The Disregarding of Separate Legal Personality

Critically discuss the circumstances for the disregarding of separate legal personality and lifting the veil of incorporation

Question

‘The circumstances in which the courts have demonstrated a willingness to disregard the separate legal personality of a company are quite narrow and have not changed substantially in recent years.’

Critically discuss this statement.

Introduction

A limited company has a separate legal personality from its members, or shareholders¹. The barrier between the company’s assets and those of its members is known as the ‘veil of incorporation’². However, courts have ‘lifted the veil’ in certain circumstances³, such as when authorized by statute, in wartime and to prevent fraud. These are narrow exceptions to the general rule. However, a number of other exceptions exist which are wider in scope. Recent cases have sought to narrow the exceptions. However, there is still uncertainty about when courts will lift the veil in future.

The Corporate Veil

In a limited company, the members’ liability for the company’s debts is limited to the nominal value of their shares⁴. A company also has a separate legal existence from that of its members. It can enter contracts, sue and be sued in its own right⁵. For instance, in Salomon v Salomon a sole trader incorporated his business as a limited company and owned almost all of its shares. However, the House of Lords held that despite this, the company was a separate legal entity from its members. Therefore, according to Salomon v Salomon the corporate veil cannot be lifted at all.

Salomon v Salomon is a House of Lords case and its authority is, therefore, ‘unshakable’⁶. However, in exceptional cases courts have ‘lifted the corporate veil’ and disregarded this legal barrier between the company and its members⁷. Some critics suggest that the circumstances in which this can be done are narrow. For instance, Taylor states that the exceptions only operate to prevent fraud or wrongdoing, and that they only apply to those who actually created the situation⁸. However, both old and recent cases contain exceptions which cannot be neatly categorized and are quite wide and uncertain.

The cases may be split into three broad time periods. From 1897 to 1966 Salomon v Salomon bound all court decisions⁹. Veil lifting was only permitted in exceptional circumstances, such as in wartime and to counter fraud¹⁰. However, after 1966 the House of Lords could use its 1966 Practice Statement¹¹ to change its mind. This led to the courts adopting a more interventionist approach¹². Finally, in the 1980s the courts returned to a more orthodox approach, typified in Adams v Cape plc¹³. Therefore, since Salomon v Salomon there has been a great deal of change in the ways courts lift the corporate veil.

Statute

Some statutes expressly authorize lifting the corporate veil. For instance, s.213 Insolvency Act 1986 states that a court may ignore the corporate veil if, during winding up a company it appears that the company’s business has been carried on with intent to defraud its creditors, a court can force anyone who is knowingly a party to this business to contribute to the company’s debts. However, there must be evidence of dishonesty¹⁴. This is a high burden of proof¹⁵. Therefore, this is a very narrow exception.

Under s.214 Insolvency Act 1986 a company director may be liable for wrongful trading if they continue to trade and they ought to have known that there was no reasonable prospect of avoiding insolvent liquidation. There is no need for any dishonesty. However, this only applies to directors, not shareholders. The Companies Act 2006 also makes no mention of lifting the corporate veil. Therefore, Parliament has not significantly widened the exceptions to Salomon in recent years.

Wartime

A court may also look behind the corporate veil to see if a company is controlled by an enemy in wartime. For instance, the House of Lords held during World War I that where a company’s directors and the majority of its shareholders resided in Germany it could be classed as the enemy¹⁶. However, this is very narrow as it only applies in wartime.

Agency

Courts have also lifted the corporate veil by finding that an agency relationship exists between a company and its shareholders. For instance, in Re FG (Films) Ltd¹⁷ a British film company was held to have been an agent for an American company which had provided all the finance and facilities for the making of a film. The UK company also had no place of business, and almost all of its shares were owned by the American company. This is a very wide exception, as an agency relationship could really apply to any company where members control the company¹⁸. Accordingly, critics have said that this case is doubtful¹⁹. Consequently, it may be of limited application.

Fraud

Courts may lift the corporate veil where the corporate form is used to commit fraud. For instance, in Jones v Lipman²⁰ the defendant contracted to sell land and later tried to get out of this by conveying the land to a company he had formed for this express purpose. The court held that his company was ‘cloak’ or ‘sham’ and lifted the corporate veil, ordering specific performance of the contract. This is quite a wide category as it can encompass many types of fraud.

However, there are limits to this exception. More recently, in Trustor AB v Smallbone (No 2)²¹ it was held that courts cannot lift the corporate veil merely because the company is involved in some wrongdoing. The corporate form itself must be used as a façade to conceal the true facts and the liability of responsible individuals²². The companies must also be set up to avoid an existing contractual obligation²³. In the last few years, the Court of Appeal has held that it is a legitimate use of corporate form to incorporate a company to avoid future liabilities²⁴. This has narrowed the exception somewhat. However, fraud still remains a potentially wide exception.

Justice

Courts have been known to lift the veil to achieve justice. For instance, in Creasey v Beachwood Motors²⁵ the judge lifted the corporate veil in the interests of justice. This exception is very wide and uncertain, depending on the facts of each individual case.

However, commentators note that although this trend was popular in the interventionist years of the 1960s and 1970s, it has recently fallen out of favour. In Ord v Belhaven Pubs Ltd²⁶ the Court of Appeal specifically overruled Creasey. In 1989 in Adams v Cape the Court of Appeal later said that the veil could not be lifted merely in the interests of justice. This has since been followed by lower courts²⁷.

However, in Conway v Ratiu²⁸ Auld LJ said that there was a ‘powerful argument’ that courts should lift the corporate veil ‘to do justice when common sense and reality demand it’. These comments were delivered by the Court of Appeal as late as 2005. However, Conway v Ratiu is per incuriam as it did not refer to Adams v Cape. Some commentators believe this means courts will not lift the veil simply to do justice²⁹. Even so, as both judgments are from the Court of Appeal it is uncertain which approach courts will follow in future.

Groups of Companies

Due to the doctrine of separate corporate legal personality, a parent company can also incorporate another subsidiary company, which also has separate corporate personality³⁰. Courts have lifted the corporate veil in the past to hold the parent company responsible for the acts of its subsidiary. In 1978 in DHN Food Distributors Ltd v Tower Hamlets LBC³¹ a parent company owned all the shares in its two subsidiaries, which were heavily involved in carrying out the parent company’s business operations. The Court of Appeal held that the group of companies were a ‘single economic entity’ and lifted the veil to make the parent company able to receive compensation payable to the subsidiary. This is a potentially wide exception that could apply to all groups of companies.

However, 2 years later in Woolfson v Strathclyde Regional Council³² the House of Lords upheld the Scottish courts’ decision not to follow the DHN case, even though the facts were similar. Lord Keith doubted that the DHN case was correct. However, DHN was not overruled, although it became less popular over time³³.

In 1989 the Court of Appeal took a different approach in Adams v Cape plc, a case involving a claim for asbestos-related injury against a parent company. Slade LJ explained the DHN decision as being actually a case of statutory interpretation involving compensation for compulsory purchases³⁴. The court then went onto say that the veil could only be lifted for groups of companies in cases involving interpretation of statutes, where the subsidiary was a façade or sham, and where there was an agency relationship. Therefore, this decision seeks to restrict the DHN case and to make it only applicable to interpreting statutes.

Adams v Cape does support lifting the veil to prevent fraud, but only if the fraud is to evade an existing liability and it involves the use of corporate structure itself. This maintains the wide exception in Jones v Lipman.

Finally, the court held that in order for there to be an express agency relationship, the subsidiary would have to be carrying on no business of its own but purely the business of its parent company. Therefore, there would be no agency relationship between companies simply because they were part of a group. This is narrower than the agency argument proposed in Re FG Films. Therefore, the courts have recently narrowed the exception relating to agency.

Consequently, Adams v Cape has narrowed the ways in which the veil may be lifted regarding groups of companies. Even so, the DHN case remains good law. Commentators note that this leaves uncertainty about which approach courts will take³⁵.

In a more recent case with similar facts, the Court of Appeal took a different approach. In Chandler v Cape the claim was for personal injury. The court held that Cape plc was so closely involved in its subsidiary’s health and safety operations that Cape owed the subsidiary’s employees a direct duty of care in the tort of negligence. However, the factual evidence was quite unusual. The court may also have been influenced by the facts that no remedy would have been available to the workers otherwise³⁶. Also, Arden LJ ’emphatically rejected’ the idea that this case involved lifting the corporate veil³⁷. Consequently, some critics have suggested that there are ‘slim pickings’ for any precedents in the decision³⁸. However, others have said this is effectively lifting the veil, even though the judges said otherwise³⁹.

Prest v Petrodel Resources Ltd⁴⁰, the most recent decision of the Supreme Court on the issue, has not clarified the matter. Lord Sumption stated that there were two principles: the concealment principle which did not allow courts to lift the veil; and the evasion principle which did⁴¹. This follows the approach taken in Jones v Lipman. However, he also said that it must be necessary to lift the veil on public policy grounds. Critics suggest that this limits the courts’ power to lift the corporate veil⁴². On the other hand, Baroness Hale did not agree and stated that it was not possible to classify the cases of veil lifting in this way⁴³. Critics note that this admits the possibility of lifting the veil to do justice, as in Conway v Ratiu⁴⁴. Also, in another recent House of Lords case, Lord Neuberger stated obiter that ‘it may be right for the law to permit the veil to be pierced in certain circumstances in order to defeat injustice’⁴⁵. Therefore, the law remains uncertain in this area.

Conclusion

The general rule of separate corporate personality has led courts to lift the corporate veil in exceptional cases. Some of these have always been narrow exceptions, such as those permitted under statute or in wartime. However, some are wider. Fraud is a wide exception, although it must involve use of the corporate form itself to avoid existing liabilities. The agency exception was also very wide but doubtful, and it has now been restricted by Adams v Cape. Lifting to veil to do justice was also a very wide exception. This has been denied in recent years. However, case law is contradictory and uncertain upon this point. Finally, an exception for groups of companies was established in the DHN case. In Adams v Cape the Court of Appeal sought to restrict this. However, a separate exception exists for tortious claims. Also, as both approaches are still possible, it is not possible to say with certainty that the circumstances in which courts will lift the veil in future are narrow.

Footnotes

¹ Salomon v A Salomon & Co Ltd ¹⁸⁹⁷ AC 22 (HL).

² C Taylor, Company Law (Pearson Education Ltd, Harlow, 2009) 27.

³ Ibid, 27.

⁴ L Sealy and S Worthington, Company Law: Text, Cases and Materials (9^th edn Oxford University Press, Oxford, 2010) 51.

⁵ Taylor (n2) 27.

⁶ Sealy and Worthington (n4) 52.

⁷ Ibid, 51.

⁸ Taylor (n2) 27.

⁹ A Dignam, Hicks and Goo’s Cases and Materials on Company Law (7^th edn Oxford University Press, Oxford 2011) 35.

¹⁰ Ibid.

¹¹ Practice Statement (Judicial Precedent) ¹⁹⁶⁶ 1 WLR 1234 (HL).

¹² Dignam (n9) 35.

¹³ Adams v Cape Industries plc ¹⁹⁹⁰ Ch 433 (CA).

¹⁴ Re Patrick & Lyon Ltd ¹⁹³³ Ch 786 (Ch).

¹⁵ Dignam (n9) 33.

¹⁶ Daimler Co Ltd v Continental Tyre and Rubber Co (Great Britain) Ltd ¹⁹¹⁶ 2 AC 307 (HL).

^{17 1953} 1 WLR 483 (Ch).

¹⁸ Sealy and Worthington (n4) 58.

¹⁹ Ibid, (n4) 59.

^{20 1962} 1WLR 832 (Ch).

^{21 2001} 1 WLR 1177 (Ch).

^{22 Para 23} per Sir Andrew Morritt VC.

²³ Sealy and Worthington (n4) 63.

²⁴ Adams v Cape plc.

^{25 1993} BCLC 480 (QB).

^{26 1998} 2 BCLC 447 (CA).

²⁷ Polly Peck International plc (No 3) ¹⁹⁹³ BCC 890 (Ch).

^{28 2005} EWCA Civ 1302 (CA).

²⁹ D French, S Mayson, and C Ryan, C. Mayson, French & Ryan on Company Law (27^th edn Oxford University Press, Oxford 2010) 148.

³⁰ Taylor (n2) 31.

^{31 1976} 1 WLR 852 (CA).

^{32 1978} P & CR 521 (HL).

³³ Taylor (n2) 34.

^{34 Para 536}.

³⁵ French, Mayson and Ryan (n30) 146.

³⁶ J Fulbrook, ‘Chandler v Cape Plc: personal injury: liability: negligence’ (2012) 3 JPIL C138.

^{37 Para 3128} per Arden LJ.

³⁸ Fulbrook (n37) C138.

³⁹ Dignam (n9) 42.

^{40 2013} UKSC 34 (SC).

^{41 Para 35} per Lord Sumption.

⁴² L Stockin ‘Piercing the corporate veil: reconciling R. v Sale, Prest v Petrodel Resources Ltd and VTB Capital Plc v Nutritek International Corp’ (2014) 35(12) Company Lawyer 365.

^{43 Para 92} per Baroness Hale.

⁴⁴ Stockin (n43) 365.

⁴⁵ VTB Capital plc v Nutritek International Corporation ²⁰¹³ UKSC 5 (SC).