Reluctance to allow lifting of corporate veil
By and large the courts in the UK have been reluctant to allow the ‘lifting of the corporate veil’. How can you explain this and do you agree with this approach?
“The law speaks of a corporation as a legal person-as a subject of rights and duties capable of owning real property, entering into contracts and suing and being sued in its own name separate and distinct from its shareholders."  Over a century ago, this fundamental principle of ‘separate legal personality’ has been established in the leading case of Salomon v Salomon  . This general rule can be described by many phrases such as ‘corporate veil’, ‘separate entity principle’, ‘Salomon principle’ etc. All these different phrases reflect the same common idea, that a corporation is a legal entity separate and distinct from its shareholders, directors and officers.
Although its considerable influence in company law around the world, it is not an absolute rule since sometimes may has the potential to be abused or lead to unjust consequences.  For this reason it has been recognized that there are some instances where courts or legislature can deviate from it. This is what is well known as ‘lifting the corporate veil’ or ‘piercing the corporate veil’. Although this issue has been considered by courts and commentators for many years, it is still very difficult to predict when the courts will disregard the Salomon principle.
The central purpose of this paper is to examine why the courts in United Kingdom have been so reluctant to allow the lifting of the corporate veil. In order to achieve this goal, we have to examine carefully the Salomon case which supports the idea of corporate personality. Related to this examination, we are going to make some important indications as regards the meaning of corporate personality and the concept of limited liability, which are the two essential pillars of company law. This discussion will help us to flow in the main theme of this paper and examine the situations under which the veil of incorporation can be lifted. Firstly we are going to discuss very briefly the statutory exceptions and then we are going to focus and make a detailed examination of the common law grounds in order to determine the reasons for judicial disregard of the corporate personality doctrine. Through all this analysis we are going to understand the basic reasons why the UK has been so unwilling to lift the corporate veil. While doing this paper, we must bear in mind that although Salomon principle exists for more than hundred years there is still uncertainty surrounding its scope and the availability for the common law grounds for lifting the corporate veil.
Salomon case and its significance
The single most important decision in company law remains the judgement in Salomon. For this reason I believe it is essential to examine closely the facts of the case and understand its contribution in company law.
Mr Salomon, from being a sole trader he decided to register the business as a company with six other members of his family following the statute. We have to note that his unlimited liability for the debts of the company as a sole trader has changed to limited liability as a shareholder in the company. He was the majority shareholder while the others held one nominal share each. The company later turned into liquidation and the principal issue was whether the liability of the debts should fall on Mr Salomon.
It was decided that Mr Salomon was a separate person from the company and thus the debts of the corporation were not debts of Mr Salomon since they were two distinct legal entities. As Lord Herschell pointed: “…both courts treated the company as a legal entity distinct from Salomon and that the then members who composed it, and therefore as a validly constituted company"  . As a result it was firstly recognized that, once a company is validly formed and always in compliance with Companies Act, it is considered to be a separate legal person and not an agent or trustee of its controller. As Lord Macnaghten stated this point: “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 person are managers, and the same hands receive the profits, the company is not in law the agent of subscribers or trustee for them".  Secondly it was pointed that assets of the company belong to the company and not to the shareholders, thus shareholders can have share of the participation right in company but not in sharing the company property. Thirdly it was seen that the motives of shareholders are irrelevant unless fraud is involved. As Lord Halsburg stated “the motive of those who took part in the promotion of the company are absolutely irrelevant". 
As we have seen the significance of Salomon’s decision lies in the recognition of the ‘separate entity’ principle. From the moment that a company is being formed and incorporated as a registered limited company, the members of that company create a body which is recognized as having an independent legal personality. However, the fact that a corporation has a status equivalent to person does not mean that they can do anything that a human can do. A corporation can conduct litigation on its own, both as a claimant or a defendant and thus can sue and be sued in its own name. Thus, corporations are conducted by the company and not by its members even if those members run company’s affairs. The court in Salomon, confirmed the idea that has been stated in Foss v Harbottle  that when a wrong is committed against a company, the company would be the plaintiff in the proceedings and not its members. General corporations can sign contracts and thus gets the benefits and obligations which belong to it since the company’s contractual rights are not those of its members. As Lord Halsbury pointed “Once a company is legally incorporated it must be treated like any other independent person with its rights and liabilities appropriate to itself".  Also corporations have one obvious advantage over real people since they have an unlimited lifespan. This means that they could not die although they can be wound up and that they cannot be affected by any changes of membership since their identity would be retained.
Through the years, Salomon principle has taken rapid evolvement and it has been highly used, not only due to the ‘separate entity’ principle but also due to the doctrine of limited liability that flow from it. President Butler of Columbia University has described limited liability as the greatest discovery of modern times.  One of the key advantages that shareholders earn when business turned into corporations is their ‘limited liability. Unlike a sole trader who would be responsible for all the debts, a corporation limits the personal liability of its shareholders. As it happened in Salomon, shareholders are not obliged to pay company’s debts and when company does not pay its debts shareholder lose only the value of their shares and nothing more. More clearly this means that shareholders are just liable only to the extent that they have contributed to company’s capital.
In a series of more recent cases, the precedent of Salomon has been confirmed. For example, in Macaura v Northern Assurance Co  it was confirmed that company’s assets belong to company and not to shareholders. Thus even if Mr Macaura owned all the shares, he had not no insurable interest in company’s property. Moreover, in Lee v Lee’s Air Farming Ltd  , Mr Lee and the company were found to be distinct legal entities and therefore capable of entering into legal relations, thus there can be a contract between a corporation and the controlling member of that corporation.
As all principles have both advantages and disadvantages the same happens with Salomon principle and the doctrine of limited liability. As Gooley has observed Salomon doctrine is a “two edged sword".  One memorable quote states that “limited liability corporation is the greatest discovery of modern times…Even steam and electricity are far less important that the limited liability corporation".  General it was a good decision since it has helped to the development of modern capitalism. Limited liability encourages public to invest without being involved in administration of the company since they do not risk anything apart their invested capital. Moreover the principle has been extended to cover small traders helping them to avoid the ‘tyranny of unlimited liability".  Thus limited liability companies have also been used from partners and sole traders in order to enjoy limited liability’s benefits. All together help the development of economy since without these principles people would run companies with the danger of losing their personal assets. On the other hand, Salomon principle is an ideal vehicle for fraud.  An example illustrating this point is the known “$2 companies" which means that undercapitalised limited companies are created in which the owners in their attempt to repay the loans, they cause large debts to the companies and when creditors seek repayment, owners argue that they do not have to pay since company is a separate legal entity. Also the fact that directors hide behind the corporate veil enable them to take unreasonable risks since they know that their personal assets would be safe. The fact that members and directors are protected while creditors are sacrificed is unfair in such cases. The famous lawyer W.S. Gilbert stated that limited liability has the “adverse effect of transfer uncompensable trading risks to creditors".  There are different types of creditors with different capacities to protect themselves against the risks.  For example small trade creditors cannot mitigate their risk in contrast with powerful secured creditors.
Lifting the ‘veil of incorporation – Exceptions to the general rule
The company’s separate existence is described as a veil and thus corporate veil is a fundamental aspect of company law since it protects those who exist behind it.  However there are occasions where the courts are under pressure to review the general principle and make decisions contrary to it. As it was stated “the justification for piercing the corporate veil is the need to avoid inequitable results or to prevent unscrupulous shareholders exploiting the separate personality of the company to commit a fraud or injustice".  Except courts, there are also a number of statutory provisions that in effect require the piercing of the corporate veil.
There are various statutory exceptions under which corporate veil can be lifted such as for taxation and financial transparency reasons, premature trading, reduction of member’s number etc. However the most important are those dealing with fraudulent actions.
Firstly we must note that Companies Act has recognized that corporate form can be used for fraudulent purposes.  There are both civil and criminal sanctions related to the offence of ‘fraudulent trading’. Under section 993 of the Companies Act 2006 there is a criminal offence for fraudulent trading and if a company is carried out with fraudulent purposes, the party who has knowingly contributed to it would be liable to imprisonment or fine or both.  On the other hand sections 213-215 of the Insolvency Act 1986 cover any civil provisions related to this offence. Under section 213, if a company is carried out with intention to defraud creditors or other fraudulent purposes  , then the court on the application of the liquidator, may decide that anyone involved in the fraud can be liable to contribute to the debts of the company.  However for this section to be applied, as it was stated in Re Patrick & Lyon Ltd  there is a precondition for proving ‘actual dishonesty, involving, according to current notions of fair trading among commercial men.’ 
Since it was so problematic to prove section 213 in practise, section 214 for ‘wrongful trading’ was introduced. In contrast with section 213, under section 214 it is not prerequisite to prove dishonesty. Moreover, section 214 covers only directors and shadow directors in contrast with section 213 which covers anyone involved in the carrying of the business. We must note that shadow directors, is anyone rather than a professional with whose directions or instructions the directors of the company are accustomed to act.  The case of Re Produce Marketing Consortium Ltd  is a good example illustrating the way that this section operates.  It was shown that two questions must be answered in order for the court to be able to issue such a declaration. Firstly, it must be asked whether the direction knew or ought to have realized that there is no reasonable prospect of the company avoiding insolvent liquidation and secondly assuming that there was no reasonable prospect of avoiding insolvent liquidation, whether the director has taken all the reasonable steps in order to minimize the loss to company’s creditors. 
Common law exceptions
Through the years, various attempts have been made trying to explain the situations when the courts will lift the corporate veil. Despite all these attempts none of them are satisfactory since sometimes the court lift the veil and sometimes refuse to do it. Thus some categories which are well known as common law exceptions have been created as guidelines in order to help the court when to disregard company’s limited liability.  In such situations, the disregarding of limited liability would result in directors and members personal liability for debts and other obligations of the company. 
Before examining the common law exception one by one we have to mention Adams v Cape Industries case which is a landmark case since all the common law exceptions were given in its judgement. Capes Industries was a registered company in England engaging in mining asbestos in South Africa. The company’s products were marketed in USA through a network of subsidiaries and associated companies. Some factory workers have contracted disease after inhaling asbestos dust. Three arguments were made in an effort to establish that Cape was present in USA. Firstly it was argued that Cape and subsidiaries were one economic unite, secondly that the corporate for was just a façade concealing true facts and thirdly that the subsidiaries were agencies of the holding company. However all the three common law grounds for lifting corporate veil have been failed. As Professor Gower stated the judgment in this case is a “mammoth, involving a number of issues, subjected lifting the veil to the most exhaustive treatment that it has yet received in the English courts".  Also this case highlights the way that limited liability and separate legal personality can result in significance injustice against claimants. 
As we have seen one of the most important statutory exceptions was based on the ground of fraud, thus it would be absurd for the courts to allow the use of Salomon principle as a vehicle of fraud. The courts have been more than prepared to lift the corporate veil when fraud was concerned and two classis examples of cases can illustrate it.
The first case is the Gilford Motor Company Ltd v Horne  in which there was an abuse of the Salomon principle since the defendant had set up the company not for a genuine purpose but rather as a sham in order to hide his intention to break covenant with his former employees. Lindley LJ hold that “ the company was a mere cloak or sham".  Moreover the second case is the Jones v Lipman  in which the court recognized that a company being sham or façade is a well-known recognized exception to ‘corporate personality’ principle.. In this case the company was formed with sole motive to avoid transaction and thus there was a façade to prevent honouring of agreement to transfer the land. Russell J was prepared to lift the corporate veil by describing the defendant’s company as ‘…the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity.’ 
Before the corporate veil would be lifted, there are some relevant factors that the courts must consider. Firstly, the motives of the person behind the alleged façade are sufficiently important to be looked.In Adams, Slade LJ held that the company must be one that is a façade which is concealing the true facts. Secondly in order to determine whether the fraud exception exists it is very important to find the character of the legal obligation being evaded. General the defendant must deny the plaintiff a pre-existing legal right and as a result if the legal right crystallizes before the incorporation of the company the fraud exception is satisfied.  However if there is no legal right, defendant’s intention to deceive plaintiff must be speculative and secondly. Finally another important factor that must be looked is the timing of incorporation. For example in Ord V Belaven Pubs Ltd  , company’s reorganisation was legitimate and not a façade to conceal true facts.  In cases such as Gilford and Lipman which have been looked above, the sham companies have been formed with the intention to carry out the fraud, whereas in this case the device company was already in business. As a result we can see that a reason why fraud exception has failed was the different time of incorporation. A case that can be contrasted to Ord case is Kensighton International Ltd v Republic of Congo where the court held that it was appropriate to lift the corporate veil.
General as it was stated in Trustor AB v SmallBon  the corporation must be the device through which impropriety is conducted since impropriety alone does not suffice  . As Payne states it does not matter whether the company started with legitimate purposes but later become a façade or whether the company was set up with the intention of fraud.  As long as “the intention to use the corporate structure in such a way as to deny the plaintiff a pre-existing legal right"  the fraud exception can be established. It is obvious that the courts would disregard the limited liability of company when the company is a sham and concealing true facts. 
The courts sometimes have been willing to lift the corporate veil where the company has been no more than the ‘alter ego’ of its shareholders. The company is said to be the ‘agent’ of the ‘alter ego’ of the shareholders when it does not carry on its own business or affairs but on behalf of its shareholders. Agent general is the person who acts on direction of another who is principal, and all agent’s acts are binding on the principal. In case of companies, a subsidiary company can be the agent of the parent company.
In Salomon case Justice Vaughan Williams stated that the company was nothing more but an agent of Salomon. However, when the House of Lords appealed the case it was held that a company did not become an agent of the shareholder simply because it was a one man company. From this decision we can understand that the mere fact that a person has all the shares in a company does not indicate an agency situation thus we must carefully consider all the facts and circumstances of each case separately.
The leading case of agency exception is Smith Stone and Knight Ltd v Birmingham Corporation  . This case was concerned with the critical question of whether the subsidiary is carrying on the business as the parent company’s business or as its own. Here the two companies were treated as one with the same entity. This case is a leading one since Atkinson J laid down some important factors that must be taken into account in order to establish whether an agency relationship exists between a holding company and its subsidiaries. We must bear in mind that these factors are just guidelines and the court will determine each case based on its own facts and circumstances. It must be considered who receive the profit, who is conducting the company, who is the head of the company, who is in charge of appointing person and most importantly who has effective and constant control of the business. When all these questions are answered in the affirmative, the group of companies is likely to be treated as a single entity
Moreover Re F.G (Films) Limited  is a similar case to Smith since the court in line with the judgement in Smith considered the particular circumstance of the case and held that the English Company was an agent of the American company. Furthermore, in Southern v Watson  it was stated that an agent relationship is very easy to be established if there is and express agreement between the principal and the agent. General from the above case law it is obvious that the court must consider very much in detail the relationship between the parent company and any subsidiaries.
By the 1960s the continuing and increased use of group structures has begun to cause problems to the courts in making their decisions. In case of group enterprises the court may lift the corporate veil in order to look the economic reality of the group itself and ignore the separate legal entities of the companies within the group. General you cannot predict with certainty when the courts would set aside the Salomon principle. However the courts will never ignore the limited liability of a subsidiary so as to allow the creditor of an insolvent subsidiary to seek redress from the holding company. Here it is important to note that personal assets of members are always safe and the question is whether parent company enjoys limited liability or not.
Firstly, Lord Denning has outlined the theory of the ‘single economic unit’ in DHN Food Distributors v Tower Hamlets LBC  . He has stated that “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." In this particular case the three subsidiaries were held to be part of the same economic group or entity and thus were entitled to compensation. It was seen that a group of companies was in reality a single economic unit and should be treated as one.
One year later, in Albazero case  it was stated that each company in a group is a separate legal entity with separate legal rights and liabilities. Finally the case of DHN was rejected by the House of Lords in Woolfson v Strathclyde Regional Council  since Lord Denning’s views were disapproved. The House of Lords stated that the veil of incorporation would not be lifted unless special circumstances are involved such as façade. A possible scenario under which courts may lift the corporate veil is the following : If a holding company set up a subsidiary in order to get advantage of limited liability and in case of holding company fail, subsidiary’s assets would be used in order to satisfy holding company’s debts. In Woolfson since the company which carried on the business did not have any control over the owners of the land, they could not be considered as a single economic entity. This decision highlighted two key factors that the court must take into account in order to decide whether companies are a single economic entity or not. Firstly, the control that parent company has on subsidiary must be examined and secondly if there is complete ownership of all shares in subsidiary company by parent. The reason is that there must be complete or nearly complete ownership is the fact that just mere share ownership is not enough.
Moreover the ‘single economic entity’ theory was rejected by the Court of Appeal in Adams v Cape Industries plc  . This judgement was a contrary judgement to the liberal approach taken in DHN case. The court supported the view that they are not entitled to lift the corporate veil just because the corporate structure has been used in such a way to ensure that legal liability would fall on another member of a group rather than the defendant company. It has set the bar very high since for an implied agency relationship to exist, would need strong evidence such as a day-to-day control exercised over the subsidiary by the parent company. Moreover in In Re Polly Peck International it was said that Salomon principle must cover group of companies and thus each company in a group must be considered as a separate legal entity.
After all, why are the courts so reluctant to lift the corporate veil?
It has significantly narrowed the ability of courts to lift the corporate veil. It is obviours that from Adams and after the courts are following a more restrictive approach. Re A Company the court will use its power to lift the veil if it is necessary to achieve justice.(gone) – interventionist period – debate whether or not this has brough uncertatiny. As Lowry states “the problem that can naturally arise from this approach is the uncertainty which it casts over the safety of incorporation.the use of the policy to erode established legal principle it not necessarily to be welcomed" – bokk p36
Despite the fact that, there are some ‘lifting of veil’ cases, it looks like that Salomon principle remains strong and possibly without any exceptions. Most of the cases, in which the corporate veil has been lifted, are where shareholders use the company as a device to achieve benefits or to avoid obligations. It is obviously thtat on very rare occasions the court would deny the corporators the advantage of hiding behinf the corporate veil. Thus it is very rare to see a shareholder being liable for any of the company’s acts or debts when that actually happens is very difficult to predict ehn this would happen since judges have different views as regards fairness and policy. Two conflicting judges are Lord Denning which was ready to lift the veil and on the other hand Slade LJ who has declined to tear away It seems like all the benefits of encouraging trade and developing economy have outweigh the disadvantages of permitting undercapitalised companies to operate. The separateness of corporate person from its member has become a fundamental established principle in English company law and thus courts are very much reluctant to lift the corporate veil. As Professor Sealy concluded “courts are refused to violate the sacred canon of limited liability". 
Moreover the court has the view that corporate veil should not be lifted simply because justice support that it should be done. For example in both Adams case and Re Polly Peck International it was concluded that the veil cannot be lifted “simply because the consequences of not doing so are unfair or even absurd". Also in Trustor case it was seen that the veil cannot just be lifted just because justice requires it. If the courts want to lift the veil, some level of impropriety must be established. Thus unless there are compelling considerations of justice and fairness the courts would respect corporate personality doctrine and would not lift the corporate veil. As Gallagher and Ziegler believe, courts are more willing to lift the corporate veil when justice is going to be achieved.  The argue that all the categories that the court uses sometimes to lift the veil, have been created in order to prevent injustice on behalf of the involved parties. 
However it is obvious that more gravity is given to certainty rather that fairness/
To sum up, after all the above analysis it seems that the decision in Salomon case has opened a legal ‘Pandora’s box and thus why it has attracted great criticisms. As a result it remains until now one of the most controversial subjects in English company law. As we have seen this decision have brought some advantages but also some disadvantages, thus all of them must be considered. On one hand the Salomon principle must definitely be used and remain strong in order to avoid any uncertainties but on the other hand some exceptions must be allowed in order to avoid unfairness but of course without affecting the law certainty. Thus a combination of both ideas would probably be the best way to deal with such cases.
Salomon will not be set aside simple because justice demands it
Table of authorities
Salomon v Salomon  AC 22
Foss v Harbottle (1843) 2 Hare 461
Macaura v Northern Assurance Co  AC 619
Lee v Lee’s Air Farming Ltd  AC 12
Re Produce Marketing Consortium Ltd (No2)  5 BBC 569
Re Patrick & Lyon Ltd  Ch 786
Gilford Motor Company Ltd v Horne  Ch 935 (CA)
Jones v Lipman  1 WLR 832
Ord v Belaven Pubs Ltd  BCC 607
Trustor AC v SmallBon (No2)  1 WLR 1177
Smith Stone and Knight Ltd v Birmingham Corporation  4 A11 ER 116
Re F.G (Films) Limited  1 WLR 483
Southern v Watson  3 A11 ER 439
DHN Food Distributors v Tower Hamlets LBC  3 A11 ER 464
Albazero case  AC 774
Woolfson v Strathclyde Regional Council (1978) ALT 159
Adams v Cape Industries  Ch 433
Re Polly Peck International plc  2 A11 ER 433