Lifting the veil on corporate personalities

Corporate personality means that “the company’s liabilities are the legal responsibility of the company and the members will not be liable for the company’s debts" (Talbot, 2008). Therefore the concept of corporate personality is heavily based upon the concept of limited liability. This refers to the sum of money which a stakeholder can lose when a company is sued, usually limited to the amount of money that they have invested into the company. Limited liability is exclusive to limited companies and public companies. However public companies have vast numbers of shareholders and therefore the shareholders are not normally susceptible to lifting of the corporate veil, although the officers or directors may still be prosecuted if they are in breach of legislation.

The first case that exemplified the difference in a company’s personality to that of its shareholders was the 1897 case of Salomon v A Salomon & Co Ltd [1] . The case looks at Aaron Salomon and his leather manufacturing. Salomon had four sons who wanted to be partners within the business so the company was transformed from a partnership to a limited company in which Mr Salomon owned 20,001 shares and the other 6 shares of the company were distributed amongst his close family. This is where the High Court and the Court of Appeal questioned the legality behind this transition as it would move Salomon from unlimited liability to limited liability and therefore would be shielded by the corporate veil. Through the transition Mr Salomon generated £40000 of which he invested £10000 into the business as a debenture allowing him to become a secured creditor. However following this, there was a host of strikes in the shoe industry and an economic downturn, this meant the government retracted a major order from Salomon Ltd to spread the risk and diversify amongst the market losing Salomon Ltd numerous sales. This led him to cancel his debenture and turn to a Mr Broderip in order to secure a loan of £5000. However the company still failed and it was here that the case became a precedent piece of common law.

The House of Lords unanimously overturned the decisions of the lower courts and stated that because the company had been set up correctly, the corporate veil was upheld to treat the company as a separate identity. They stated that even if a company has a majority shareholder and the other shareholders support that individual, the company should still not be viewed as a reflection of that person’s will. Lord MacNaughten [2] concluded that “The company is at law a different person altogether from the subscribers to the memorandum" and it is now this principle that defines the difference between a company and a partnership.

In an example of how the Salomon principle has been upheld in terms of case law during Tunstall vs Steigmann 1962 [3] the corporate veil was maintained. In this case Steigmann was a landlord who had rented a property to Tunstall, and after the lease was up Tunstall applied to grant a new tenancy, however Steigmann wanted to resume possession on the premises under Part II of the Landlord and Tenant Act, 1954. However because Steigmann had transferred the property into a business asset, he no longer qualified as a landlord of the property with regards to the Landlord and Tenant Act,1954. Therefore the corporate veil worked against Steigmann because being a limited company he became a separate legal entity to the company and therefore the property. It also meant that it was the limited business that would carry on the business rather than the landlord, thus eliminating the grounds in which the landlord could reject the tenancy of Tunstall.

There are multiple statutory cases in which the Salomon principle is ignored and the corporate veil can be lifted. The 1986 Insolvency Act gives four key examples of how the corporate veil can be lifted under various situations. Firstly under section 122(1)(g), it states that you may need to lift the corporate veil in order to see whether the company has been correctly set up throughout its life in order to wind up the company in a fair manor. Secondly, section 213 looks at fraudulent trading, which states that if a company has been carried on with the intentions of acting in a fraudulent manor any parties that acted with knowledge of this fraud can be made liable to charges that the court determines.

Next, section 214 regards wrongful trading whereby if a company enters insolvent liquidation and the director was aware that the company had no feasible way of avoiding insolvency, the director can be made liable for any outstanding debts the company has from the trade. An example of this section being used in a case is in the Re Produce Marketing Consortium Ltd (No 2) [4]  . This case looks at a company which was involved in the importing of grapefruits, oranges and lemons, and the case follows a Mr Eric Peter David and a Mr Ronald William Murphy, the directors of the company and how they had breached section 214 of the Companies Act of the 1986 Insolvency Act. Between 1981 and 1984 the company had generated a loss of £91,000, they then claimed that the company had become insolvent, however if it continued to trade they were certain it would cover its losses. However by 1987, when the auditors revealed a £175,000 loss , it was at this point that the auditors said to the bank that if they did not receive any support they would enter insolvent trading. Therefore the bank did offer aid, however they were considerably less generous than before and with the company suffering from debts of over £317,694 they entered voluntary liquidation on 2nd October 1987. The conclusion to the case was that David and Murphy should have known that the company was failing and that there was no feasible way to avoid liquidation. Therefore the pair were directly made liable to pay £75,000 between them as they were prosecuted under section 214(3) and thus should not have been trading when insolvency was inevitable.

Finally, section 216 of the 1986 Insolvency Act gives insight into “phoenix companies". A phoenix company is one which is set up under a similar or identical name to an insolvent company. It determines that any director that is interlinked with a company similar to the insolvent company can be prosecuted providing the alliance was within a year before the company enters liquidation.

The Companies Act 1985 contains a host of situations in which the corporate veil can be lifted, the first example is a failure to obtain a trading licence. This is found in section 117(8) and also in the 2006 renewal under section 767(3). This states that if a public company fails to attain a trading licence but proceeds to trade, the director can be made liable for any loss and/or damage that the trade incurred. Section 349(4) of the Companies Act 1985 also states that if a company participates in an exchange in which the company’s name is not included, the person that signed the bill can be made liable. However if the amount that is stated is correctly paid by the company, there would be no grounds for the prosecutor to sue. The Companies Act 2006 on the other hand, states that if a company does not put their name on relevant documents they will be subject to criminal penalties, however there is no written law that suggests a change in liability. Unfair prejudice is another factor stated within the Companies Act 2006, under section 459 that if a company has been manipulated to benefit certain members of that company, the members that experience unfair prejudice will be able to make a petition to the court. This will uncover the unfair operations of the selected staff within the company and make them liable to any penalty due, resulting from the unfair decisions.

Section 15 in the Directors Disqualification Act 1986 also provides an example of how the directors of a company can be made liable. It states that if a person that has been prohibited from their roles as a director or manager of the company and they disregard the disqualification, any debts incurred through their actions can be directly targeted to that person.

Now if we begin to look at common law we can see that the Salomon principle is regarded sceptically as the High Court’s do not want it to be a basis under which fraud can be committed. A prime example of this is the Gilford Motor Company Ltd v. Horne [5] whereby Gilford Motor Company Ltd was claiming against Horne due to a breach in a covenant between the two parties. Horne was Managing Director for Gilford Motor Company Ltd and was planning on leaving the company where he entered into a covenant that stated he was not allowed to use the customers that his current employer was using. However upon leaving the company he founded his own rival company and solicited the claimant’s customers, however he had issued all the shares to his wife and friend therefore not making him the majority shareholder of the company in an attempt to break the covenant. However when the Court of Appeal were shown the case they concluded that the new company was purely a façade to conceal his violation of the covenant and thus made Horne and his company liable to the penalty that the covenant orders. We can see that this case is similar to so-called “phoenix companies" stated before under the 1986 Insolvency Act however in the case law there is no link to insolvency as it was a breach of a covenant between two parties rather than a single party trying to maintain its consumer base and avoid facing liquidation.

Another example of this is Jones v Lipman [6] where Lipman was sold a house to Jones under a written contract, however when Jones tried to complete the sale, Lipman refused. Lipman then proceeded to take action in taking the house out of reach of Jones via conveying the house to a company that he had just set up. Russel J stated that the company was a “device and a sham" [7] as the defendant company was at all times under control by Lipman and that the purchase of this company and the transfer of the property "was carried through solely for the purpose of defeating the plaintiff's rights to specific performance and in order to leave them to claim such damages, if any, as they might establish" (Hicks & Goo, 2004).

Another alternative example of common law lifting of the veil is in the case of

Daimler Ltd v Continental Tyre and Rubber Co Ltd [8] which demonstrates lifting of the veil in a time of war where the veil is lifted in order to see the alliance of the company as it is not permitted to trade with enemy aliens.

So far all cases and examples are of a director within a corporation attempting to use the Salomon principle as an engine of fraud by manipulating the company or making fraudulent decisions. However, the Salomon principle can be demonstrated amongst groups of companies whereby the corporate veil is naturally lifted in most circumstances. Section 399 of the Companies Act 2006 states that “If at the end of a financial year the company is a parent company the directors, as well as preparing individual accounts for the year, must prepare group accounts for the year unless the company is exempt from that requirement". This rule is supported by ensuring all companies within a group produce profit and loss accounts and consolidated balance sheets. This makes sure that the companies are transparent and are not hiding behind the Salomon principle to cover outgoings within and part of the group.

However the law is always changing and now it can be seen that courts are becoming reluctant to lift the veil, for example in the Adams v Cape Industries plc [9] case the courts emphasised that they would not lift the veil if it was only in the interest of justice. This case shows Cape Industries, an English company that controls multiple subsidiary companies, in the mining and marketing of asbestos. The company found itself being faced with a class action law suit in the United States. This lead Cape Industries PLC to try to avoid the lawsuit by stating that the American law suit had no jurisdiction against them for the purposes of English Law. The Court held that Cape Industries had operated in a correct manner and because they were not currently in the United States, and the method of accumulating the damages caused to each claimant opposes the English Law idea of natural justice.

In conclusion we can see that lifting the veil on corporate personalities can be allowed by the court in various instances in statutory and common law. Lifting the veil has a high focus on the Salomon Principle as it illustrates how the corporate veil can be upheld, it is now therefore in the interests of the courts that the Salomon Principle is not used as an engine of fraud. There are a large number of cases that demonstrate lifting of the corporate veil in statutory law as there are multiple acts that aim to benefit the stakeholders through fair trades and transparent company accounts. On the other hand in common law there are fewer examples of lifting the veil as with the changes in law, the courts are becoming more reluctant to lift the veil if it is for the sole purpose of justice. Therefore in common law when it is a single party versus a company, if the defendant has abided by all their legal obligations, however the claimant has been unfairly treated, the defendant may win the case if justice is the only grounds to prosecute. The benefits of lifting the corporate veil are that it protects the buyers and sellers in their transactions. For example in the case of Jones v Lipman, Lipman lost the case as the company was a said to be a sham and only set up to overpower Jones’s rights thus lifting the veil can be seen to encourage fairness. On the other hand it may also promote injustice as companies act within the law even if their motives are spurious holding hope that the corporate veil will be upheld like in the Tunstall vs Steigmann case. For example the directors of a partnership will find it more desirable to have a limited company as they will be subject to limited liability so may convert the company within the boundaries of the law to benefit from the corporate personality.