Expose Shareholders and Directors

In What Way May The Corporate Veil Be Pierced In Order To Expose Shareholders And Directors To Personal Liability For The Debts Of The Company?

The issue of piercing the corporate veil describes a legal decisions to treat the rights or liabilities of its shareholders or directors against their personal rights and liabilities.

Companies are legal entities which exist completely separate from their owners, called the shareholders or subscribers. Usually it is treated as a separate legal person and has a distinct legal identity, rights and obligations. It solely responsible for its debts and credits. It can sign contracts and pay taxes normally. The major characteristics are separate legal entity, see Salomon v Salomon Co Ltd (1897), Macaura v Northern Assurance Co Ltd (1925), possibility of limited liability, see case See Lee v Lee Air’s Farming Ltd (1961), perpetual succession, S16(2) of the Companis Ordinance Cap 32, capacity, S5A of the Companies Ordinance Cap 32.

Common law countries usually uphold these principles but in exceptional situation may pierce the corporate veil. A simple example is a businessman set up a company compete with his former company which contrary to the contract that he signed with his former company. Technically it would be the company itself but not the person himself competing. But it is likely a court would say that it is just a sham or a fraud and would look at the factors and evidences to consider whether to allow the veil be pierced.

Jenkinson J, in Dennis Willcox Pty Ltd v Federal Commissioner of Taxation,32 stated that:

“The separate legal personality of a company is to be disregarded only if the court can see that there is, in fact or in law, a partnership between companies in a group, or that there is a mere sham or facade in which that company is playing a role, or that the creation or use of the company was designed to enable a legal or fiduciary obligation to be evaded or a fraud to be perpetrated.”

Salomon v. Salomon & Co. is the leading case which was decided by the House of Lords in 1897. It was basically the first case to uphold the concept that a corporation is an independent legal entity, simply means that the company is independent and separate from any other entities who are related to it.

The factors for court to consider includes the length relationships with related entities, the accuracy of incorporate records, whether it is just a shell company for personal dealing and other factors that courts find it relevant, these factors may be grouped into the following categories, agency, fraud, sham or façade, group enterprise and unfairness, justice.

Generally, there are three ways for piercing the corporate veil.

The first one is by voluntary piercing. It apply for unlimited liability companies, personal guarantee of directors, letters of comfort from directors. Also, under ss159-160 , Articles of Assocaiation, it may impose unlimited liability on directors, under Companies Ordinance s93(5); Bills of Exchange Ordinance s26, directors may comtarct in a personal capacity and thereby incur personal liability. Under S26 of the Bills of Exchange Ordinance Cap.192, directors may also be personally liable to pay compensation be issuing untrue statements in prospectors or issuing corporate cheques. For example in the compulsory acquisition cases, a company in a corporate group may attempt to pierce the corporate veil in order to gain further compensation for losses incurred by related companies due to the acquisition. Some of the piercing arguments were also brought in response to a party seeking the protection of the veil (described as “reverse piercing the veil”). Note the case Macaura v Northern Assurance Co Ltd is an example of that. Mr Macaura was the sole owner of a company he had set up to grow timber. The trees were destroyed by fire but the insurer refused to pay since the policy was with Macaura himself but not the company and he was not the owner of the trees. The court upheld that refusal based on the separate legal personality of the company.

Generally, company seeks to pierce its own veil only when there is benefit the company.

The second one is the statutory piercing. There are a number of statutes which provide for piercing the veil, including Companies Ordinance, Bills of Exchange Ordinance and Inland Revenue Ordinance.

The third one is judicial piercing. In most case the company is unwilling to pierce their corporate veil itself because of its own interest. However, there are many factors that a court will seek for a judicial piercing and there are various cases of these.

Based on the factors of fraud, sham, evasion of existing obligations, note the case of Gilford Motors v Horne 1933, Jones v Lipman 1962, HKSAR v Leung YAt Ming 1999.

By national interest, note the case Daimler Co v Continental Tyre & Rubber 1916, it concerned about the illegality that trading with the enemy during the war.

About Agency, note the case Firestone Tyre & Rubber Co v Lewellin 1957.

Single economic entity. Note the case Adam v Westbourne Galleries 1973

Connection with statutory offences. Note the case R v M G Michandani 1977

Criminal activities concealed. Note the case Re.H and others 1996

Fraudulent evasion of excise duty. Note the case Secretary for Justice v Lee Chau Ping 2000

Revenue Case. Note the case Unit Construction Co v Bullock 1960

Despite the court will not pierce the veil in normal way, however there are instances where the courts will pierce the corporate veil that will look beyond the company behind and find out the liability on the person. See the case China Ocean Shipping Co v mitrans Shipping Co Ltd, if the court think that the company is use to defraud, the court can pierce the veil and directly impute liability on the person himself. The judgment said that it is not allow to use a corporate structure to evade legal obligations but to avoid it is not objectionable.

Although courts have been inconsistent with regard to piercing the veil, generally the courts in United Kingdom and Hong Kong will not pierce the veil to expose shareholders to personal liability. Although in some instance it is morally wrong for some businessman to gain advantages through transactions by shell company to defraud and evade taxes. And also, it is impossible for piercing the veil of corporation which is publicly traded because of large numbers of shareholders and huge exchange.