Lifting the Veil Separation of the Personality

Introduction

‘Lifting the veil’ refers to the situations where the judiciary or the legislature has decided that the separation of the personality of the company and the members is not to be maintained. The veil of incorporation is thus said to be lifted. It is also described as ‘piercing’, ‘lifting’, ‘penetrating’, ‘peeping’ or ‘parting’ the veil of incorporation.

Once registration has been successfully completed a new legal person is created: its legal liabilities are totally separate from those of its members. What the courts have described as a veil of incorporation prevents the members being held responsible for the company’s liabilities, no matter how close their connections with it. This is clearly illustrated in the case Salomon v Salomon & Co. Ltd (1897, HL). The company had been created properly in according to the Companies Act and was a separate entity on whose behalf Mr. Salomon acted as agent. It was not relevant that after incorporation ownership and management stayed in the same hands as they had before. The company had borrowed the money and was legally liable to pay it back to its secured creditor who tool preference over the other creditors. This is the most famous case of lifting the veil of on corporate personality.

There are a number of example where the courts are prepared to ignore the veil of incorporation and hold members personally liable for the debts of the company. Such exceptions to the general principle in Salomon are known as ‘lifting the veil’ and can be found in both state and common law.

Statutory

The taxation authorities in the UK have been highly aware of the potential for group moving assets and liabilities to avoid taxation. So, there are lots of examples of taxation legislation directed at ignoring the separate entities in the group. The Companies Act also recognises that group structures need to be treated differently for financial and disclosure reporting purposes in order to get a suitable overview of the group financial position. The CA 1985, s227 therefore provides that parent companies have a duty to produce group accounts. Section 231 also requires the parent to provide details of the subsidiaries’ names, country of activity and the shares it holds in the subsidiary. The Employment Rights Act 1986 also protects employees’ statutory rights when transferred from one company to another within a group, treating it as a continuous period of employment.

The Companies Act also has a number of general provisions which affect the separate legal personality of the company. For example s24 provides for member liability for the company’s debts if the membership of the company less than two for more than six months. Since 1992 this provision only applies to public companies, as single-member private companies are allowed. The provision will be obviously further affected by the Company Law Reform Bill which advises single-member public companies. Another example is s349 (4), which give personal liability to agents or officers of the company who sign cheques or money orders on which the company’s name does not appear. The officer or agent will be personally liable if the company does not then pay. As many of the situations where ‘lifting the veil’ is at issue involve corporate bankruptcy, the Insolvency Act 1986 has some key veil lifting provisions.

The Companies Acts have long recognised that the corporate form could be used for fraudulent purposes. The 1948 Companies Act contained both civil and criminal sanctions for what is known as ‘fraudulent trading’. While the CA 1985 still contains a criminal offence in s458 for fraudulent trading the civil provisions are now contained in ss 213-215 of the Insolvency Act 1986. It is these civil sanctions that operate to lift the corporate veil.

Section 213 states:

If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose, the following has effect

The court, on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper.

This section and its predecessor in the 1948 Act consistently proved difficult to operate in practice. The main difficulty was that there was the possibility of a criminal charge also arising. The courts therefore set the standard for intent fairly high. As the court explained in Re Patrick and Lyon ltd (1933), this involved proving ‘actual dishonesty, involving, according to current notions of fair trading among commercial men, real moral blame’. It is difficult to achieve this standard and finally a new provision was introduced in s214 of the Insolvency Act 1986 to deal with what is known as ‘wrongful trading’.

Section 214 was introduced to deal with situations where negligence rather than fraud is combined with a mistreatment of corporate personality and limited liability. In other words there was no need to prove dishonesty. This is known as ‘wrongful trading’. Section 214 states:

… if the course of the winding up of a company it appears that subsection (2) of this section applies in relation to a person who is or has been a director of the company, the court, on the application of the liquidator, may declare that that person is to be liable to make such contribution (it any) to the company’s assets as the court thinks proper.

This subsection applies in relation to a person if

the company has gone into insolvent liquidation,

at some time the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, and

that person was a director of the company at that time.

The idea behind the process of the section is that at some time towards the end of the company’s trading history there will be a point of no return. That is, things are so bad the company can no longer trade out of the situation. A reasonable point he will risk having to contribute to the debts of the company. The case of Re Produce Marketing Consortium Ltd (No 2) (1989) is a good example of the way the section operates. Over a period of seven years the company had slowly drifted into insolvency. There was no suggestion of wrongdoing on the part of the two directors involved; it was just that they did not put the company into liquidation in time and thus they had to contribute ￡75,000 to the debts of the company.

While s213 covers anyone involved in the carrying on of the business, thus qualifying the limitation of liability of members, s214 is aimed specifically at directors. In small companies directors are often also the members of the company and so their limitation of liability is indirectly affected. Parent companies may also have their limited liability affected if they have acted as a shadow director. A shadow director is anyone other than a professional adviser from whom the directors of the company are accustomed to take instructions or directions.

Common Law

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.

In the case Gilford Motor Co. Ltd v. Home [1933] Ch 935 (CA), the defendant was formerly managing director of the claimant company and was subject to a covenant not to approach clients of the company after his employment had ended. After leaving the company, he incorporated a company with his wife and used the company to approach the customers of his former employers. The defendant had set up the company, not as a genuine business, but rather as a ‘sham’ or ‘façade’ to hide his intention to break the covenant with his former employers, This was an abuse of corporate personality.

In the same way as a person can own a company and be separate tram it by means of the doctrine of corporate personality, so can another company and it is increasingly common for one company (known as a ‘holding company’) to set up another (known as a ‘subsidiary company’) to take advantage of the principle of limited liability. A successful company faced with a risky business venture may choose to incorporate a separate company to exploit the opportunity sate in the knowledge that, should it tail, only the assets of the subsidiary company can be used to satisfy its debts, leaving the holding company safe. In this way, it is not uncommon for large groups of companies to be owned by the same ‘parent company’.

Despite this legitimate use of corporate personality to reduce risk, the courts have been prepared to ignore the corporate veil and treat the holding and subsidiary companies as one and the same. However, this is only under very particular circumstances and the approach adopted by the courts has been far from consistent.

In the case The Albezero [19771 AC 774 (HL), a shipment of oil belonging to one company was transferred to company during its voyage from South America to Europe. Both companies were entirely owned by the same ‘parent’ company. After the transfer of ownership, the ship sank and the cargo was lost. When the first company tried to claim for the loss, the ship owners argued that the second company was the true owner of the oil and it could not claim because the limitation period on such claims had expired. Therefore neither company could claim. Roskill LJ: ‘each company in a group of companies … is a separate legal entity possessed of separate legal rights and liabilities that the rights of one company in a group cannot be exercised by another company in that group even though the ultimate benefit of the exercise of those rights would [be] to the same person or corporate body’.

However, in other cases, the courts have adopted a more liberal view.

In the case DHN food Distributors Ltd v. Tower Hamlets London Borough Council [2976] 1 WLR 852 (CA), OHN was a parent company, owning two subsidiaries. One of the Companies owned a plot of land from which the other company ran a fleet of lorries to deliver goods for DHN. On the compulsory purchase of the land, the question arose as to which company could claim for disruption to its business. Although these were separate companies they could be regarded as a ‘single economic entity’. Denning MR: ‘This group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point.’

The key factors in determining whether the companies were a ‘single economic entity’ were: 1. the degree of control which the parent company exercised over the activities of the subsidiary company (evidenced by the companies having the same board of

directors). 2. the complete ownership of all of the shares in the subsidiary company by the parent company.

In the case Woolfson v. Strathclyde Regional Council [1978] 2 EGLR 19 (HL), Limited company ‘A’ carried on a retail business at a shop comprising five premises. Three of the premises were owned by Woolfson and the other two by another limited company ‘B’. Woolfson was the sole director of ‘A’ and owned 999 shares of the 1,000 issued shares of company ‘A’, the remaining share being owned by his wife. Woolfson also owned 20 of the 30 issued shares of company ‘B’, with the other 10 being owned by his wife. When the premises were compulsorily acquired by the local authority, both Woolfson and company ‘B’ jointly sought compensation from the Lands Tribunal which held that they were not entitled to such compensation. Held: as the company which carried on the business had no control whatever over the owners of the land, they could not be regarded as a single economic entity and so the rule in Salomon would apply.

Over time, the liberal approach applied in DHN has been less popular.

In the case Adams v. Cape Industries plc [1990] Ch 433 (CA): An English Company-Cape, mined asbestos which it sold through a subsidiary company in the UK and another in the USA. The US company was sued by a number of former employees for injuries arising from exposure to its asbestos but, as the company had disposed of its assets in the USA, only a successful action against the UK parent company would secure damages for the claimants. The law recognises the creation of subsidiary companies and, even though they are under the control of their parent companies, they will generally be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities.

Conclusion

As a result, ‘lifting the veil’ is to achieve two common features to all of the recognised exceptions:

They are designed to prevent the protection of limited liability being abused to perpetrate fraud or other wrongdoing.

They will only apply to members of the company who actually created the situation.