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Judicial Commentary

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RECENT JUDGEMENTS ON THE ISSUE OF CORPORATE PERSONALITY PARTICULARLY IN THE GROUP CONTEXT SHOW STRONG AND CONTINUED SUPPORT FOR THE IDEA OF SEPARATE CORPORATE PERSONALITY. DISCUSS One of the consequences of incorporating a limited liability company is that it becomes a separate legal entity. This means that it is has a separate and distinct personality from the members of the company, and so becomes a person in a legal sense.[1] Thus the company bears its own liabilities and debts separate from the shareholders and has rights and duties.[2] The principle of the separate personality of a company was discussed at length in the case of Salomon v. A Salomon,[3] where Lord Macnaghten stated: “…The company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act.”[4] Consequently, the fact that one person owned all or majority of the shares of the company did not make that person the sole owner of the business in the eyes of the law. This was emphasized in the Salomon case when Lord Macnaghten stated: “I cannot understand how a body corporate thus made "capable" by statute can lose its individuality by issuing the bulk of its capital to one person, whether he be a subscriber to the memorandum or not.”[5] In the case of Lee v Lee Air Farming Ltd,[6] Lord Morris made it clear that it was possible for an individual to enter into a contract with his own company. The judge stated that if the company was accepted to be a separate legal entity, then there was no reason to challenge the validity of any contract between the company and another individual, even if that individual was its majority shareholder. It was the judge’s view that control would in fact remain with the company regardless of whoever the company’s agent was. Therefore, as a separate entity, the company can own property which would belong solely to it and not to its members. Neither a member of the company or a creditor has any interest in that property.[7]The company as a legal personality does not hold the property in trust for the shareholders.[8] They simply have no right to it. The aim of this discussion is to look at the separate legal personality theory in terms of groups of companies and discover what the attitude of the courts is with regard to the theory and group companies. The first step in this will be identifying the exception to this theory, which is described as lifting the corporate veil, when it can be used and the attitude of the courts to this theory in past case law. Moving forward, the application of the principle and its exception will looked at from an international point of view. Finally, the discussion will focus on groups of companies with the aid of case law and an analysis will be made about the recent stance of the courts regarding the theory. Under certain circumstances, it is possible for the courts to look behind the company’s framework or separate personality to make the members of the company liable for a wrongdoing. This process is referred to as ‘lifting the corporate veil.’[9] In as much as the corporate veil saves shareholders from liability by separating them from the company, it also makes it possible for them to hide behind the corporate veil in order to defraud creditors.[10] It has been suggested that the corporate veil would be lifted by the courts if there was evidence of fraud.[11] In the past, the UK courts have been criticized for showing little reluctance in lifting the corporate veil.[12] An example of this is in the case of Daimler Co Ltd v. Continental Tyre and Rubber Co (Great Britain) Ltd[13] where the Continental Tyre company sued Daimler company for debts owing. The tyre company was incorporated in the UK but all except one of its shareholders were German residents. All the directors of the company also lived in Germany. The issue was whether the company had the right standing in England to sue and recover a debt when there was an ongoing war between Britain and Germany at the time. The tyre company was allowed to sign a summary judgment which was appealed, and Lord Reading, while affirming the previous decision, emphasized that once a company was formed and registered under the Companies Act, it had a real existence with rights and liabilities as a separate legal entity. It was a different person altogether from the shareholders on the register therefore if the appellants were to succeed then the debt owed would be payable to the shareholders and not to the company. However, a debt due to the company was not a debt due to the shareholders. The House of Lords reversed this decision and Lord Parker stated that while no one could deny the separate legal existence of a company, the character of the members of the company was not irrelevant to the character of the company. As much as a natural person could have enemies, the company as a legal person could also have enemies. He went further to state that the acts of a company’s organs, directors, managers and so forth were the acts of the company and may invest in it enemy character. The difference between the approach of the Court of Appeal and the approach of the House of Lords is noticeable in this case. The idea of a company having a separate legal personality is popular in the sense that it retains a personality different from that of its shareholders. Therefore as an artificial creation of law, it also retains the nationality of the place in which it was incorporated.[14] It seems a bit arbitrary that a company is given the characteristics of its shareholders if as a limited liability, it has been separated from them in the first place. A very recent case which shows support for attributing the character of shareholders to the company is the United States case of Burwell v. Hobby Lobby Inc.[15]The United States Supreme Court held that closely held corporation owners could be exempted from a law based on their religious beliefs if there was a less obstructive method of promoting the law’s objective. In this case, the owners of Hobby Lobby Inc. refused to provide contraception for their female employees because of their religious beliefs. The basis of this decision was to extend rights to corporations to protect the rights of the people connected with the corporation including its shareholders.[16] In recent times however, the courts have been less willing to lift the corporate veil. In the case of Prest v. Petrodel Resources,[17] Mr Prest owned a network of offshore companies over which he exercised total management control. The business of those companies was originally limited to owning various residential properties, including the matrimonial home he shared with his wife, but later the companies were used in his business. When their marriage failed Mrs Prest made a claim under sections 23 and 24 of the Matrimonial Causes Act 1973 for financial assistance based, in part, on the value of the real estate owned by that network of companies. Mr Prest argued that he was not entitled to those properties and refused to comply with orders for full disclosure as to his assets. In giving their judgement, the Supreme Court laid down the appropriate situations in which the corporate veil could be lifted. Lord Sumption found that in the case of piercing the corporate veil, it was only cases which were true exceptions to the separate legal personality rule, where a person who owned and controlled a company could be said in certain circumstances to be identified with it in law by virtue of that ownership and control. He went further to state that in civil law jurisdictions, the juridical basis of lifting the corporate veil is generally the concept of abuse of rights, where the veil could be lifted in cases of misuse, fraud, malfeasance or evasion of legal obligations. The broader principle in English law however, was that the corporate veil may be pierced only to prevent the abuse of the corporate legal personality. The abuse could be the use of a company to evade the law or to frustrate its enforcement. The court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller of the advantage that they would otherwise have obtained by the company's separate legal personality. The separate legal personality principle has also been applied internationally. In Rayner v Department of Trade and Industry,[18] the International Tin Council was a United Nations international organisation established by a treaty to regulate the tin market and it had various member states as shareholders. The tin market got into difficulty and the contracts which were made could not be honoured. It was held that that the International Tin Council had a legal personality separate and distinct from its members and that under the common law the members of the Tin Council had no liability for the contracts made. Internationally, fraud seems to be the motivating factor for several countries in applying the principle and its exception. In Germany, lifting the veil is known as breaching the walls of the corporation, [19]and it is applied where a sole shareholder has failed to distinguish between his private assets and the assets of the company and has gained a benefit from that.[20] The principle is however limited to situations where the actions of the shareholder has rendered it impossible for creditors to obtain satisfaction of debts from the company’s assets.[21] There is also the issue of undercapitalization where a shareholder gives a loan to the company and actually receives payment on that debt from the company. Fraud is also present in other Civil Law jurisdictions like France and Argentina, and an example of fraud is in one man companies. This type of company is treated as fictitious on the basis that that a company is treated as a contract, and plurality is an important element of contract law, thus a company which is made up of one man lacks the element of a contract and is therefore fictitious.[22] Also the concept of fraud in terms of companies is used to solve problems arising from a company being used as a shelter to evade contractual obligations towards third parties.[23] There have been times where the UK courts have ignored the corporate veil completely because of fraud. This usually happens when a company has been set up as a means to defraud creditors or other bodies, and is operating as a façade or a sham. The illustration of this principle is in the case of RE Darby, ex parte Brougham.[24] Darby and Gyde, two undischarged bankrupts with convictions for fraud registered a company called City of London Investment Corporation Ltd (LIC) in Guernsey. It had seven shareholders and issued £11 of its nominal capital of £100,000. They were the only directors and entitled to all profits. The company then registered another company in England called Welsh Slate Quarries Ltd, for £30,000. It bought a quarrying licence and plant for £3500 and sold it to the new company for £18,000. The prospectus invited the public to take debentures in the new company but failed to mention the names of the two incorporators or the fact that they would receive the profit on sale. The new company failed and went into liquidation. The liquidator claimed Darby’s secret profit, which he made as a promoter. Darby objected that the first company had been the promoter of the second and not him. The court held that they had incorporated the company in order to perpetrate a fraud. They acted through the company in order to make a profit, which is why they concealed their identity as the promoters of the new company so they could hid behind the separate personality of the old company.[25] When the principle of a separate legal entity is applied to group companies, every member in a group of companies has a separate identity and in the same vein they are separated completely from their shareholders, whether the shareholder is a private person or a holding company. Thus a holding company cannot control the documents of its subsidiary.[26] The UK Companies Act 2006 defines a group of companies as a parent undertaking and its subsidiary undertakings.[27] Accordingly, one company runs as the head, or holding company and runs a number or legally separate companies which make up the group.[28] However, the application of the separate legal entity principle to cases involving liability in group companies has not always been straight forward. Judges have previously relied on tools like agency[29] or the fact that group companies can be regarded as a separate legal entity in order to lift the corporate veil. In DHN Food Distributers Ltd v. Tower Hamlets London Borough Council,[30] the courts were willing to treat a parent company and its subsidiary as a single economic entity. In giving his judgement, Lord Denning stated that when a parent company owned all the shares of the subsidiaries, it could control their every movement. These subsidiaries are then bound hand and foot to the parent company and must do just what the parent company says. A second example is in the case of Re FG (Films) Ltd,[31] where the courts were willing to create an agency relationship between a British subsidiary and its American shareholder in order to lift the corporate veil. By the terms of an agreement between the two companies, the American company had undertaken to finance the making of a film by the British subsidiary. The film was held to be an American film and therefore was not registered as a British one. The basis of this agency relationship used by the courts is that the ‘principal’ (controlling shareholder or holding company) had induced the ‘agent’ (the company or subsidiary) into acting according to their directions, and therefore the act of the ‘principal’ was the act of the company.[32] The introduction of a single economic entity in group companies has actually been met with a negative response.[33] Industrial Equity v. Blackburn[34] has found that the principle works to prevent a holding company from handling a subsidiary’s profits as its own. The Australian High Court went further to state that in the absence of a contract creating some additional right, the creditors of company a subsidiary company within a group, could only look to that company for payment of their debts. They could not look to the holding company, for payment. Also, in Woolfson v. Strathclyde Regional Council,[35] the House of Lords refused to follow the ruling in DHN Food Distributers Ltd v. Tower Hamlets London Borough Council and Keith L.J affirmed that the only reason to pierce the corporate veil would be where a company was operating as a façade. He stated that in the DHN Foods case, the company that owned the land was the wholly-owned subsidiary of DHN who was in control of anything which might affect the business. In the Woolfson case however, the company had no control over the owners of the land thus Woolfson was not entitled to any compensation. Generally, it seems the courts are leaning towards the application of the separate legal entity principle but with a number of reservations. In Adams v Cape Industries,[36] the Court of Appeal looked at the instances of agency, the group as a single economic entity and the subsidiary company used as a façade for the parent company. The court stated that there was no justification for lifting the corporate veil using the tool of agency, Slade LJ stated that there was no presumption of agency, neither was there one that the subsidiary was the parent company's alter ego. On the issue of groups being a single economic unit, the judge stated that there is no general principle that all companies in a group of companies are to be regarded as one. Quite to the contrary, the fundamental principle was that "each company in a group of companies is a separate legal entity possessed of separate legal rights and liabilities"[37] the judge went further to state that the corporate veil could only be lifted in the case where the company was operating as a façade or a sham. The effect of this was summed up by Templeman L.J. in the case of Re Southard & Co Ltd[38] where he stated: “A parent company may spawn a number of subsidiary companies, all controlled directly or indirectly by the shareholders of the parent company. If one of the subsidiary companies, to change the metaphor, turns out to be the runt of the litter and declines into insolvency to the dismay of its creditors, the parent company and the subsidiary companies may prosper to the joy of the shareholders without any liability for the debts of the insolvent subsidiary.”[39] It would seem that the general position on lifting the veil for group companies is that the courts will not find holding companies liable for the acts of their subsidiary, however, the position is still in dispute. In the case of Millam v The Print Factory,[40] the employees of a wholly-owned subsidiary were found to be the employees of the holding company because the activities of the subsidiary company were so integrated with those of the holding company that the two companies were considered as a single entity. Although the companies were separately registered, the holding company paid the wages of the subsidiary’s staff, managed their pension scheme and actually combined some of their meetings. Also in the case of Beckett Investment Management v. Hall,[41] a restrictive trade contract was held to include a holding company and its subsidiaries because Considering, it is submitted that the UK courts have previously taken a very eager view of lifting the corporate veil. It comes from the fact that there should be accountability where corporations are involved. The limited liability is in place to protect the shareholder, though, the very same people it protects have also come up with a way to abuse it by hiding behind it whenever it suits them. It should however be stated that creating a way for courts to go poking behind corporate veils has the disadvantage of making the law very uncertain, which seems to be the direction the courts have taken in terms of their recent decisions. It is submitted that the idea of a separate legal personality keeps the image of a corporation intact to enable it to carry on business, and the aim of the courts in lifting or piercing the corporate veil should be to protect the company. Thus in as much as the shareholders or the directors of a corporation might be personally liable for debts owed to creditors, the reach of the court should be to point Basically that doctrine exists in order to preserve the principle of limited liability. It is concerned with the rights of creditors in the context of company law. 1
[1] Salomon v. Salomon [1897] AC 22 [2] Len Sealy & Sarah Worthington, Sealy's Cases and Materials in Company Law (9th edn, Oxford University Press 2010) pg. 32 [3][1897] AC 22 [4] Lord Macnaghten, Salomon v. Salomon [1897] AC 22 [5] ibid [6][1961] AC 12 [7] Macura v. Northern Assurance Co. [1925] AC 619 HL [8] JJ Harrison (Properties) Ltd v. Harrison [2001] EWCA Civ 1467, [2002] 1 BCLC 162 [9] Len Sealy & Sarah Worthington, “Sealy's Cases and Materials in Company Law” (9th ed, Oxford University Press 2010) pg. 53 [10] RE Darby, ex parte Brougham [1911] 1 KB 95 (King’s Bench Division) [11] Ottolenghi S, ‘From Peeping Behind the Corporate veil to Ignoring it Completely’ (1990) 53 MLR 338 pg.338 [12] Cohn EJ and Simitis C, ‘“Lifting the Veil” in the Company Laws of the European Continent’ 12 International & Comparative Law Quarterly 189 pg.219 [13] [1916] 2 AC 307 [14] Gasque v. IRC [1940] 2 KB 80 (King’s Bench Division) [15] [2014] 573 U.S__ [16] The Dictionary Act defined persons to include corporations and the Religious Freedom Restoration Act, 1993 extended religious freedoms to all ‘persons.’ [17] [2013] UKSC 34 [18] [1990] 2 AC 418 [19]Cohn EJ and Simitis C, ‘“Lifting the Veil” in the Company Laws of the European Continent’ 12 International & Comparative Law Quarterly 189 [20] Ibid pg.191 [21] Ibid [22] Ibid pg. 842 [23] Ibid pg. 844 [24] [1911] 1 KB 95 (Kings Bench Division) [25] The legislative basis for the holding in this case can be found in section 213 of the Insolvency Act, 1986 [26] Lonrho v Shell [1980] 1 WLR 627 [27] Section 474, UK’s Companies Act, 2006 [28]Collins H, ‘Ascription of Legal Responsibility to Groups in Complex Patterns of Economic Integration’ 53 MLR 731 [29] In the case of Salomon v. Salomon the argument for agency was advanced where the company was said to be the agent of Salomon. [30] [1976] 1 WLR 852 [31][1953] 1 WLR 483 (Chancery Division) [32] In the case of Gramophone and Typewriter Limited [1908] 2KB 89, the court held that a subsidiary could not be held to be the agent of their holding company. [33]Though the corporate veil can be extended o that it encompasses a group of companies. Here the veil is lifted of a company them drawn over the larger group of companies thus the court is dealing with an “enterprise entity.” The Companies Act, 2006 gives credit to this extension under section 399 where, the directors of a parent company, as well as preparing individual accounts for the year, must also prepare group accounts for the year unless the company is exempt from that requirement. Ottolenghi S, ‘From Peeping Behind the Corporate veil to Ignoring it Completely’ (1990) 53 MLR 338 pg. 347 [34][1977] 137 CLR 567 [35] [1977] 137 CLR 567 pg.577 [36] [1990] Ch 433 (Court of Appeal) [37] The Albazero [1977] AC 774 at p. 807 per Roskill LJ. [38] [1979] 3 All E R. 556 [39] Re Southard & Co Ltd. [1979] 3 All E R. 556 at 565. [40] [2007] EWCA Civ 322 [41] [2007] EWCA Civ 613
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