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Separate legal personality
The case of Salomon v A. Salomon & Co. Ltd established the principle of “separate legal personality” as was provided in the Companies Act of 1862 and as it is still provided in the Companies Act of 2006 under the United Kingdom Company Law. In this case Mr Salomon a shoe manufacturer had sold his business to a limited liability company where he and his wife and five children where the shareholders and directors of the company (to comply with the Companies Act of 1862 which required a minimum of 7 members). Mr Salomon owned 20,001from the 20,007 shares of the company with the remaining 6 shared equally amongst his wife and children. The company ran into some financial difficulties and sort a loan of £5,000 from one Mr Edmund Broderip who granted the loan. Subsequently the company went into more financial difficulties and was unable to pay its debt of which an action for liquidation was carried out against it. When Mr Edmund's failed to realise his unsecured loans he instituted an action claiming for Mr Salomon's personal liability. The High Court and Court of Appeal held Mr Salomon liable. Upon appeal to the House of Lords, it overturned the decision arguing that a company had been duly created and cannot be deprived of its separate legal personality. However as I shall be pointing out in the course of this essay certain exceptional situations have developed over time through statutory and judicial decisions where the court will disregard the corporate status and go after natural person(s).
A Company acquires corporate status upon registration under section 16(2) of the Companies Act (subsequently known as CA 2006) with the registrar of companies. Section 15(1) provides that upon registration a company must be given a certificate as proof of incorporation. By incorporation it means a company becomes a corporation or body corporate. What then is a corporation? A corporation is an artificial person in law distinct from its members (Shareholders and employees) with the power to sue and be sued, enter into legal and contractual relationships, acquire property etc. One distinct feature of a corporation is its distinct legal personality which is different from its members. By this members are exempted from personal liability. However in certain circumstances the law will deny the corporate status and hold a person (director, agent) liable or accountable. See the case of Kosmopoulos v Constitution Insurance Co where the Justice Bertha Wilson held that “the best that can be said is that the separate entities principle is not enforced when it would yield a result too flagrantly opposed to justice, convenience...”One may then wonder what are those circumstances. This work shall be trying to analyse and discuss those rare situations.
Section 7(1), (2) and section 16(2) of the CA 2006, provides for the registration and incorporation of a limited liability company so long as the aim legal. The Insolvency Act provides in section 74 that an incorporation of a limited liability company restricts the liability of its members. By this natural persons will not be held personally liable if an act is done in the name of a company. See the case of Salomon v A. Salomon Ltd (supra). However a problem will arise where a member(s) of the company have taken advantage of the separate legal status to act fraudulently or act in a manner which seems unjust. In such a situation the court acts with caution and depending on the fact and surrounding circumstances the law may go after the individual who has acted dishonestly to hold him liable. In the case of Atlas
Mayson e tal, 2009 pointed out two views; the narrower view and the wider view, which the court will consider when denying corporate status. In the narrower view the court will deny corporate status when the company's property, rights or liability are regarded as though they belong to another person on the basis of statutory provisions, contractual relationship, agency relationship, authority over another's property and fraud. The second view is that the court will disregard the corporate status when the court puts into consideration the surrounding circumstances and fact regarding the members, directors, other companies in the same group when deciding a case concerning a company. See the case of EBM Co Ltd v Dominion Bank where the court stated that
“Their Lordship of the privy [of the Privy Council] believe it to be of supreme importance that the distinction should be clearly marked, observed and maintained between an incorporated company's legal entity and its action, assets, rights and liabilities on the one hand, and the individual shareholder and their actions, assets, rights and liabilities on the other hand.”
However the courts have experienced some difficulties in deciding what term best suits the situation of describing the act of denying corporate status. In the case of Atlas Maritime Co SA v Avalon Maritime Ltd Staughton LJ attempted a clarification by stating
“To pierce the corporate veil is an expression that I would reserve for treating the rights or liabilities or activities of a company as the right or liabilities or activities of its shareholders. To lift the corporate veil or look behind it, on the other hand should mean to have regard to the shareholding in a company for some legal purpose.”
In the words of Staughton LJ, the term to ‘pierce the corporate veil' covers a broader perspective of denying corporate status than the term ‘to lift the corporate veil or look behind it' which only covers the wider view however both situations create legal consequences. Note however that common law makes no provision for a wider view when it comes to determining separate corporate status however as evidenced from the case of Atlas Maritime Co SA v Aalon Maritime Ltd (supra) and EBM Co Ltd v Dominion Bank (supra) the courts on some occasions take cognisance of the wider view.
The adoption of a wider view is controversial in it and must be treated with great caution to avoid confusion however the wider view does not deny a corporate status per se but rather it seeks to recognise such corporate status existence. Mayson e tal 2009 pointed out that the use of a wider view helps in determining the liability and obligations of a company through the acts of human beings. They stated that “...using information about persons connected with a company to determine the character of the company's act is when a human being is identified with the company and the human's knowledge, actions, criminal intent or other physical or mental attributes are taken to be those of the company”. Being an artificial person a company cannot do acts which are only possible with natural persons. However a company would be held liable nonetheless for wrongful acts done by human beings acting on behalf of the company. See the case of Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd where Viscount Haldene had this to say
“... a corporation is an abstraction. It has no mind of its own any more than it has a body of its own; its active and directing wil must be consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and centre of the Personality of the corporation...if Mr Lennard was the directing mind of the company, phen his action must, unless a corporation is not liable at all, have been an action which was the action of the company itself within the meaning of s. 502...”
The phrase ‘directing mind and will' has become the most significant basis for relating the acts of a natural person acting on behalf of a company as the act of the company. See the Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd(supra). More often than not attributing the act of natural person as the act of a company is required to be done by person in actual authority for example the directors and managers of a company. See the case of H L Bolton (Engineering) Co Ltd v T J Graham and sons Ltd where at the first and second instance the court pointed out that “...the state of mind of these managers is the state of mind of the company and is treated by law as such”. See the case of Tesco Supermarkets Ltd v Nattrass where Lord Reid pointed out that the intent of Lord Denning's decision in the former case was not intended to included “...all servant of a company whose work is brain work, or who exercises some managerial discretion under the direction of a superior officer of the company...”. However in some cases that have come before the courts the court has thought it wise to attribute act or thought than have been done by individuals who do not form part of the directing body of the company as acts forming part in order to make the company liable. See the case of Moore v I Bresler Ltd where the court held a company liable for false publication of taxable transactions by the company's secretary and the branch sale manager. Contrast this with the case R v Rozeik where defendant was not held liable because he was not part of the directing mind of the company. See also the case of Director General of Fair Trading v Pioneer Concrete (UK) Ltd and the case of Bank of Credit and Commerce International SA where the court attributed the ‘directing mind and will' to individuals who were not part of the directing body in order to prevent the directing mind and will of the company from escaping liability. See also the case of Meridian Global Fund Management Asia Ltd v Securities Commission where Lord Hoffman guarded against the use of the phrase ‘directing mind and will' as a determining factor of the acts of a company by natural persons.
In rare circumstances as early pointed the court will deny corporate status and hold natural person(s) liable for acts done fraudulently or where the act is criminal, charge them for such an act because of the impossibility of charging the company for such an offence. See the case of Richmond v London Borough Council v Pinn and Wheeler Ltd where the court held that where a criminal act requires corporal punishment the court will not embark on a fruitless journey of instituting an action against a company bearing in mind that even where the company is found guilty no substantial implementation can be made of the punishment. It will rather institute the action against the natural offender who can be detained or murdered for his crime. See also the case of R v IRC Haulage Ltd where the court pointed this out ‘...by embarking on a trial (of a company for the offence in which, if a verdict of guilty is returned, no effective order by way of sentence can be made'. Turner J in the case of R v P and O European Ferries (Dover) Ltd argued that the criminal liability of a company must be weighed each crime on its own. See also the case of R v Murray Wright Ltd where the court pointed out that it has been statutorily provided under the New Zealand that an artificial person cannot be held liable for manslaughter. Contrast the situation in New Zealand with the situation as it is here in the United Kingdom where there are no express parliamentary provisions however the courts have used discretion and caution to imply a similar reasoning to cases that involve Corporal punishment. See the case of Richmond London Borough Council v Pinn (supra) and Wheeler Ltd (supra).
A criminal action can however the instituted against a company. See the case of R v Birmingham and Gloucester Railway Co and Great North of England Railway Co where the court established that criminal proceedings can be brought against a corporate personality. However what becomes confusing is when the court holds a company liable for an act which requires one's mental state of mind to prove criminal liability. I guess the case of Director of Public Prosecutions v Kent and Sussex Contractors Ltd the court used the identification theory (where a company is held liable for the act of its members acting on its behalf) and held the company liable under the Defence (General) Regulations 1939 for the act of the transport manager who had given false information. Where natural persons have acted in their capacity as employees of a company it is only reasonable that liability goes to the company. It will be a different ball game if the act had been done for their personal interest. See the case of Jones v Lipman where the court held the first defendant liable to the plaintiff and not the company as in the word of the judge the company was a ‘cloak'. See the case of R v ICR Haulage Ltd (supra) and Tesco Supermarket Ltd v Nattrass (supra) where the court further re iterated the criminal liability of a company that requires mens rea.
Common law will impose criminal liability on an individual who had acted in the course of his duty in such a manner as to aid, abet, counsel or procure the commission of any offence. Section 432 (2) of the Insolvency Act further provides for prosecution against a director or any such person who has directing powers who had acted in a manner deliberately or negligently as to create criminal liability. See the case of Jones v Hellard where the chief executive of a company was held liable for including the title fellow of the Royal Institute of British Architects (FRIBA) after his membership expired. The court held that it was a personal act and not that of the company. See also the case of Brown v Director of Public Prosecution where the court held the manager director of a publishing company who was not involved in the editing personally liable for the contravention of the provision of section 4 of the sexual Offences (Amendment) Act 1967 by the company.
The absence of a clear parliamentary provision has made the denial of corporate status ambiguous and difficult to implement. See the case of Dimbleby and Sons Ltd v National Union of Journalist where Lord Diplock pointed out this difficulty. However statutory provisions like section 30(1A) and 30(2A) of the Landlord and Tenant Act of 1954 as amended allows a Landlord occupy a land for business or residential purposes where he has a controlling interest in the company for a period of not less than five years. See the case of Tunstall v Steigmann .
Another statute which pierces the veil of a company is the Inheritance Tax Act of 1984 which allows a natural person for the purpose of income tax relief in agricultural property hold the occupation of a property by the company controlled by him as occupation held by him [see sections 116, 117, 122 and 123 of the Inheritance Act of 1984]. See also section 213 of the Insolvency Act 1986 which holds a person in a company personally liable for any act which is calculated in the course of employment to defraud creditors or for any other fraudulent purpose and may be so disqualified under section 10 of the Companies Directors Disqualification Act of 1986. Section 993 of the CA 2006 restricts such liability until such a time when the company is being wound up. Where a person deliberating participate in company trading which are fraudulent he will be expected to contribute to the company's asset upon it being wound down. However such a person may be prosecuted at anytime for such criminal act and if found guilty maybe sentence to period spanning 10 years and maybe disqualified under section 2 the CDDA 1986. See the case of R v Kemp where the court pointed out three offences which the provision of section 993 CA and section 213 of the Insolvency Act 1986 frowns at and an individual will be held liable in the course of carrying on the business of a company. These offences are:
where there is an intent to defraud the creditors of the company
where there is an intent to defraud creditors of any person
where the fraudulent act is done to a customer(s) of the company
Where there is intent to defraud a creditor of a company it will suffice that the act was done against just a single or in the course of one transaction to attract personal liability. See the case Re Gerald Cooper Chemicals Ltd. However a company will not be regarded as fraudulent just because a single fraudulent act had been done by the company against a person. This was decided in the case of Morphitis v Bernasconi. See also the case of Re Darby where two directors had fraudulently incorporated a company to pocket money belonging to the public and the courts held them liable to pay back all the money that had been fraudulently received.
The third part is that it is sufficient that the act done was done in the course of the company business. It is irrelevant whether the act was the only reason for incorporating the company. See the case of R v Philippou where the court held the accused persons guilty for carrying on fraudulent business as a result of concealing information about the financial status in order not to be deprived of their licence. See also the case of Re H and others (restraint order: realisable property) where the court held the asset of a company as asset of the owners and not the company.
The case of Salomon v Salomon (supra) established that an agency relationship cannot exist between a company and its shareholders however in some rare situation an agency relationship may be imputed into a relationship between a company and the shareholders as was decided in the case of Gramophone & Typewriter Ltd v Stanley however this relationship in most cases will arise between a parent company and its subsidiary. In the case of Smith, Stone & Knight Ltd v Birmingham Corp, Atkinson J pointed out that the issue of an agency relationship will depend on the surrounding facts of each case. The court held in this case that the parent company as a matter of law and fact owned the business and profit of the subsidiary company as the subsidiary was a mere legal entity operating on its behalf. See also the case of Re FG (Films) Ltd where the court refused to grant separate legal entity to the English film company on the basis that the company was an agent of the American company which owned 90% of the shares. Contrast these two cases with the case of Adams v Cape Industries plc where the court held that a certain subsidiary company in the United States was not an agent of the parent company in the United Kingdom as both companies did not have an agency relationship.
In most cases the court will be eager to pierce the corporate veil of a company where it finds out that the whole incorporation is a mere hoax. How then do the courts determine when a company is a mere facade? In the case of Gencor ACP Ltd v Dalby a director who had breached his fiduciary duty had diverted business opportunities meant for the company he was working with to a personal company owned and operated by him. When this was discovered the claimant company had sought to recover the money of which the defendant denied personal liability. The court however found that the company was only a mere facade intended for receiving cash and operated no business at all. The court held the defendant personally liable. See also the case of Woolfson v Strathclyde Regional Council where the court ruled that the court will only deny corporate status where the company is found to have been incorporated for the purpose of carrying out a fake business or not for the purpose for which it makes others believe. In this case the court refused to treat two separate entities as one for the purpose of compensation. This case established the mere facade test See also the case of V-C in Trustor AB v Smallbone In this case the defendant had resigned and set up a company. It was then discovered that the sum of £39m had gone missing and £20m was traced to a company owned by the defendant where the court pierced the veil and found out that the defendant company was a mere facade owned by the former managing director of the claimant company who had only created the company to create the illusion of separate legal personality. He was held personally liable. This re iterated the court's decision in the case Woolfson v Strathclyde Regional Council (supra) and Adams v Cape Industries plc (supra) where the court argued that the corporate veil will only be pierced where there is indication that the company is only a mere facade. See the case of Re Darby (supra).
In most situations the court will be willing to pierce the corporate veil where a fake company has been created by the defendant to escape the limitation on his conduct by law and such rights of relief which third party hold against him. As pointed out in the case of Adams v Cape Industries plc (supra) one essential tool which the court will be looking out for is the intent of the defendant. Where the intents do not seem genuine the court will not hesitate to lift the veil and go after the defendant or the person who has acted suspiciously or fraudulently. In the first instance the court will prevent from escaping liability when the court imposes specific performance on such a person. In the case of Gilford Motors Co Ltd v Horne a director had been contracted to work for a company and one of the conditions was that he was not to operate a business similar to that of the claimant company. He subsequently incorporated a company which carried on similar business like the claimant company and in order to conceal this fact had he had made his wife and some other persons the directors and shareholders of the company. The court granted an injunction against the company and the director noting that the company was a mere hoax. See the case of Jones v Lipmam (supra) where the court orders specific performance against the defendant company which was merely a hoax.
The second instance in which the court will not hesitate to pierce the veil and go after a natural person is where the company had been incorporated to escape liability to third parties. In the case of Re a Company the defendant had set up companies in order to put away assets so as to conceal the fact that he was capable of meeting his liability to the plaintiff. The court pierced the veil and permitted the plaintiff to recover liability from the defendant. See also the case of V-C in Trustor AB v Smallbone (supra) where the court pierced the veil to hold a director liable for the sum £20m traced to his personal company from the claimant company where he was a former director. See also the case of Kensington International Ltd v Republic of Congo where the veil was lifted to expose the Republic of Congo as the sellers of oil and receiver of profit from the sale. Contrast this with case of Ord v Belhaven Pubs Ltd where the court argued that where there is no sufficient evidence to pierce a company's veil if will refrain from doing such.
Note also that the court will not pierce the veil of incorporation so that the third party may acquire possession in a future date. See the case of Adams v Cape Industries plc (supra) where the court pointed out that it will refuse to “...accept as a matter of law that the court is entitled to lift the corporate veil as against a defendant company...in respect of particular future activities of the group...”.
The law as it is under the English company law will rather impute the principle of separate legal personality to a limited liability company as was the case in the case of Salomon v Salomon than apply the doctrine of lifting the veil. However the law will be ready to go after a person who takes advantage of the principle of the case in Salomon v Salomon to act in a fraudulent or unspeakable manner. It is the intent of the law is to create justice and fairness as it evidenced in both statutory provision and judicial decisions. However the principle of separate legal personality comes with it some vagueness especially when one looks at the exceptions which come with the principle. It is therefore necessary that something is done to reduce if possible eliminate such vagueness.