a corporate fiction which is regarded as a legal juristic person with a separate legal entity, which is distinctive from the shareholders who own it and which gives the primary benefit of limited liability to shareholders. The main aim behind is that to encourage the shareholders to offer capital and to assume more risk on investments. By designing this, not only the costs are externalised but also the risk is mitigated to third parties. Due to this limited liability criterion, investor confidence is encouraged which in turn will kindle the economic development. Thus, limited liability can be seen as the foundation of the capitalism. Further, as moral hazard comes into operation, the benefits may not be equal to the externalisation costs thereby creating economic losses to third parties. So as to promote justice and fairness, the court may disregard the assumption of limited liability infrequently and thus court will inflict personal liabilities on the shareholders for the losses suffered by third parties in dealing with the company. This doctrine is called as lifting of corporate veil and this research essay will analyse how the courts are lifting the corporate veil when fairness and justice require it. Thus, the lifting of the corporate veil is a highly litigated issue in the corporate law sector1. Lifting of Corporate Veil under Fairness and Justice Grounds Under English Companies Act, the company is a distinct legal person wholly divergent from its members, and the company is entrusted to enjoy the privileges and owe some duties, which are distinct from that of rights or duties enjoyed by its shareholders. This notion has been regarded as a veil, a curtain or a shield between the members and the company. As an iron curtain, the shield is regarded as an impassable curtain. This has been well established in the case Salomon v Salomon & Co Ltd2. In this case, “it was held by the House of Lords that the company had been incorporated appropriately, and it was a legal person before the law and was different from those who established it”. As there was no fraud was committed by Solomon, the House of Lords were of the opinion that the secured debentures issued to Solomon would have priority over the unsecured creditors in the case of winding up proceedings of the company. Though 100% shares were held by Solomon and his family members, the court observed that company is distinct from its shareholders3. The creditors witness an inherent peril in dealing with a company since liability of shareholders is limited. When the risks are improperly or excessively transferred to creditors by the shareholders, then the liability shield is not justified. Under this scenario, courts have the capacity to disregard the separate corporate identity. The courts balance two competing features namely offering economic and democratic justification for the limited liability characteristic so as to promote the growth of the economy and the corporations and hence, the courts will be always hesitant to lift the corporate veil. However, the society and the creditors should be safeguarded as well from any peril unleashed by the companies and the shareholders. This fairness argument compels the courts to lift the corporate veil in appropriate cases. Thus, the courts will occasionally disregard the separate legal entity and will inflict the personal liability, mainly to compensate the sufferer, to deter probable wrongdoers and to sanction the offenders4. Nonetheless, this characteristic of distinct legal personality is lifted or pierced by the court, if the same is employed to defeat the public expediency, to defend crime, to justify wrong or to safeguard fraud. In such scenarios, the law ignores the distinct entity and will look beyond the legal facade to ascertain the real economic background. In such circumstances, the court will disregard the concept of artificial person and will pay attention to the legal characteristic of natural persons – the board of directors of the company5. The court will look beyond the corporate veil and will go beyond what had been held in Salomon v Salomon & Co. Ltd when such corporate veil is needed to be lifted on the ground of justice and fairness. Fundamentally, the courts are in a diverse situation in arriving at a conclusion, whether to lift the veil or not. However, over the passage of time, the courts have transformed from its hard rule of extending the rationale applied in Salomon case and have started to apply more interventionist approach, mainly to accomplish justice in a specific scenario. In Adams v Cape Industries Plc, the Court of Appeals declined to lift the corporate veil and strictly enforced thee separate legal entity principle. In Adams case, the Court of Appeals observed that to lift the corporate veil, the following should be present: Where the company is mere a sham Where a court is construing a document or a statute so as to turndown fairness Where the subsidiary functions as an agent of a parent company. The court lifted the corporate veil when there were health and safety issues. In Connelly v RTZ Corp Plc , the Court ignored the place where the major decisions of the company were taken ( England) and considered in favour of the jurisdiction where the major decisions were took effect (Namibia). In Rachel Lubbe v Cape Plc, the parent company was held liable for the health and safety issues of its subsidiary in South Africa6. When separate legal entity facade was abused or infringed, the courts will never hesitate to lift the corporate veil on the grounds of justice and fairness. In Gilford Motor Co v Horne, when corporate entity was used as a cloak or sham, the court never failed to interfere and lifted the corporate veil. In this case, Horne was the erstwhile managing director of the Gilford Motor Co and Horne had made a promise through a contract that he would not solicit any customers of the Gilford Motor Co in case if he departs from the company. Later, he resigned and formed his own company and started to woo the customers of Gilford Motor Co. Horne argued that though he was bound by the contract, and he would not be held accountable for the contracts entered by his company as the company is a distinct legal personality. In this case, the court lifted the corporate veil and held that Horne’s company was mere a sham or a cloak and Horne employed the corporate structure to evade the contractual obligations with the Gilford Motor Co. Thus, to safeguard the justice and fairness, the court will never allow the corporate structure to be an instrument of illegality or fraud. Thus, the court will never hesitate to lift the corporate veil if a company is used for illegimate or for fraud transactions. In Jones v. Lipman, the defendant agreed to sell a freehold land to the plaintiff. During the pendency of such agreement, the defendant transferred the said land to a company where the defendant and his employee were shareholders. The plaintiff initiated an action for specific performance and he argued that the company was mere a sham or cloak for the defendant. It was held by the court that the company was the invention of the defendant, and it was nothing but a mask or sham and he misused the corporate identity, mainly to disrupt the acknowledgement by the eye of equity. Hence, the court passed a verdict on the defendants to specifically perform the agreement between the Lipman and the plaintiff. 7In Dimbleby & Sons Ltd v National Union of Journalists8, Lord Diplock was of the view that even the parliament had the intention to lift the corporate veil as it had expressed in unequivocal and clear language that court would intervene on justice and fairness grounds when situation needs it. In Conway v Ratiu9 , Auld LJ was of the opinion that courts would not be hesitating to lift the veil to do justice when common reality and sense require it. In matters of contract and property, the courts would be rather hesitant to lift the corporate veil on the ground of reality or common sense or fairness. Those who employ company form of business should be ready to take the rough with the smooth as held by Browne – Wilkinson V-C in Tate Access 10Floors Inc V Boswell11. In Smith, Stone and Knight Ltd v Birmingham Corporation,12 the defendant company made a compulsory acquisition the premises on which the subsidiary of plaintiff’s company carried over the business. The plaintiff company sought the compensation for the loss suffered. However, the defendant argued that only subsidiary of the defendant can be made accountable as it is a separate legal entity from its parent company. Atkinson J held that as the subsidiary was carrying on business on behalf of its parent company, the parent company was authorised to receive compensation for the loss suffered13. Companies Act, 2006 appear to disregard the probability of lifting the corporate veil to make the shareholders of the company liable for the wrongs of the company and instead, it makes the directors and officers of the company liable for the wrongs of the company in specified scenarios. Further, the insolvency law makes the directors personally liable for the debts of a limited company in case if there is wrongful or fraudulent trading. Conclusion The separate legal entity principle as developed in Salomon case is really a double-edged sword. However, despite some of its short comings, the separate legal entity principle has definitely played a vital role for the development of modern capitalism and has resulted in the abundant economic and social wealth across the globe. In some scenarios, the application of separate legal entity principle may pave the way to an unfair outcome. So as to safeguard justice in law, in some scenarios, it is essential for the courts to look beyond the corporate veil and should use the sledgehammer to break open the corporate shell. In various cases, the courts have fundamentally regarded the notion of corporate legal liability on the directors and members of the company. The courts have come forward to disregard the separate corporate legal entity or to lift the corporate veil when there is a need to safeguard the public interest from the wrongdoings of the company or where a company is used to evade tax liabilities and in such cases, the courts have found the company being a trustee or an agent for its members. Thus, the verdict given in Salmon case is not only robust and also remains without any exception. The courts still give paramount consideration to the limited liability concept as it still remains solid and firm and the courts will not hesitate to lift the corporate veil if fairness or justification needs it. 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