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Published: Fri, 02 Feb 2018

The courts as a general rule

Once a company is incorporated it becomes a separate legal entity from its members and shareholders. Therefore it is the company that has perpetual existence, can sue and be sued in its own name, can own property and has limited liability, so liabilities will be the legal responsibility of the company; the members will not be liable for the company’s debt. This is commonly referred to as the doctrine of corporate personality. This was illustrated in the leading case of Salomon vs. Salomon [1] , where the House of Lords firmly laid down the principle that a company is a distinct legal person different from the members of that company, so there is a veil separating the two. This separation is recognised in almost all situations, although a body of law has developed through the courts via common law and statutes that create exceptions, so in certain circumstances the court will lift or ‘pierce’ the veil of incorporation and ignore the separate legal personality of a company.

A common law exception where the veil of incorporation can be pierced is if the company is a sham or a mere facade concealing the true facts, for example avoiding an existing legal obligation such as in the case of Gilford Motor Company Ltd v Horne [2] . Mr Horne, a former employee of the company contracted not to solicit the customers of the company. However he formed a separate limited company in his wife’s name and solicited the customers. The court of appeal held that ‘the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr Horne’ [3] . The company was a sham and the court granted an injunction against the company and him.

The veil of incorporation can be lifted when a group of companies are actually one single economic unit. In the case of DHN Food Distributors v London Borough of Tower Hamlets [4] , DHN, a parent company ran a ‘cash and carry’ business from a warehouse, owned by one of its subsidiaries, Bronze Investments LTD. Vehicles were owned by another subsidiary. However in each of the three companies the directors were the same. Tower Hamlets issued a compulsory purchase order on the warehouse which they wanted to demolish. Under statute, compensation was available on both the value of the land and for disturbing the business. However Tower Hamlet was only prepared to pay compensation for the land, as they argued Bronze Ltd only owned land and no business would be disturbed. The court lifted the veil as DHN wanted, and DHN and the two subsidiaries were treated as one economic entity allowing DHN to claim compensation on both.

However the court’s decision in DHN was doubted by the House of Lords in another case [5] . Lord Keith of Kinkel doubted whether the ‘Court of Appeal properly applied the principle that it is appropriate to pierce the veil only where special circumstances exist indicating that is a mere facade concealing the true facts’ [6] . Although the decision in DHN wasn’t overruled, it should be taken into consideration that this case represents the ‘high watermark of judicial lifting the veil’ [7] and so there is no general principle that all groups of companies should be treated as one economic unit, such as in the case of Adams v Cape Industries [8] , where the courts strictly returned to the Salomon principle.

In this case there were two subsidiaries of an English parent company, Cape, of which one was in the USA and one in South Africa. The subsidiary in South Africa mined asbestos and sold it to an American subsidiary. Unfortunately, the asbestos caused a number of deaths in America, which resulted in the American subsidiary going into liquidation. In order to enforce the judgement against Cape, Mr Adams and the plaintiffs had to show that the defendant Cape had been present, through its wholly owned subsidiaries, when proceedings were commenced in the USA. Cape argued that he should not be liable for the activities of its subsidiary companies. The court refused to lift the veil as there was no basis to make Cape liable for the activities of its subsidiaries, and also the subsidiaries weren’t set up as a facade concealing the true facts.

Another point linked to group companies where the courts may lift the veil is if the company is an agent for the other. In Smith, Stone & Knight Ltd v Birmingham Corporation [9] , the subsidiary company was operating as an agent on behalf of the parent company, and so the parent company could claim the compensation. Establishing whether an agency relationship exists between one company and another is difficult and rare. So another reason why the veil was not lifted in Adams v Cape Industries was because the court held that an agency relationship between parent and subsidiary could only be proven by evidence of an express agreement that the subsidiaries actions was authorised by the parent.

If it appears that a company has been formed or is being used for the purposes of avoiding tax liabilties or evading taxes , then the courts may lift the veil to see who the person responsible for it is such as in the case of Littlewoods Mail Order Stores LTD v IRC [10] , where Littlewoods attempted to pass off a capital purhace as a running cost.

The corporate veil may be pierced to determine the nature of the company or shareholders, so when there is a reason to suspect that the person in control of the company may be enemies, such as in the case of Daimler Co Ltd v Continental Tyre and Rubber Co Ltd [11] . During the World War 1 German shareholders held the shares of an English company. The court held that ‘the company was a hostile partnership and so incapable of suing and that any payment to it would be illegal as a trading with the enemy’ [12] . This was only determined by looking behind the veil to discover the nationalilty of its shareholders. To reach the decision the case was heard by eight law lords, this illustates the importance of the decision. Lifitng the veil to determine whether there are enemy characters is esablished, however it happens very rarely as it is only limited to times of war.

There are circumstances where the court will lift the veil under statute. The Companies Act has recognised that the corporate form may be used for fraudulent purposes. One of the reactions of parliament to the Salomon principle was to introduce the offence of ‘fraudulent trading’. Although section 993 of The Companies Act 2006 contains the criminal offence for fraudulent trading, the civil provisions are now in s213-215 of The Insolvency Act 1986. These civil sanctions operate to lift the veil of incorporation.

Section 213 [13] states if the company is in the cause of winding up, if any business of the company has carried on with the intention for any fraudulent purpose, to defraud creditors or any other person of the company then the ‘persons who were unknowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make contributions (if any) to the company’s assets as the court thinks proper’ [14] . This section proved difficult to operate in practice as the main problem was that there was a possibility of a criminal charge also arising, as the courts set the standard for intent fairly high. Proving dishonesty was very difficult so a new provision was introduced under s.14.

S.214 known as ‘wrongful trading’ deals with situations where negligence was involved rather than fraud, so there is no need to prove dishonesty. It has similar provisions to s.213 and only operates in cases of insolvent liquidation. A director will be liable if it appears that trading continued before winding up, when the director knew or ought to have known that at that time there was no reasonable prospect that the company would avoid liquidation. The court will not make a declaration under this section if the director or shadow director ‘took every step with a view to minimising the potential loss to the company’s creditors as he ought to have taken’ [15] , or if s (he) ought to know before 28th April 1986.

The Insolvency Act 1986 also allows the court to pierce the corporate veil in the case of ‘phoenix company’s’, which is where a new company is created with a similar or the same name to an insolvent company. In section 216, the ‘restrictions on company names exist in order to prevent abuse of limited liability through measures that prevent the reuse of a company name for five years’ [16] , by shadow directors or directors during the 12 months before that company went into insolvent liquidation. If the director or shadow director breaches section 216 and re-uses the name in that 5 year period the veil will be lifted and s(he) will be personally liable for the for the debts of the company under section 217.

There are criminal penalties for failing to use the company’s name on relevant documents under section 84 of the Companies Act 2006; however there are no provisions that impose personal liability [17] .

The taxation authorities in the UK are aware that group structures may avoid tax liabilities by moving assets and liabilities around the group. As well as taxation legislation directed at ignoring the separate entity in the group, s.399 of The Companies Act 2006 [18] provides that parent companies have a duty to produce group accounts which must include consolidated balance sheets and profit and loss accounts of the parent company and its subsidiaries undertakings. S.409 requires the parent company to provide details of the subsidiaries names, country of activity and the shares it holds in the subsidiary. The process naturally requires the veil of incorporation is lifted in order to identify which companies form the group. The courts have justified the decision of lifting the veil by reference to legislation and finding out that one company was an agent of another.

The Company Directors Disqualification Act 1986 is to ensure that only responsible and honest people act as directors so that shareholders, employees of companies, those who trade with the company can be protected from possible fraud. Under s.15 of the act if a person has been disqualified from being a director or from managing the company he will be liable for all the debts that were incurred when he was acting.

In conclusion, the Salomon principle remains the general rule and the corporate veil is protected in almost every circumstance, it will only be lifted in the most exceptional circumstances. The courts will not lift the corporate veil to benefit shareholders or to impose liabilities on a shareholder for the company’s debts. After the court of appeal’s decision in Adams v cape industries it has been shown that the courts will not simply lift the veil for interest of justice as they returned to the strong principle in Salomon’s case. The courts ability to lift the veil is limited to cases where the company’s incorporation was merely a façade [19] , formed to avoid legal obligations, or an enemy incorporation [20] but this is a rare situation. The veil is only usually lifted when statutes allow to do so, but when there are no statutory guidelines the courts have become even more unwilling to lift the veil.

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