Court is Willing to Lift the Veil of Incorporation

Young v Edward Box & Co Ltd [1951] I TLR 789 4

Q1. Discuss the advantages and disadvantages of the different business entities that are available in the United Kingdom. 5

Q2. Explain the instances where the court is willing to lift the veil of incorporation, and the effect that these have on shareholders, companies and creditors. 6

Q3. ‘Justice is not served when companies are made liable for the acts of their employees.’ Discuss. 7

Bibliography: 10

Table of Cases

Adams v Cape Industries plc [1990] 1 Ch 443,

Aldred v Nacanco [1987] IRLR 292 CA,

Atlas Maritime Co SA v Avalon Maritime Ltd [1991] 4 All ER 769 at 779,

Daimler Co. Ltd v. Continental Tyre and Rubber Co. (Great Britain) Ltd [1916] 2 AC 307,

DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852 (CA),

Dimbleby & Sons Ltd v National Union of Journalists [1984] 1 WLR 427 at 435, HL,

Gilford Motor Co Ltd v Horne [1933] Ch 935,

Harrison v. Michelin Tyre Co. Ltd [1985] 1 All ER 918,

Irving and Irving v Post Office [1987] IRLR 289 CA,

Lee v. Lee’s Air Farming Ltd [1961] AC 12,

Lennard’s Carrying Co. Ltd v. Asiatic Petroleum Co. Ltd [1915] AC 705,

Lister v Romford Ice & Cold Storage Co Ltd [1957] AC 555, HL,

Macaura v. Northern Assurance Company [1925] AC 619,

Rose v Plenty [1975] 1 WLR 141,

Royal British Bank v Turquand (1856) 6 E & B 327,

Salomon v. Salomon & Co. Ltd [1897] AC 22,

Trustor AB v Smallbone (No 2) [2001] 1 WLR 1177,

Tunstall v. Steigmann [1962] 2 AER 417,

Woolfson v Strathclyde Regional Council [1978] SLT 159,

Young v Edward Box & Co Ltd [1951] I TLR 789

Q1. Discuss the advantages and disadvantages of the different business entities that are available in the United Kingdom.

The business organisations in The UK are the sole trader, partnership and the registered company. The most important distinction is that, where persons choose to register a company, the company is a juridic or arti”cial legal person which has the same rights and liability under the law as a natural person. The sole trader and partners are individually responsible. The registered company provides protection of limited liability for its members [1] .

The sole trader is liable for all the losses up to the full extent of his/her private fortune and any legal action in respect of the business will be against the proprietor. The proprietor retains all the profits but suffers disadvantages such as (i) limited capital; (ii) limited borrowing; (iii) time off; (iv) limited scope for expansion [2] .

The partnership provides an increased capital base, improved borrowing and reduces the problems relating to holidays and sickness. Under the law, and partners are jointly liable for debts and obligations s.9 PA 1890; and jointly and independently for torts committed by partners and employees of the firm: s.12 PA 1890. Partnerships are formed and regulated under the Partnership Act 1890 (PA 1890) which defines a partnership as ‘the relation which subsists between persons carrying on a business in common with a view of profit’: s.1 (1) PA 1890 [3] .

The Companies Act 2006 s 3 defines a company may be limited by shares or by guarantee by an appropriate limiting provision in the company’s constitution. Where there is no such limiting provision on the liability of the company’s members, a company is an unlimited company. An unlimited company has no limit on the liability of its members. In a limited company this liability is restricted by law [4] .

CA 2006 s 4 defines ‘private’ and ‘public’ companies as follows: a private company is any company that is not a public company; and a public company is a company with a certificate of incorporation that states it is a public company which has complied with all the necessary provisions of the Act as regards registration as a public company. Public companies have the advantage of being able to offer their shares by advertisement to the public for investment (CA 2006 s 755); but they are subject to a greater degree of regulation by the law [5] .

An advantage which is enjoyed by companies over sole traders or partnerships, is that companies can give what is known as a floating charge as security for a loan, which could be a motivating reason for incorporation. A floating charge is a security given over assets which, in the normal course of business, change from day to day, for example, raw materials or stock in trade [6] .

Q2. Explain the instances where the court is willing to lift the veil of incorporation, and the effect that these have on shareholders, companies and creditors.

A company is separate from the shareholders, Salomon v. Salomon & Co. Ltd [7] . The principle of the ‘veil of incorporation’ separates the incorporators of a company from the company itself. A person can be managing director and also an employee of the company under a separate contract, see Lee v. Lee’s Air Farming Ltd [1961] AC 12 [8] . The general rule is that if the liability of a company’s members is limited ‘by shares’ or ‘by guarantee’, then the company’s creditors cannot seek satisfaction from the members if the company has insufficient funds to pay its liabilities [9] . The consequences can be unexpected and disturbing. In Macaura v. Northern Assurance Company [1925] AC 619 [10] .

The decision in Salomon has not been uniformly adopted and describing also as ‘calamitous’ [11] . ‘Lifting the corporate veil’ refers to the possibility to make the members liable, as they are normally not liable to outsiders, but only liable to pay the company what they agreed to pay for the share purchase price or guarantee [12] .

In some instances the law is prepared to regard the ‘realities [13] ’ of the situation, ‘treating the rights, liabilities or activities of a company as that of its shareholders, while – on the other hand, to ‘regard the shareholding of the company for some legal purpose [14] ’ – eg looking to the nationality of the shareholders whether a company is under enemy control in wartime [15] . Thus in Daimler Co. Ltd v. Continental Tyre and Rubber Co. (Great Britain) Ltd [16] , the Continental was regarded as an enemy alien because its shareholders were mainly German nationals. Under the ‘identification theory’, the court attributes the intention or knowledge of a person identified with the company as the intention of the company. See Lennard’s Carrying Co. Ltd v. Asiatic Petroleum Co. Ltd [17] .

The ruling in Salomon has been revisited and reinforced in cases such as Adams v Cape Industries plc [18] . In Adams the CA expressly declined to “pierce the veil of incorporation” even when it was alleged that the corporate structures with respect to a subsidiary had been created purely to place liability most advantageously for the parent company [19] . Here, the Court followed the principle in Woolfson v Strathclyde Regional Council [20] that it is only permissible for a court to lift the veil where ‘special circumstances exist. Little guidance is given as to what is meant when a company is a mere façade for the factors which are to be employed in determining whether this is so, in either Woolfson or Adams [21] . In Trustor AB v Smallbone [22] , Sir Andrew Morritt VC held that although it is not appropriate for a court to pierce the veil merely because a company is involved in some impropriety, it is entitled to do so when the latter is used ‘as a device or facade to conceal the true facts and liability of the responsible individuals’ [23] , to prevent the use of the registered company for fraudulent purposes. The Court of Appeal in Gilford Motor Co Ltd v Horne [24] regarded this company as a ‘cloak or sham’, formed merely as a ‘device or stratagem’ in order to ‘mask the solicitation’ and an injunction was granted against both the managing director and the company from acting in breach of the covenant [25] .

The veil is lifted to establish the company’s liability where proof of the company’s intention is required to establish liability. Under the ‘identification theory’, the court attributes the intention or knowledge of a person identified with the company as the intention of the company. See Lennard’s Carrying Co. Ltd v. Asiatic Petroleum Co. Ltd [26] . The House of Lords ruled that fault and privity could be established, in respect of a company, by establishing the existence of fault or privity in the mind of a person who is ‘the directing mind and will’ of the company [27] .

The CA 2006 seems to ignore the possibility to make members of a company liable for the company’s wrongs; attention is given to making directors and other officers liable for corporate wrongs in specified circumstances. In Dimbleby & Sons Ltd v National Union of Journalists [28] , Lord Diplock, whilst not wholly excluding the possibility that a contrary construction might sometimes be justified, said [29] :

‘The ‘corporate veil’ in the case of companies incorporated under the CA, is drawn by statute and it can be pierced by some other statute if such other statute so provides;’

In the DHN [30] case the readiness of judges to use their interventionist powers and disregard the Salomon principle, probably reached its peak, the trend has been almost entirely towards reasserting the orthodoxy of the Salomon principle [31] .

Q3. ‘Justice is not served when companies are made liable for the acts of their employees.’ Discuss.

A person who actually commits a tortious act is always liable. An employer is vicariously liable for the tortious acts of employees, within the scope of their employment, whereas s/he is only liable in exceptional circumstances for the torts of an independent contractor [32] . This concept has found favour with courts and claimants alike, because, realistically, the employer is likely to have the money to pay for any claim for damages, whereas the main tortfeasor, the employee, will not. This does not mean that the employee will escape liability [33] . Under the Employers’ Liability Act 1969, an employer must have insurance cover against such liability. The doctrine contradicts two major principles of liability in tort: namely that (i) a person should only be liable for loss or damage caused by his/her own acts or omissions; and that (ii) a person should only be liable when s/he was at fault [34] .

The test for employer’s liability is ‘whether a reasonable man would say either that the employee’s act was part and parcel of his employment, in which case the employer was liable, or that it was so divergent from his employment as to be plainly alien to his employment, and wholly distinguishable from it, in which case the employer was not liable’: Harrison v. Michelin Tyre Co. Ltd [35] .

A person dealing with a company was deemed to know the contents of the company’s memorandum and articles of association. The critical distinction is, therefore, between acts done in excess of the capacity of the company on the one hand and acts done in excess or abuse of the powers of the company on the other [36] . Thus, as in Royal British Bank v Turquand [37] itself, where the articles stated that the board of directors could borrow such sums as were authorised by a resolution of the shareholders in general meeting, a lender was entitled to assume that such a resolution had indeed been regularly obtained. The absence of such a resolution was said to be a matter of the indoor management of the company and would not prevent the lender from enforcing its rights against the company [38] .

This rule did not operate in a completely unrestricted manner [39] . It is inherent in the rule that if the transaction in question could not in the circumstances have been validly entered into by the company, then the third party could not enforce it. Second, the rule only protected ‘outsiders’, that is persons dealing ‘externally’ with the company; directors. Third, actual notice of the failure to comply fully with internal procedures precluded reliance upon the rule. Fourth, an outsider could not rely upon Turquand’s Case where the nature of the transaction was suspicious. Fifth, it has often been said that the rule in Turquand’s Case cannot apply in cases of forgery [40] .

Where the employee carries out a prohibited act, the question is: ‘Who is the intended beneficiary of the prohibited action?’ In Rose v Plenty, Lord Denning applied his own earlier judgment in Young v Edward Box and Co Ltd [41] , in which he said [42] :

‘In every case where it is sought to make the master liable for the conduct of his servant, the first question is to see whether the servant was liable. If the answer is yes, the second question is to see whether the employer must shoulder the servant’s liability’.

For an employer to be liable for the criminal acts of his employees there must be some nexus between the criminal act of the employee and the circumstances of his or her employment. How far the question of nexus is becoming an issue in all cases of vicarious liability can be seen in Irving v Post Office and Aldred v Nacanco. Where an employee is involved in a fraud, the fact that the employer has placed the employee in a position to perpetrate the fraud may result in the employer being vicariously liable [43] .

The case of Lister v Hesley Hall Ltd [44] , it challenges the common law. The case involved gross acts of sexual abuse by the warden of a boarding school against boarders aged between 12 and 15 years. The House of Lords held [45] :

‘In determining whether an employee’s wrongful act has been committed in the course of his employment so as to make the employers vicariously liable, the correct approach is to concentrate on the relative closeness of the connection between the nature of the employment and the employee’s wrongdoing. The question is whether the employee’s tort was so closely connected with his employment that it would be fair and just to hold the employers vicariously liable’.