How Corporate Expose Shareholders and Directors

In what ways may the corporate veil be pierced in order to expose shareholders and directors to personal liability for the debts of the company?

Meaning

Lifting the veil of incorporation means that in certain circumstance the courts can look through the company to the identity of the shareholders. The usual result of lifting the veil is that the members of directors become personally liable for the company’s debts.

Lifting the veil of incorporation

There are a number of occasions, including statutory, at common law and by voluntary, when the doctrine of separate personality will not be followed. On these occasions it is said that the veil of incorporation, which separates the company from its members, is ‘pierced’, ‘lifted’ or ‘drawn aside’. Such situations arise as follows:

1 under statute

If a public company starts to trade without first obtaining a trading certificate, the directors can be made personally liable for any loss or damage suffered by a third party:S767 CA06.

Under the Company Directors Disqualification Act 1986, if a director who is disqualified participates in the management of a company, that director will be jointly or severally liable for the company’s debts.

Under the insolvency Act 1986, members and/or directors held liable for wrongful or fraudulent trading may be made personally liable for losses arising as a result.

Exception – In case of Bakri Bunker Trading Co Ltd v The Neptune (1986), the plaintiff sued the company who owned the third ship and demand the court to lift the veil on the ground of fraud in order to establish that the beneficial owner of the three ships was the said person. It was held that it is necessary to provide positive evidence to prove fraud. In this case, there did not have any positive evidence to prove, therefore the court would not lift the veil.

2 at common law

As in most areas of law that are based on the application of policy decisions, it is difficult to predict when the courts will ignore separate personality. The courts will not permit the corporate form to be used for a clearly fraudulent purpose or to evade a legal duty. Thus in Gilford Motor Co Ltd v Horne (1933) an employee had covenanted not to solicit his former employer’s customers. After he left their employment he formed a company to solicit these customers and it was held that the company was a sham and the court would not permit it to be used to avoid the contract

The courts are prepared to ignore separate personality in times of war in order to defeat the activity of shareholders who might be enemy alians. See Daimler Co Ltd v Continental Tyre and Rubber Co (GB) Ltd (1916). Where groups of companies have been set up for particular business purposes, the courts will usually not ignore the separate existence of the various companies, unless they are being used for fraud. Although there is authority for treating separate companies as a single group (DHN Food Distributors Ltd v London Borough of Tower Hamlets (1976) later authorities have cast extreme doubt on this decision (Woolfson v strathclyde Regional Council (1978). More recent cases would appear to suggest that the courts are now more reluctant to ignore separate personality where the company has been properly established (Adams v Cape Industries plc (1990))

Recently, there is an uplifting corporate veil case (PCCW) in Hong Kong. Shareholders have taken derivative action against director.

3 by voluntary

In the company, directors have a very limited control which can be exercised over them by the shareholders of the company. In particular circumstances, director may have a personal liability if he has breached the fiduciary duties to the shareholders individually. Coleman v Myers (1977) NZ is the case of fiduciary duties. It was held that a fiduciary duty existed between the director and shareholders. The company was a private company with shares held largely by members of one family who had looked to the directors for business advice, and since information affecting the true value of the shares had been withheld from them, the directors were liable to compensate the shareholders. Basically, the directors are knowingly carrying on business in a reckless trading. Directors have a duty to act bona fide for the benefit of the company. If they did not act honestly to contracted debts for the company, the debt would be paid when it fell due. Furthermore, the directors can be made personally liable for debts of the company. Therefore, the director can lift the veil for their defence to persuade court that they acted honestly and reasonably.

Consequences of veil of incorporation

A number of consequences flow from the fact that corporations are treated as having legal personality in their own right.

1 limited liability

No one is responsible for anyone else’s debts unless they agree to accept such responsibility. Similarly, at common law, members of a corporation are not responsible for its debts without agreement. However, registered companies, i.e. those formed under the Companies Acts, are not permitted unless the shareholders agree to accept liability for their company’s debts. In return for this agreement, the extent of their liability is set at a fixed amount. In the case of a company limited by shares, the level of liability is the amount remaining unpaid on the nominal value of the shares held. In the case of a company limited by guarantee, it is the amount that shareholders have agreed to pay in the event of the company being wound up.

2 perpetual existence

As the corporation exists in its own right, changes in its membership have no effect on its status or existence. Membership may die, be declared bankrupt or insane, or transfer their shares, all without any effect on the company. As an abstract legal person the company cannot die, although its existence can be brought to an end through the winding –up procedure.

3 business property is owned by the company

Any business assets are owned by the company itself and not the shareholders. This is normally a major advantage in that the company’s assets are not subject to claims based on the ownership rights of its individual members .It can, however, cause unforeseen problems as may be seen in Macaura v Northern Assurance Co(1925). The plaintiff had owned a timber estate and later formed a one-man company and transferred the estate to this company. However, he continued to insure the estate in his own name. When the timber was lost in a fire it was held that Macaura could not claim on the insurance as he had no personal interest in the timber, which belonged to the company.

4 legal capacity

The company has contractual capacity in its own right and can sue and be sued in its own name. The extent of the company’s liability, as opposed to the members, is unlimited and all its assets may be used to pay off debts. The company may also be liable in tort for any injuries sustained as a consequence of the negligence of its agents or employees.

5 Crimes

A company can be convicted of a crime, regardless of whether its directors are also convicted. Some limitations: it has been held that a company cannot be convicted of a crime which requires the physical act of driving a vehicle-Richmond on Thames Borough Council v Pinn & Wheeler (1989). A company cannot be convicted of any crime for which the only available sentence is imprisonment. In order to convict companies of common law crimes, court may regard the mens rea of those individuals who control the company to be the mens rea of the company.

Conclusion

Salomon v Salomon & Co Ltd (1897)

Although courts have been inconsistent with regard to piercing the veil, it appears that they will, in the absence of a compelling reason, uphold the principle of Salomon. It is a good case to set out the doctrine of corporate personality. The company is separate legal entity (separate from its shareholders) .S as shareholder and director had no personal liability to creditors, and he could be repaid in priority as a secured creditor. This enshrined the concepts of separate legal personality and limited liability in the law.

References

Workbook on Business Associations

Hong Kong Company Law –Vanessa Stott