Company Revision 2: Piercing the Veil

Corporate personality

Salomon v Salomon: after incorporation, a company becomes a legal entity separate and distinct from its shareholders and is not the agent of those shareholders, not even if it is a one-man company with one shareholder controlling all activities.

• The company is not, per se, an agent of its shareholders.

Gramophone v Stanley:

• Facts: shares of a German company owned by English shareholders. Was the business of the German company business of its shareholders? Where is the company taxed?
• Buckley LJ – German company was legitimate, it conducted real business
• Was it really an agent of English shareholders?
• Held: No. It is well established that the holding of all shares does not establish the relationship of P-A, therefore company taxed in Germany.

Agency

Smith, Stone & Knightv Birmingham Corp

• Parent company tried to maximise compensation from compulsory purchase of its subsidiary.
• Argued that subsidiary is an agent
• Atkinson J – Test: agency relationship is a question of fact in each case, and depends on whether the subsidiary is carrying on the business as the parent company’s business or as its own. (but this approach was criticised in Yukong Line as coming close to the approach rejected by the HoL in Salomon).
• Was the parent’s control of the subsidiary so comprehensive (effective and constant control) as to make the subsidiary an agent? Held that subsidiary was a legal entity, and ‘that is all it was’. ➔ agent.

Adams v Cape Industries:

• English company with subsidiaries in the USA
• On such subsidiary carried out some actives as its own principal
• CA held that it was indisputable that a substantial part of the business carried on by the subsidiary was in every sense its own business ➔ no agency relationship

Sum up

• Salomon v Salomon: no agency relationship per se
• SSK v Birmingham: courts will look at the detailed circumstances, but they must be more than mere control and ownership of shares to amount to A-P relationship.

Macaura v Northern Insurance Co: the main shareholder cannot insure company’s property. ‘the corporator, even if he holds all the shares, is not the corporation.’ Per Lord Wrenbury.

Foss v Harbottle: Where a wrong is done to the company, the company is the proper plaintiff of it. Shareholders cannot sue for loss from diminution of shares resulting from the wrong (e.g. where company has a claim in tort against the wrongdoer), his loss in share value is only reflective of the loss by the company.

Disregarding the separate entity

In general: The ‘piercing’ doctrine is used sparingly, lest it creates uncertainty. The original position in Salomon v Salomon was respected. However, piercing does not remove the incorporation of the company, merely to address a particular wrong which allows courts to use its jurisdiction.

• Remedy is granted against both the company and the wrongdoer
• Court recognises the legal status of the company, but still enforces obligation against the ‘true defendant’

Piercing does not disregard the corporation, it is limited in operation ad consequence.

Antonio Gramsci Shipping Corp v Stepanovs: “there is no good reason of principle or jurisprudence why the victim cannot enforce the agreement against both puppet and puppeteer who, all the time, was pulling the strings”.

• Similar to Guildford Motor v Horne
• Distinguishing feature here was that subsidiaries created specifically for fraud

Yukong Line: the veil cannot be pierced to have retrospective effect. A charter-party was entered into and repudiated, but the veil cannot be pierced to make the parent retrospectively a party to that contract.

VTB Capital v Nutritek Intl Corp: The doctrine cannot make the defendant a party to the contract.

• Only gives rise to equitable remedies, such as and order for account or injunctions (the only thing that ignores privity of contract).
• E.g. in Gramsci, equitable relief was ordered against puppeteer so they cannot escape contract obligations.

Piercing the corporate veil – the ‘mere façade’ test

Woolfson v Strathclyde Regional Council:

• Applied for compensation (under the LPA?) for compulsory acquisition of land
• Land belonged to W, but C occupied it.
• Argued that W and C should be the same for purposes of compensation
• HL dismissed the argument, holding that: “it is appropriate to pierce the veil only where circumstances exist indicating that the company is a mere façade concealing the true facts”
• Facts: W had no interest in C, and only held 2/3 of shares. Therefore, it cannot be treated as the sole owner, and there seems to be no element of impropriety here.

This test applied in : Adams v Cape, Trustor AB v Smallbone

Ben Hashem v Ali Shayif: There is no particular magic in the word ‘façade’. Must establish control and impropriety.

Gramsci: if there are a number of wrongdoers with a common purpose in material control of the company, the veil may be lifted against one or all of them.

Adams v Cape: piercing does occur when a corporate structure has been used to evade i) limitations imposed on his conduct by law, ii)such rights of relief as third parties already possess against him. The motive of the D’s very important in applying the mere façade test (to evade limitations imposed by law).

Examples of evasion of performance

Jones v Lipman: D tries to avoid specific performance, transfers property to company he owns. Courts imposes specific performance on both the D and the company.

Gilford v Horne:

• Facts: Covenanted not to sell to customers for time period after employment.
• D set up company and sold to old customers.
• Held: company was formed as a device to mask the carrying on of business in breach of pre-existing legal duty ➔ injunction against both eh company and defendant.

Evasion of consequences following non-performance of obligation

Re a Company: Asset transferred so as to be out of reach of claimants. Veil pierced so asets can be pursued.

Trustor v Smallbone: £39k went missing from claimant company, £29k ended up in one company which is front for S, a former director. Held S and company was jointly and severally liable from the money. S had no defence. Application of the Woolfson test.

Kensington v Republic of Congo: Several companies set up to mask the Congo’s sale of oil. The Congo was held to be the seller in fact, as it received proceeds of sale. This was done to avoid creditors who are taking aggressive action against the country. Held a façade.

Piercing the veil, policy

Rights of relief that third parties may later on acquire will not validate piercing (as incorporation may only be an exercise in risk management): If original business plan was to prevent future risk falling on this entity and not that entity… it is valid (Adams v Cape).

Macdonald v Costello: If the contractors were able to enforce liability upon the owners of the dissolved business, the would be unfair on other secured creditors. To avoid the risk, contractors should have sought out personal guarantees beforehand.

Chandler v Cape Industries: there is liability in tort only if 4 part health test as above.

Corporate group – separate legal entities

Courts will take the default position in Adams v Cape (was subsidiary carrying out substantially the same business of the parent company?), “save in cases which turn on the wording of particular statues or contracts, the court is not free to disregard the [default principle] merely because it considers that justice so requires…”. (courts cannot pierce merely because it is just to do so).

Some suggestions to change this stance:

• This approach is inappropriate in the modern world?
• Veil should be pierced more often to reflect commercial reality that companies often trade as a group.
• Lord Denning in DHN Food v Tower Hamlets suggested development of a group enterprise law, but this was rejected in Woolfson.

Reasons for a group structure

Primary reasons for a group structure might be: to limit liability, diversification, geographical spread or administrative convenience. Templeman J in Re Southward Ltd pointed out:

• Risk management: “the parent company can discard the runt of the latter”
• But in reality it does not make economic sense to do, especially if creditors are also creditors or suppliers of the parent company, and the parent needs to retain reputation.

But if creditors are to protect their position, they must use contractual devices to do so.

Kleinwort Benson v Malaysia Mining Corp: a letter of comfort has no legal effect. This is a just a moral obligation. Creditors with lower bargaining power may only e able to extract such documents in the hope the company decides to honour their moral obligations.

It is also possible that, in insolvency, a liquidator may be able to establish that parent has exercised such control over the subsidiary as to constitute itself as a shadow director of the subsidiary. Re Hydrodam ➔ potential civil liability. But it is a remote prospect, would be easier to claim under wrongful trading…

Position of creditors

Case law generally how lack of sympathy for voluntary creditors. However, if they are involuntary creditors – victims of some occupational disease/corporate accident ➔ there will be remedies in tort of company was found to breach a duty of care (Chandler v Cape).

Corporate acts and liabilities

Corporate liability idea – attribution ➔ deciding whether the acts of an individual(s) should be attributed to the company such that they are acts of the company. Examples include:

• Fraud of a controlling beneficial owner
• Ex turpi causa (a claimant cannot claim if it arises in connection with his own illegal act)
• Prevents companies relying on insurance policy which excludes liability for deliberate acts of the company.

Corporate liability in contract

Two things need to be considered

• Commitments made are within capacity of company or authority of the contracting agent
• If all due formalities has been carried out

Corporate liability in tort

Separate legal entity, so can sue and be sued in tort. However, al torts of a company are committed through human agents.  

• Vicarious liability: for acts of an agent acting in the scope of his authority or in the course of his employment.
• Agent is personally liable, and company vicariously liable as joint tortfeasors, each for the entire loss caused.

Lloyd v Grace, Smith & Co: “principal liable for the frauds, deceits, concealments, … of his agent in the course of his employment, although the employer did not authorize, justify … or even if he forbade the acts, or if he disapproves of them.”

Should a director be liable? Important in one man company cases

Conflicting policy issues:

• Holding a director liable conflicts with the Salomon principle, denying protection conferred by statute.
• General approach: a director is not automatically identified with his company for the purpose o law of torts, “enterprise should not be discouraged by subjecting directors to such onerous personal obligation w/o due regard to the role he plays personally in the acts complained of” (Evans and Sons v Spritebrand)

VS

• Individuals should not be able to avoid liability by hiding behind a corporate veil (MCA v Charly)
• Status as director does not confer immunity from personal liability (Standard Chartered v Pakistan National Shipping).

Standard Chartered v Pakistan National Shipping

• Facts: Director presented false documents, company obtained £1.1 million from a bank.
• Found liable under tort of deceit, but was director personally liable for representation not made for himself but on behalf of the company?
• Yes
• L. Hoffman: noted the director was not being sued for the company’s tort, but his own tort, all elements proven, liable not because he was a director, but because he committed fraud…
• His status as director at the time of the act did not confer immunity

Other personal liability cases:

GE v Gee: executive chairman owned 80% of the company. Finance director made a misrep, known and encouraged by executive chairman. Chairman was personally liable.

Negligent misrepresentations

However, the position here is different.

Williams v Natural Life Health Foods Ltd: Negligent advice by a one man company, relied on and resulted in losses. Held director was not personally liable. Company functions centred in one man does not make him liable, unless he assumes personal responsibility (special relationship test). Can plaintiff personally rely on assumption of responsibility?

Directors’ liability for procuring wrongdoing

MCA Records Inc v Charly Records Ltd: A director is not liable as a joint tortfeasor with the company if he does no more than carry out his constitutional role in the governance of the company e.g. voting powers.

• But if a director or controlling shareholder chooses to exercise control otherwise than through the constitutional organs of the company, and circumstances are such that he would be liable if he were not director or controlling shareholder, no reason why he should not be joint tortfeasor…
• Question is: is A the director of B (primary infringer)

Question is: was the director personally involved?

Koninklijke Philips Electronics NV Prico: the director’s close involvement of the day to day actions of the company, his independent authority in respect of those actions, were sufficient to render him liable as a joint tortfeasor with the company. (following factual analysis of course)

Criminal liability

Liable as a legal person, apart from unique offences such as murder, bigamy, etc. Actus reus and mens rea analysis also used.

Vicarious liability

Can be liable via vicarious liability, Attributed in accordance to rule in Meridian Global Funds Management Asia Ltd v Securities Commission which sets out rules of attribution, by Lord Hoffmann (Privy Council decision).

Prior to Meridian:

• test was ‘the directing mind and will of the company approach’
• requires finding natural persons who are seen as embodiments of the company such that their acts may be attributed to the company (identification doctrine), which derives from Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd:
• “corporation is an abstraction … no mind/body of its own.. acts through agents ⇒ the directing mind and will, the very ego and centre of the personality of the corporation”

Lord Denning’s distinction in HL Bolton v TJ Graham

• some agents are hands that carry out the work, others are directors who direct the mind and will of the company. “…the state of mind of those managers is the state of mind of the company and shall be treated as such.”

Tesco v Nattrass

• Failure by one of a hundred directors, one could not be embodiment of the company
• Defence: default of ‘another person’
• Company has exercised reasonable care

Until Meridian ⇒ Broad purposive approach (purpose of the Act)

Applies to situations where individuals are not vicariously liable, nor can be the directing mind and will of the company…

Facts:

• 2 employees of a HK investment management company, one of them chief investment officer, used company funds to purchase 49% of NZ company
• not disclosed, contrary to NZ Securities Amendment Act 1988
• argued:
• employees not the directing mind and will
• no breach

Privy Council:

• on a true construction of the relevant statute in view of the policy of legislation, it was appropriate to attribute knowledge of senior employee … otherwise policy of Act would be defeated
• otherwise would be beneficial for board of directors to be negligent

Lord Hoffmann:

• it was a question of construction in each case as to whether the particular rule requires that the knowledge that an act has been done, or the state of mind with which it was done, should be attributed to the company?

Morris v Bank of India

• Key issue: was the bank employees responsible for entering into the transactions at issue knew that they were assisting a fraud by BCCI? And should their knowledge be attributed to the bank?
• Court look at construction and purpose of statute
• found that it would be inappropriate to limit attribution
• whose knowledge counted?
• would defeat the section if those just below board level did not make company liable
• here the senior agent had more knowledge than board in this transaction
• Caution: “it would be wrong to attribute to a company the knowledge of any agent irrespective of the facts… Main issue: would purpose of Act be defeated?

Continuation of old rule

Meridian rule just an addition, a special rule.

A-G’s Ref No 2 of 1999

• Meridian was an additional rule geared to the purpose of the statute
• Primary ‘directing mind and will’ rule still applies, but not determinative in all cases, new rule affirms identification theory.

Stone & Rolls v Moore Stephens

• Company used as vehicle for fraud by S, beneficial owner
• Defrauded banks sued company, but insolvent
• considers defence of ex turpi causa…