This
separate artificial person is capable of owning property, being a party to
contracts, and being a claimant or defendant in legal proceedings.
Consequently, the members of the company enjoy limited liability as the
company is ‘separated’ from them. There is a ‘corporate veil’ in between of
the members of the company and the company per se.
Salomon v Salomon
& Co Ltd (1896) UKHL
The appellant (Salomon) was a boot manufacturer. His family
wanted to become business partner, so he has decided to incorporate his
business as limited company. At the time the legal requirement (Section 6 Companies Act 1862) for
incorporation was that there must be at least seven subscribers to the company.
He was the managing director, and also a shareholder who owned 2,001 of the
company shares, out of 2007. The remaining 6 shares were shared individually
between his wife, daughter and four sons. The purchase price for his business
was £39,000 and to be paid to him in the following ways:
(a) £9,000 was paid in cash
(b) £20,000 was taken in form of 2,000 shares (£20,000 was
paid by transferring of the company shares)
(c) £10,000 in debentures (£10,000 debts to him, which was
secured by a charge over the company’s assets. In other words, he could take
the company assets and sell them to get his money back, if he is not repaid the
debt)
In the first instance it was held that the company was a mere
sham, since Mr. Salomon was the only person running the company. Vaughan J raised the argument of
agency. The High Court felt that the principal was actually Mr. Salomon and
the company was the agent who acts on behalf of the principal. He is the
person who has the duty to pay off the creditors in the event of insolvency.
The HOL considered that the CA 1986 requires nothing more than what was mentioned in the
statute itself. That being said, the question of bona fide and motive to
incorporate is irrelevant. As long the requirements are met, a company is
legally been formed and has separate legal personality from its members.
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Cases illustrating the Salomon
Principle
(i) Lee v Lee’s Air Farming Ltd (1960)
Mr. Lee
owned 2999 shares of the company’s 3000 issued shares. He was the sole director
and also a chief pilot of the company. He was killed in a plane clash and his
widow claimed workers compensation for his death in the basis that he was a
‘worker’ to the company.
The Court of Appeal of
New Zealand held that Mr. Lee wasn’t a worker when he was in effect the
employer of the company. The Privy Council applied The Saloman Principle, held that the company is capable to contract
on its own since the company was a separate legal person.
(ii) Macaura V Northern Assurance Co
Ltd (1925)
Mr. Macaura
owns some timber business and estate, which he later sold them to the company
formed by him. He bought insurance for the timber in his own name. Subsequently
the timber was burnt off.
House of Lords held
that he could not claim the insurance because by selling the business to the
company, the asset was owned by the company rather than Mr. Macaura himself. A
company is capable to hold property in its own name.
(iii) Adam v Cape Industries plc (1990)
This case
involved liability within a group of companies. The first defendant, Cape
Industries, was an English company, head of a group of subsidiary companies.
Its subsidiaries mined asbestos in Africa and shipped it to other countries
which included US. The US marketing subsidiary company called NAAC. A number of
the former employees of NAAC sued Cape Industries, NAAC and other subsidiaries
for personal injuries arising from exposure to asbestos in Texas court.
The Texas
court held that Cape Industries is liable for breach of duty of care in
negligence to the plaintiffs. However, for the US default judgment to be
enforceable in England, the Texas court must have jurisdiction over Cape. Under
the conflict of laws rules, it must be either Cape had consented to US
jurisdiction or was present in the US. It can be the case only if the veil of
incorporation between Cape Industries and its subsidiaries has been lifted,
otherwise Texas court would have no jurisdiction over Cape Industries as NAAC
and Cape Industries are legally separated from each other.
The Court of Appeal held
that the Salomon principle applies equally to the group companies. The parent
company and its subsidiaries are also legally separated from each other;
they all have separate legal personality individually.
LIFTING THE CORPORATE VEIL
Following
the above decision, it could be seen that a company has a separate legal
personality and a veil is drawn between the company and its members or other
companies within the same group organisation.
In some exceptional
situations, the veil may be lifted and the law is then considered
the rights or duties of a company as the rights or liabilities of its
shareholder or parent/subsidiary company. This is known as ‘piercing the
corporate veil’ or ‘lifting the corporate veil’.
A person
(includes a director) can be made personal liable under the Insolvency Act 1986 (statutory
lifting).
According to the case of Adam v Cape Industries, it appears to be three situations for veil
of incorporation to be lifted:
(i) Where the company is a mere ‘façade’
to conceal the true fact
The
courts have been prepared to lift the veil of incorporation where it is deemed
that the company has been used as a ‘sham’ or ‘façade’ to hide another,
dishonest purpose.
The Court of Appeal in Adams v Cape Industries
recognised the ‘mere façade concealing the true facts’ as being a
well-established exception to the Saloman principle. In the case itself, the Court of Appeal looked at the motive of Cape Industries in restructuring its US
business through various subsidiaries. It came to the conclusion that although
Cape’s motive was to minimize its presence in US (therefore avoid
future tax liabilities) and there was nothing legally wrong with it.
This
could be seen in Jones v Lipman (1962),
where Mr. Lipman agreed in writing to sell some land to Mr. Jones, which he
later transferred the land to a company set up by him. It was submitted that
his sole motive in creating the company was to avoid the transaction.
The corporate veil was lifted by the court as the motive of incorporation was
to evade existing contractual liability. Specific performance was
granted.
In Gilford Motor Company Ltd v Horne (1933), a
former employee, who was bound by a covenant not to solicit customers from
his former employer, has set up a company which carried on business in
competition and solicited customers from his former employer. He argued
that he was bound by the covenant but the company was not. The corporate veil
was lifted and an injunction was granted against the former employee.
In Kensington International Ltd v Republic of
the Congo (2008), Congo attempted to avoid its debts by trading oil through a
network of companies. Evidences revealed that these companies and the relevant dishonest
transactions were shams because it was designed to evade existing
liabilities. The veil of incorporation was then lifted. This case
shows the willingness of the court to lift the veil of incorporation
where the motive of incorporation was to evade existing liability.
In Trustor AB v Smallbone (No. 2) (2001), a
managing director of the claimant company, in breach of fiduciary duty,
transferred a various sum of money to another company owned and controlled by
him. The court lifted the veil and held that the company was used as a
device or façade to conceal the true facts that the company was
incorporated to avoid existing liabilities.
Lord Sumption also suggested in Prest v Petrodel Resources Ltd (2013) that the
sham will require an abuse of the corporate structure to evade a previous
liability arising before incorporation.
(ii) Where the subsidiary is an agent
of the company
The court
is willing to lift the veil where the subsidiary is an agent of the company.
This would be the case if a company was carrying on business on behalf of a
principal. The law of agency states that the principal is responsible for
the acts of his agent.
In Smith, Stone & Knight v Birmingham
Corporation (1939), SSK was a paper manufacturer who also owned a factory which
was being rented out to its subsidiary. The Council decided to compulsorily
acquire the land and SSK sought compensation from it. It was held that an
applied agency relationship existing between SSK and its subsidiary. Atkinson J stated that merely
holding all of the shares in a company does not result in lifting the corporate
veil.
It must
be proved that the subsidiary was in reality carrying it on behalf of the
parent company. This is essentially a question of fact (Smith, Stone & Knight v Birmingham Corporation).
However,
this guidance wasn’t followed by the House of Lords in Woolfson v Strathclyde RC (1978) and the Court of Appeal in Adam v Cape Industries. House of Lords in Woolfson
v Strathclyde RC overruled the principle of implied agency and
stated that an agency relationship must be proved by written evidence.
The Court of Appeal in Adam v Cape Industries agreed with the House of Lords and stated that the required degree of control is a high one.
It must be proved that the principal have a day-to-day control over the
said agent. In the absence of the express agreement, the argument of agency
will be very difficult to establish.
(iii) Where the court is interpreting
a statute or document (Single Economic Entity?)
In DHN Food Distributors Ltd v Tower Hamlets (1976),
DHN was the holding company in a group of three companies. There were two
subsidiaries, wholly owned by DHN. One subsidiary owned land used by DHN, the
other owned vehicles used by DHN. The land was subject to compulsory purchase,
and DHN sought compensation for disturbance of its business. The Court of Appeal held that DHN
was entitled to claim. Lord Denning MR
said that the group of companies was in reality a single economic entity
and should be treated as one. DHN was the “head and brain” of its
subsidiaries. The three subsidiaries are bound to follow whatever DHN said and
they served no purpose other than to own the holding company’s assets. Shaw LJ makes it clear that the facts
of the case were of “very special character”.
Two years
later the House of Lords in Woolfson v Strathclyde
RC specifically disapproved Lord
Denning’s views on group structures in finding that the veil of
incorporation would be upheld unless it was a façade. According to Lord Keith, the veil of incorporation
can be lifted only where special circumstances exist indicating that the
company is a mere façade concealing the true fact.
Over the
years, a number of authorities were referred to support the single economic
entity argument, but the Court of Appeal in Adams v Cape Industries distinguishes them and pointed out that the
argument only come into play where there is lack of clarity about a statute
or document, and the court are therefore involved in interpreting a
statute or document, which would allow the court to treat the group
companies as single entity.
In
constructing the application of an EU Regulation, the Court of Appeal held in Samengo-Turner v J & H Marsh &
Mclennan (2007) treated a group companies as a single legal entity on the basis of
their single economic interest.
Similarly,
in Backett Investment Management Group
Ltd v Hall (2007), the Court of Appeal constructed a clause in an employment
contract in the context of a group of companies that formed a single economic
entity, holding that it was not appropriate to be inhibited by
considerations of corporate legal personality.
(iv) Other grounds to lift the
corporate veil – Transfer of assets? Justice?
The Court
of Appeal in Adam v Cape Industries plc
(1990) makes it clear that justice is not one of the grounds to lift the
veil.
Justice
was once a recognised ground to pierce the corporate veil. According to Cumming Bruce LJ in Re A Company (1985), the courts will
exercise its discretion to pierce the corporate veil if it is necessary to
achieve justice irrespective of the legal efficacy of the corporate structure in
question. This is of cause only applicable to specific circumstances where it
is in the interest of the justice to pierce the corporate veil.
Surprisingly, the court managed to lift the corporate veil in the interest of
justice in the case of Creasey v
Breachwood Motors Ltd, which is a case came after Adam v Cape Industries plc. It could be said that this reflect a
reversion to the Salomon strict
approach to lift the corporate veil.
In Creasey v Breachwood Motors Ltd (1993),
the plaintiff was dismissed from his post of general manager at Breachwood
Welwyn Ltd. He claimed that this constituted wrongful dismissal, in breach of
his employment contract. However, before he could claim, Breachwood Welwyn Ltd
ceased trading, and all assets were moved to Breachwood Motors Ltd, which
continued the business. Other creditors were paid off, but no money was left
for his claim. The court lifted the veil and held that he is entitled to
enforce the wrongful dismissal claim. It appears that the element of justice
has been reintroduced by the court since the court was influenced by the
fact that the plaintiff had financial difficulties and was relying on legal
aid.
The
decision was soon overruled by Ord and
Another v Belhaven Pubs Ltd (1998). Here the parties were engaged in a
legal action about a lease. Belhaven was one within the group companies. During
the course of action, Belhaven was reorganized and therefore had no assets to
pay any coming judgment against it. Mr. and Mrs. Ord requested the parent
company to be substituted for Belhaven to enforce the judgment. The Court of
Appeal rejected the request and held that the re-organisation of group
company structure was a legitimate one, rather than a façade to conceal the true facts. The
assets were transferred at full value and the motive appeared to be the group’s
financial crisis rather than avoiding liabilities.
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The
following cases show the unwillingness of the court to expand the scope of
lifting corporate veil but they would always find the other way out if the
justice requires so. In the following cases, the court granted remedies from
other branches of law, in order to achieve appropriate results on the facts of
each case.
VEIL LIFTING AND TORT (Parent company
personal injury tortious liability)
Following
the decision of Adam v Cape Industries,
it is clear that the courts are cautious in lifting the corporate veil. It
appears that the courts are not willing to pierce the corporate veil unless it
falls under one of the above situations.
Where the
case does fall within one of the above situations, but it is in the interest
of the justice to hold the person or the company in question personally
liable, the courts would find a way out through the other branches of law.
Although
it was claimed that the corporate veils are not lifted in the following cases,
but ultimately the outcome of the cases are the same as the corporate veils
being lifted, namely the persons or the company would be personally liable and
would not be allowed to hide themselves under the corporate veil.
In Connelly v RTZ Corporation plc, an
employee of a wholly owned subsidiary (Namibia Company) developed cancer in the
course of employment. He sued the parent company (UK company), alleging that it
played a role in setting its subsidiary’s health and safety procedures, and
therefore owed him duty of care. Although the action was time barred under the Limitation Act 1980, nevertheless the Wright J commended that the situation
was likely to give rise to a duty of care.
In Lubbe v Cape plc (2000), the case concerned
litigation brought by over 3000 employees and nearby residents of Cape’s wholly
owned asbestos-mining subsidiary in South Africa claiming damages from the
parent company in London for death and personal injury caused by exposure to
asbestos at or near the mining operation in South Africa. It was alleged that
Cape Industries owed them duty of care as it played a role in setting its subsidiary’s health and
safety procedures. Cape settled the action for £21 million. The issue was
reconsidered by the court in Chandler v
Cape plc (2012).
In Chandler v Cape plc (2012), the claimant was
the employee of a wholly owned subsidiary of Cape who suffered asbestos related
injuries in the course of his employment. The subsidiary was no longer existed
therefore the claimant sued Cape for damages. The question was whether Cape
could be liable for the damages, despite the fact that the subsidiary company
being largely independent and legally separate from Cape.
Both the
High Court and Court of Appeal held that Cape plc owed a direct duty of care to the
employees of its subsidiary. The Court of Appeal found that Cape has assumed
responsibility to the employees of its subsidiary, by having superior knowledge
and control over the health and safety policy at the subsidiary, created
a special relationship between the claimant and the parent company which gave
rise to a duty of care. It was submitted that the subsidiary acted on
advice from Cape, for which Cape has employed experts who were responsible and
dictating health and safety policy to all the employees within the Cape group.
The duty of care had been breached by Cape because Cape was aware that system
of work is unsafe but had done nothing to it.
The Court of Appeal held that a parent company may have assumed responsibility for the health
and safety of its subsidiary’s employees if:
(1) The businesses
of the parent and subsidiary are in a relevant respect the same;
(2) The
parent has, or ought to have, superior knowledge on some
relevant aspect of health and safety in the particular industry;
(3) The
subsidiary’s system of work is unsafe as the parent company knew,
or ought to have known; and
(4) The
parent knew or ought to have foreseen that the subsidiary or
its employees would rely on its using that superior knowledge for the
employees’ protection.
In relation
to (4), Arden LJ stated that it is
not necessary to show that the parent is “in the practice if intervening” in
the subsidiary’s health and safety policies. Rather, courts will look at the
group structure more widely and they may find that element (4) is established “where the evidence
shows that the parent has a practice of intervening in the trading
operations of the subsidiary, for example production and funding
issues.”
The Court
of Appeal makes it clear that Cape and its subsidiary are separate entities and
there shall be no imposition of assumption of responsibility by reason only
that a company is the parent company of another company. The corporate veil
between Cape and its subsidiaries is not lifted and Cape is liable for
the reason that it breached the duty of care owed to the employees.
In order
to impose a direct duty of care on the parent company, the threefold test
is required to prove. According to Caparo
Industries pIc v Dickman (1990), the three ingredients are:
(a) The
damage should be foreseeable
(b) There
should be a relationship of proximity
(c) The
situation is one which the court would consider it to be fair, just and
reasonable to impose a duty of care
In Thompson v The Renwick Group plc (2014), the claimant
was employed as a driver by his first employer, which was later taken over by
his second employer in a series of acquisitions. His second employer was a
subsidiary of the defendant. The defendant appointed an individual as the
director of the subsidiary, who was responsible to the day-to-day operations
of the subsidiary. It was submitted that there is uniform branding
or merging of the activities of the defendant and its subsidiaries. The
claimant’s work had involved handling raw asbestos, which eventually caused him
contacts illness.
The Court of Appeal held that the defendant did not owe duty of care to the claimant. The
director had not been acting on behalf of the defendant, but pursuant to his
fiduciary duty owed to the subsidiary. The co-ordination of operations
between the companies is not sufficient to confer a duty of care, unless
it was demonstrated that the group holding company assumed control in such a way
as to show an assumption of duty to the employees of the subsidiaries.
To
establish such a duty, the claimant would have to show that the defendant has a
superior knowledge or expertise, to protect its subsidiary’s
employees against the risk of injury, to such an extent that it was fair to
infer that the subsidiary would rely upon the parent deploying its superior
knowledge to protect its employees. The defendant here had no knowledge
of the hazards of handling raw asbestos superior to that which the subsidiary
could have been expected to have.
This is
to be contrasted with Chandler v Cape plc, where Cape has employed experts
to aim at the health and safety policy issues relating to all employees
within the Cape group, and Cape had actual knowledge about the risk
of exposure.
MCA Records Inc v Charly Records Ltd (No.5) (2003),
a director was held liable as a joint tortfeasor for authorising a number of
infringing acts. The Court of Appeal concluded that:
(a) A
director will not be treated as liable with the company as a joint tortfeasor
if he does no more than carry out his
constitutional role in the governance of the company (for example, voting
at board meeting)
(b) A
director or controlling shareholder of a company cannot escape from liability
if his participation or involvement in the wrongful acts goes beyond the
exercise of constitutional control
VEIL LIFTING AND COMMERCIAL TORT: Williams v Natural Life Health Foods
Ltd [1998] UKHL 17
The
plaintiff had been induced to enter into a franchise agreement with the first
defendant company and to acquire a leasehold health food shop, as a result of
negligent misstatements made by Mr. Mistlin. Mr. Mistlin was the managing director and majority
shareholder of the first defendant company. The franchised ship ceased trading
after losing a substantial amount of money. The plaintiff bought an action
against the first defendant company for losses suffered as a result of
negligent information. The first defendant company subsequently ceased to trade
was dissolved. The plaintiff then continued the action against Mr. Mistlin,
alleging he had assumed a personal responsibility toward him.
The House of
Lords held unanimously that the plaintiff’s claim would fail. The House of
Lords considered that a director or employee of a company could only be personally
liable for negligent misstatement if there was reasonable
reliance by the plaintiff on an assumption of personal responsibility
by the director so as to create a special relationship between them.
Here the corporate veil was not lifted because there was no evidence
in the present case that there had been any personal dealings which
could have conveyed to the claimant that Mr. Mistlin was prepared to assume
personal liability for the franchise agreement.
VEIL LIFTING AND FAMILY LAW: Prest v Petrodel Resources Ltd [2013] UKSC 34
Mr. Prest
wholly owned and controlled (directly or indirectly, through intermediate
entities) a number of non-UK resident companies which, between them, owned
seven residential properties in the UK. The question for the Supreme Court was
whether it could order the properties to be transferred to the wife, as part of
the financial settlement on divorce, given that they legally belonged to the
companies not Mr. Prest.
The Supreme
Court held that the
provisions of the Matrimonial Causes Act
1973 did not entitle the court to ‘pierce the corporate veil’ and order a
husband to transfer assets which he was not entitled to his wife. The court can
only ‘pierce the corporate veil’ – that is disregard the separate legal
personality of a company – if there is some impropriety. This will be the case
where a person is under an existing legal obligation or liability, or subject
to an existing legal restriction, which he deliberately evades, or whose
enforcement he deliberately frustrates by interposing a company which is under his
control.
Surprisingly,
Mrs. Prest was still held to be ultimately entitled to the properties. It was held
that Mr. Prest beneficially owned the assets of the companies under a resulting
trust because he contributed to their purchase price. There was no
need to pierce the corporate veil, which could only be done in limited
situations. However, because Mr. Prest had been "entitled" to the
assets of his companies under a resulting trust, under the section 24 of Matrimonial
Causes Act 1973 the court had jurisdiction to transfer half the value of
the properties to Mrs. Prest.
VEIL LIFTING AND CONTRACT: VTB Capital (Appellant) v Nutritek
International Corp and others (Respondents) [2013] UKSC 5
The claimant
bank, VTB, entered into a loan agreement with RAP, in which it was alleged that
the loan agreement was induced by fraudulent representations made by Nutritek.
It was alleged that Mr. Konstantin Malofeev, a Russian businessman, was the
ultimate owner of the RAP LLC (a Russian company) and Nutritek. It was claimed
that Malofeev controlled RAP through companies in the British Virgin Islands
and Russia. RAP defaulted the payment and became insolvent. VTB alleged that
the misrepresentations made by Nutritek were part of conspiracy and sought
permission to pierce the corporate veil and find the defendant companies liable
under the loan agreement. It shall be noted that the defendant companies were
third parties to the loan agreement.
Nutritek was
relying on the principle established in Antonio
Gramsci Shipping Corp v Stepanovs (2001). The principle that the corporate veil
would be lifted if the corporate structure was being used as a ‘sham’ or façade
to conceal wrongdoing, was controversially extended in Antonio, in which Burton J held that the veil could be pierced to allow the controllers
of a company to be sued under the company’s contracts as if they were
themselves a contracting party.
The Supreme
Court dismissed the appeal and overruled Antonio Gramsci
Shipping Corp v Stepanovs. It was held that such an extension was unncessary since remedies
already existed in tort: If VTB could prove its case on fraudulent misrepresentation, it
would prima facie be entitled to redress against the defendant companies. The
court refused to depart from Salomon principle and extend the rules under Adams v Cape Industries plc.
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