Examine The Concept Of Corporate Veil Essay

Question:

Critically examine the concept of corporate veil?

Answer:

Under the company law a company is generally considered as a juristic person. The result is that it has the same rights and the duties and can also own real property, enter into contracts in its own name and the company also has the capacity to sue and be sued using its own name. The result is that a company is considered as a juristic individual and mostly, it is considered as a natural person. At the same time, a major factor that motivates the registration of a company is the benefit of limited liability provided to the stockholders. As a result of this doctrine, the shareholders of the company are liable only to the amount of their shares. However, a significant exception is present to the doctrine of limited liability. Therefore, under some circumstances, the court may decide to pierce the veil for the purpose of looking through the corporation (Robert, 1991). This act of the court is known as piercing the veil. In such a case, the court can treat the shareholders personally accountable for the obligations that may otherwise be imposed only against the company.

The principle of lifting the veil is invoked in cases where the distinction between the corporation and its shareholders has been blurred. At this point, it has to be mentioned that although a company enjoys a legal identity, that is separate from its members however the company can act only with the help of human agents. The result is that to main methods at present through which a company can be held liable. These are the direct liability (in cases of direct infringement) and through secondary liability (related with the acts of human agents acting course of employment).

In this way, after a company has been registered, it starts to enjoy a legal personality and is considered as a juristic entity. The company enjoys an identity of its own and it is separate from the owners, shareholders of the members of the company (Farrar, 1990). As mentioned above, certain rights are provided to the company in such a case. Similarly the most significant consequence of the incorporation of a company is the advantage of limited liability offered to its shareholders. Limited liability has been introduced with a view to provide a minimum insurance to the investors regarding the investments made by them in the business and their personal lives. The effect of this doctrine is that the member of the company is liable only to the extent of the amount paid by the member for the shares owned by such a member in the company. On the other hand, the creditors having claimed that is the company can only recover their dues from the assets of the company and generally they are not allowed to sue the personal assets belonging to the members of the company (Ford, Austin and Ramsay, 1999). As a result of this doctrine, a significant advantage was enjoyed by the investors as a cap has been imposed on the risk faced by them. Under these circumstances, it is clear that the companies exist, at least partly, for the purpose of protecting the shareholders from any personal liability regarding the liabilities of the corporation.

The notion of limited liability emerged in England during the 17th century because before this doctrine, individuals were afraid of investing in a company because all the partners are considered as being equally responsible for the liabilities of the business. On the other hand, as a lot of capital was required for the purpose of financing large projects, and as a result much more money was required to be raised, the investors were not coming forward to finance owing to the risk that was involved in standing guarantee for the whole debt of the corporation. In Salomon v Salomon & Co, the court affirmed the legal principle according to which, after its incorporation, a corporation is generally known as a separate entity. The rule provided by the court in this case is still relevant today and is applied by the courts. It was firmly established as a result of this decision that a company can act in its own right and name. Similarly in another case (Gas Lighting Improvement Co Ltd v Inland Revenue Commissioners, 1923), the court stated that between an investor, and the undertaking carried on, the company is interposed by the law as a real, although artificial person. Therefore the business that is carried on in such a case is the business of the corporation and similarly the capital used in the undertaking is the capital of the company and it cannot be considered as the capital of the shareholders, provided the company has been duly incorporated and it is not sham. Another legal notion established by this case was that under the common law, the shareholders can be considered as liable for the debts of the corporation, beyond the amount invested by them in the shares of the company (Ian and Noakes, 2005). Similarly, they do not have any proprietary rights over the property owned by the company. In this regard, it has been mentioned in The King v Portus (1949), for example that while deciding if the employees of the corporation that was controlled by the Federal Government can be considered to be employed by the Federal Government itself, it has to be kept in mind that a company is detached from the stockholders. The stockholders can be responsible for the creditors of the corporation regarding their debts. Similarly, the property of the company is not owned by its shareholders.

But sometimes, the court may decide to lift the corporate veil. This act is totally opposite to the concept of limited liability. Although, the idea of limited liability has several merits, it may sometimes results in the problem of over inclusion that maybe disadvantageous for the creditors. Therefore, it has been claimed that the law has over sheltered limited liability. When the court lifts the veil the shareholders ‘personal assets may also be sued as is the case in a sole proprietorship or partnership.

A registered corporation has its own legal identity that is distinct from the owners (shareholders) or the controllers (directors) of the company. However there are certain circumstances where the law allows records to ignore the rule of the limited liability of the companies and in this way, lift the corporate veil. In such circumstances, the members are individually held responsible for the actions of the company although the limited liability rule provides that the company has a distinctive identity that is separate from its participants. At this point, it should be noted that piercing the corporate veil is considered as one of the most litigating issues under the company law of the UK (Bainbridge, 2001). However before arriving at the decision to use the corporate veil in a particular case, there are certain factors that have to be considered by the courts. It is also worth mentioning that generally the courts are unwilling to do so and in this way, they like to maintain the separate identity of the companies. However there are certain circumstances where a court may arrive at the conclusion that the separate identity of the company should be ignored, for example where they are acting as a single economic unit or for the purpose of achieving justice. In the same way, the corporate veil can be lifted by the courts when the argument of a sham or facade has been made and the same is the case with the agency argument.

In this way, after the legendary decision given in Salomon v Salomon (1897), the courts have recognized the number of factors due to which the corporate veil may be lifted by the courts.

The Single Economic Unit Argument: In the leading case titled as Adams v Cape (1990) it has been argued that in case of a group of companies, the basic principle is that each company of the group has to be considered as having its own distinct identity. But there are certain circumstances when this basic principle can be ignored by the courts and therefore, the companies of the group can be considered as a single company. Therefore in this case, the court arrived at the conclusion that the group of companies can be considered as a single company where it has been allowed by a particular law or by the provisions of the contract between the parties otherwise the rule provided in Salomon's case will apply (Hawke, 2000). In the same way, another leading case in this regard is that of DHN Food Distributors Ltd v Tower Hamlets London Borough Council (1976) where the court considered a group of corporations as a single economic entity and as a result, compensation can be paid for the compulsory purchase of land. In this way, these decisions can be considered as a "short step" that has been taken in the direction of the proposition that the principal provided in Salomon's case can be disregarded by the courts if doing so can be considered as just and equitable. However, these days, such situations are treated as very rare and at the same time, doubts have also been raised on several occasions regarding the decision of the court given in DHN Case, for example in Woolfson v Strathclyde Regional Council (1978).

The Achieving Justice Argument: In the same way, the corporate been calculated by the courts when doing so is required in the interests of justice or where any impropriety has taken place. In this regard, it has been argued that the courts can pierce the veil if doing so is necessary for the purpose of achieving justice, regardless of the legal efficacy of the corporate structure that is being considered in a particular case. However in Adams v Cape Industries, the arguments made in favor of piercing the corporate veil in the interest of justice have been rejected by the court (Ball Jr., Matthew and Nelson, 1997). In the same way, in Trustor v Smallbone (2001), doubts have been expressed by the courts if the veil can be impaled by the courts on the basis of impropriety. Under these circumstances, it can be said that the veil can be lifted in the interests of justice if there is also evidence present to suggest that the Corporation is a sham or a facade.

In the same way, in Woolfson v Strathclyde Regional Council (1978), the House of Lords had stressed upon the fact that the principle of the separate identity of a corporation that has been provided in Solomon's case cannot be disregarded whenever doing so is required by justice or equity.

The Sham/fa?ade Argument: As mentioned above, the Court has recognized in Adams v Cape Industries that it is well recognized that the court may decide to impale the veil and hold the directors all shareholders responsible if the corporate structure is only a facade designed to conceal the real facts (Easterbrook and Fischel, 1985). For example in this case, the court arrived at the conclusion that one of the companies of the group can be considered to be falling in this category. In the same way, the House of Lords has also discussed the argument of facade in Woolfson's case although the meaning of this term has not been explained by Lord Keith. However, regardless of the exact meaning of the term considered by the courts while applying this argument, it was clearly stated by the House of Lords that the Salomon principle cannot be disregarded if it is required by justice or equity. However, it is generally recognized as an exception to the general principle and therefore the corporate field can be pierced by the courts if the Corporation is a sham that has been designed with a view to commit a fraud or for the purpose of avoiding any present contractual obligation (Baxt, 1991). An example in this regard can be given of Gilford Motor Co v Horne where respondent was previously acting as a director of Gilford and had signed an agreement with the company that he will not solicit the customers of the company, in case he quits the business. Under the circumstances, the former director and his wife incorporated a company that was used for the purpose of breaching the terms of this agreement. As a result, the court arrived at the conclusion that the new company incorporated by the defendant and his wife was merely a sham or a cloak and therefore the defendant was liable for the breach of the agreement.

However it needs to be noted in this context that the veil is not lifted if the new company has been established with a view to avoid future liabilities. In this regard, it has been argued by some commentators that in these cases, the piercing the veil is not involved at all (Griffin, 1996). However the argument of sham or facade is the strongest argument that may prompt the court to impale the corporate veil in a given case. In this regard it also needs to be mentioned that this argument is very close to the argument of fraud, although generally this argument can stand in the court on its own. This argument is available when a company can be considered as merely a facade or a sham. Such a situation takes place when the corporate form has been incorporated or used for the purpose of hiding the real purpose that the Comptroller of the corporation has. In Sharrment Pty Ltd v Official Trustee (1988), it has been stated by Lockhart J that "a 'sham' can be described as something that had been created with an intention to be erroneously believed to be something else or something that is in reality not but it imports to be. In this way, it is a disguise or a spurious imitation. In this context, it also needs to be mentioned that the argument of sham or facade can be made independently, without arguing fraud.

The Agency Argument: In some cases, the court arrived at the conclusion that the corporate veil should be lifted where the company in question is only the 'alter ego' of its shareholders. In such a case, it is said that the corporation is the 'agent' or the 'alter ego' of the corporation's shareholders as in this case it does not perform its own business but it merely carries on business on behalf of the shareholders. In this context, an agent can be described as a person who acts on the basis of the directions given by another person, called the principal and in such a case, all the actions of the agent are considered to be binding for the principal. For example in case of corporations, in some cases a subsidiary can be treated by the law as the agent of the parent corporation (Farrar and Hannigan, 1998). For example in Salomon's case, it was stated by Williams J that the company can be considered as an agent of Salomon. But on appeal, the House of Lords arrived at the conclusion that a corporation cannot be considered as an agent of its shareholders only on the ground that it was a one-man company. Therefore on the basis of this decision, it can be said that the presence of an agency situation is not indicated by the fact that all the shares of the company are owned by a single person. As a result, the facts and circumstances of each case has to be considered separately.

Smith Stone and Knight Ltd v Birmingham Corporation (1939) is a leading case that is related with the agency exception. The question that had to be decided was if the subsidiary can be considered as carrying on the business of its parent company or in the eyes of law, the subsidiary was carrying on its own business. In this case, the two companies were treated by the law as a single entity. This case is considered as a significant case related with the agency argument because in this case, the significant factors that have to be considered while deciding the question if the agency relationship is present between holding company and its subsidiaries were mentioned in detail by the court in this case. However, it needs to be noted that these factors act only as guidelines and as a result, each case has to be decided by the courts on the basis of individual facts and circumstances that are present in each case. For example, it has to be considered who's going to receive the profit, who has the authority to appoint and another very crucial factor in this regard is to see who has constant and effective control over the business of the company. When affirmative answers have been given to these questions, it can be said that the group of companies has to be considered by the court as a single entity.

In the end, it can be said that the decision to lift the corporate veil is still one of the most controversial matters under the corporate law. However in this work, an attempt has been made to discuss the principles related with the application of the rule of piercing the veil. For this purpose, the arguments that are generally made in favor of piercing the veil by the court have also been discussed

References

Bainbridge, S.M. 2001, Abolishing Veil Piercing, 26 J. Corp Journal of Corporate Law Spring, 479

Ball, C. Jr., Matthew M. S. and Nelson C. S. 1997, The corporate veil. When is a subsidiary separate and different from its parent? Cornerstone Research Foundation

Baxt R, (1991) ‘Ultra Vires – Has it Been Revived?’ 1 Company and Securities Law Journal 101

Farrar, J and Hannigan, B (1998) Farrar's Company Law (4th edn), p.75

Farrar, J. (1990) 'Fraud, Fairness and Piercing the Corporate Veil’, 16 Canadian Business Law Journal 474

Ford, H. A. J., Austin R. P. and Ramsay, I. M. 1999, Ford's Principles of Corporations Law, 9th Ed

Frank H. Easterbrook & Daniel R. Fischel, (1985) Limited Liability and the Corporation, 52 U. CHI. L. REV, 89

Gower and Davies (2003) Principles of Modern Company Law (7Ed) London Sweet and Maxwell

Griffin, S. (1996) Company Law Fundamental Principles (2nd edn), p.19

Hawke, N. 2000, Corporate Liability, London Sweet and Maxwell, p. 108.

Ian R. M. and Noakes, D.B. 2005 Piercing the Corporate Veil in Australia, Melbourne University Press

Robert B. 1991, Thompson, Piercing the Corporate Veil, an Empirical Study, 76 Cornell L. REV. 1036

Case Law

Adams v Cape Industries [1990] Ch 433

DHN Food Distributors v Tower Hamlets LBC [1976] 3 A11 ER 464

Gas Lighting Improvement Co Ltd v Commissioners of Inland Revenue [1923] AC 723

R v Portus; Ex parte Federated Clerks Union of Australia (1949) 79 CLR

Salomon v Salomon & Co [1897] AC 22

Sharrment Pty Ltd v Official Trustee in Bankruptcy [1988] FCA 179

Smith, Stone & Knight Ltd v Birmingham Corp [1939] 4 All ER 116

Trustor v Smallbone [2001] 1 WLR 1177

Woolfson v Strathclyde Regional Council (1978) ALT 159

How to cite this essay: