Essay: Exceptional cases under statute and common law where the corporate veil can be lifted

Under sections 7-16 of the Companies Act 2006, a company is formed by registering with the Registrar of Companies and is incorporated when the Registrar issues the certificate of incorporation (G. Black, 2015). Section 16 of the Companies Act 2006, implements also, that a company is a separate corporate personality. The members of a company have limited liability over the debts of the company and their liability is limited to any value which remains unpaid on their shares. As a result, members are not personally liable for any debts or liabilities of the company. The corporate veil can be seen as a natural barrier that differentiates between the shareholders and members of a company and the company itself. This essay attempts to indicate the very exceptional cases under both statute and the common law where the corporate veil can be lifted.
The case of Salomon v A. Salomon & Co Ltd , is regarded as one of the most important cases in company law. Mr Salomon was running a leather boot manufacturing company as a sole trader. He sold his business to a company whose shareholders were himself, his wife and children. For the transfer of his business, Mr Salomon received 1000 pounds in cash and 10000 pounds worth of debentures form the company. The company was essentially a one-man company and it was controlled by Mr Salomon. When the company fell on hard times, Mr Salomon cancelled his debentures and reissued them to a Mr Broderip for 5000 pounds which he then applied towards the company’s debts. The financial problems of the company were not resolved and as a result a liquidator was appointed to carry the proceeds of the sale of the company. After the proceeds were distributed to the creditors, Mr Broderip only got part of the due debt and sought recovery from Mr Salomon personally. The final decision was given by the House of Lords which held that Mr Salomon was not liable for the debts of the company because of the fact that the company is a separate personality as was then defined by the Companies Act 1862 and the company has fully complied with the requirements of the Act. As mentioned before, this case is regarded as one of the most important cases in company law as it clearly established that members and shareholders of a company have limited liability over the debts of the company and that a company is a separate legal person distinct from its owners. A further example which makes clear that a company is regarded by law as a separate legal personality, is the case of Macaura v Northern Assurance Ltd . Macaura was the owner of a timber estate who then sold the timber to a company in which he was the only shareholder. The timber was insured against fire in his own name by several insurance companies and when the timber was destroyed by fire he sued the insurance companies to recover the loss. The House of Lords ruled that the timber was owned by the company and that it basically was not insured as the insurance was in Macaura’s name and that Macaura did not have the right for any compensation. This decision means that the court did not pierce the corporate veil between the company and Macaura so that he can receive compensation from the insurance companies.
Exceptions to the separate corporate personality principle under common law can be made as far as fraud and shame companies and agency and group companies are concerned. As seen throughout the years, these are the most common cases where the corporate veil is lifted and in most cases courts do not seem reluctant in lifting the veil of incorporations. In cases which a business was incorporated and used to hide the real purposes of its controllers, a sham exception to the separate legal personality is used by the courts. In such cases courts have experienced little difficulty in piercing the corporate veil. An example of such case is Gilford Motor Co v Horne . Mr Horne had a clause in his contract restricting him from soliciting customers of Gilford Motor Co for 5 years after leaving the company. After the termination of his contract, Mr Horne started soliciting customers of his former employer through a company whose only shareholder was his wife, knowing well that he would breach the contract with Gilford Motor Co if he solicited those third parties personally. Lord Hanworth M.R. ruled that the sole purpose of the business was to enable Mr Horne to solicit customers of his former employer and avoid the clause of his contract. The court pierced the corporate veil in this case and made both Mr Horne and the company liable to the contract with Gilford Motor Co. Where fraud is involved, the controller “must have the intention to use the corporate structure in such a way as to deny the plaintiff some pre-existing legal right” (Payne, 1997). In Standard Chartered Bank v Pakistan National Shipping Corporation , a director presented a bill of lading to the bank even though he knew that the bill of lading was outdated and that the bank would incur a loss by paying the company. The director was held personally liable by lifting the corporate veil. His status as a director influenced the decision of the court as if an employer of the company had written the same document for the company then personal liability would most probably not have been imposed (Nyombi, 2014).
One of the most commonly used exceptions to the separate legal personality doctrine as mentioned in Nyombi(2014), is the agency exception which arises when a member of a company or a parent company is qualified as a principal based on the degree of control over a specific company. An example where the court has ignored the separate legal personality of a company is the case of Re F.G. (Films) Ltd where an American business through its British subsidiary financed the production of a film. Due to the lack of contribution from the British company, the Board of Trade was against the registration of the film as British. The court decided that the British company was just an agent of the American company and in that way the separate personality was set aside. “Lord Denning’s “single economic unit” argument raised in DHN Food Distributors Ltd v Tower Hamlets LBC , created a new approach to the agency exception” (Nyombi, 2014). Slade LJ disagreed and stated that “There is no general principle that all companies in a group are to be regarded as one. On the contrary, the fundamental principle is that “each company in a group of companies” is a separate legal entity possessed of separate rights and liabilities” . Although agency and group companies is one of the most common exceptions to the separate legal personality doctrine, there is difficulty amongst the courts in determining a principal-agent relationship as most cases may not be straightforward. The case of Adams v Cape Industries is an example that many times courts can be reluctant in posing liability on the parent company. In this case an English registered company was presiding over a group of companies with business in mining and marketing of asbestos. The company got in a lawsuit in the USA and the plaintiff received a judgement against the English company in the American courts. As there were no assets left in the USA, the case was brought to the English courts against the principal company where the courts ruled that even though the structure of the group was set in a way that liability would fall only on a particular subsidiary, Cape Industries had the legal right to structure the group in that way and that the parent company was not liable for the debts of its subsidiary.
The piercing of the corporate veil can also be the result of the violation of provisions of the Companies Act 2006, even though separate corporate personality is enforced through the Act, as well as the provisions of the Insolvency Act 1986. A statutory exception to the doctrine of corporate personality is fraudulent trading and as stated in the Insolvency Act 1986 “on the winding up of a company, where it appears that any business of the company has been carried on with intention to defraud creditors, or for any fraudulent purpose, the court may declare any person who was knowingly involved in the fraud to make such contribution to the company’s assets as the court thinks fit”. Under the same Act, exists the exception of wrongful trading and it is stated that “on the winding up of an insolvent company, the court may declare a company director liable to make such contribution to the company’s assets as the court thinks fit, if some time before the commencement of the winding up of the company, he knew or ought to have concluded that there was no reasonable prospect of the company avoiding going into insolvent liquidation” . For the exception of fraudulent trading, criminal offence is attached to fraud and thus hard evidence is required, as for the exception of wrongful trading no evidence of fraud is required but this exception can be hard on directors trying to save their company. Another example of a statutory exception which will result in piercing the corporate veil is contracts executed before a company is incorporated and the certificate of incorporation is issued. “A contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and his personally liable on the contract accordingly” . If a company wishes to take advantage of a pre-incorporation contract, after the incorporation of the company, a new contract must be formed with the third party to carry out any agreements stated in the pre-incorporation contract.
Most companies these days are limited liability companies which indicates that limited liability and the doctrine of separate legal personality play a crucial role in the business world. Limited liability companies are artificial persons and as a result a company needs agents to make decisions and run the day to day operations of the company. Acting on behalf of the company, agents tend to think that responsibility will only fall on the company for their actions because of limited liability. Courts are entitled to set aside the principle of corporate legal personality and impose liability on the agents of the company, where inappropriate or unlawful actions were made through the company, for their own interest and benefit. Lord Keith observed that “it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere façade concealing the true facts” . The observation of Lord Keith, along with the exceptions discussed in this essay, indicate that the corporate veil must be lifted in exceptional cases and that courts must be reluctant and cautious before taking any such decision.