1.1: Introduction
A corporation under Company law or corporate law is specifically referred to as a "legal person"- as a subject of rights and duties that is capable of owning real property, entering into contracts, and having the ability to sue and be sued in its own name. In other words, a corporation is a juristic person that in most instances is legally treated as a person, and empowered with the attributes to own its own property, execute contracts, as well as ability to sue and be sued.
One of the main motivations for forming a corporation or company is the limited liability it offers its shareholders. By this doctrine (limited liability), a shareholder can only lose only what he or she has contributed as shares to the corporate entity and nothing more.
Nevertheless, there is a major exception to the general concept of limited liability. There are certain circumstances in which courts will have to look through the corporation, that is, lift the veil of incorporation, otherwise known as piercing the veil, and hold the shareholders of the company directly and personally liable for the obligations of the corporation.
The veil doctrine is invoked when shareholders blur the distinction between the corporation and the shareholders. It is worthy of note that although a separate legal entity, a company or corporation can only act through human agents that compose it. As a result, there are two main ways through which a company becomes liable in company or corporate law to wit: through direct liability (for direct infringement) and through secondary liability (for acts of its human agents acting in the course of their employment).
The doctrine of piercing the corporate veil varies from country to country. In the opinion of two Corporate law scholars, apparently, there is a general consensus that the whole area of limited liability, and conversely of piercing the corporate veil, is among the most confusing in corporate law."
There are two existing theories for the lifting of the corporate veil. The first is the "alter-ego" or other self theory, and the other is the "instrumentality" theory.
The alter-ego theory considers if there is in distinctive nature of the boundaries between the corporation and its shareholders.
The instrumentality theory on the other hand examines the use of a corporation by its owners in ways that benefit the owner rather than the corporation. It is up to the court to decide on which theory to apply or make a melange of the two doctrines.
Courts are generally reluctant to pierce the corporate veil, and this is only done when liability is imposed to reach an equitable result.
1.2: Meaning of Corporation in Company Law
To begin with, the word company will be used in this paper to refer to a legal entity with an identity different from that of its owners. It goes without saying that the owners in such an entity are not held liable for the firm's obligations in excess of the value of their investment therein. In fact, a company is equal in law to a natural person.
In different legal systems, corporate law and company law mean the same thing. In either circumstance, the term is used to denote the field of law concerning the creation and regulation of companies or corporations and other business organizations.
The important thing to note however is that although a separate legal entity, a company or corporation can only act through human agents that compose it. As a result, there are two main ways through which a company becomes liable in company or corporate law to wit: through direct liability (for direct infringement) and through secondary liability (for acts of its human agents acting in the course of their employment).
1.3: Veil Doctrine as derivative from Separate legal personality concept
As aforementioned, a company once incorporated becomes a legal personality or a juristic entity that has a separate and distinct identity from that of it's owners or members, shareholder; and it's further empowered with it's own rights, duties and obligations, can sue and be sued in it's own name, etc.
The most important ingredient that flows from the separate legal personality clause is that of limited liability. It is aimed at giving investors minimum insurance in their business over their own private lives. Hence, the most a member in the company can lose is the amount paid for the shares themselves and thus the value of his/her investment. Thus, creditors who have claims against the company may look only to the corporate assets for the satisfaction of their claims as creditors and generally cannot proceed against the personal or separate assets of the members. This has the potential effect of capping the investors' risk whilst, consequently, their potential for gain is unlimited. Evidently, corporations exist in part, in the first place to shield their shareholders from personal liabilities for the debts of that corporation.
The concept of limited liability was invented in England in the 17th century, and prior to this period, people were scared to invest in companies because any partner in a general partnership could be held responsible for all the debts of the corporation. As the capital needed to finance the largest projects grew, and along with it the necessity of raising money, investors were reluctant to invest because of the risk involved in essentially guaranteeing the entire debt of the business entity.
In fact, the concept of separate legal personality goes hand in hand with the doctrine of limited liability. The main importance of the limited liability concept is that it protects the company and its members, as well as to facilitate commercial ventures in which the company may be interested. The principle further act to attract and encourage corporate investment, much needed in any society to speed up development. It is believed to be the springboard to raise managerial standards in a corporate organization. It goes without saying that it facilitates better investment strategies by the company question.
Farrar has described the concept of separate legal personality as "...essentially a metaphorical use of language, clothing the formal group with a single separate legal entity by analogy with a with a natural person"
In fact, corporate law requires that company owners respond to organisational realities of the corporation as well as conforming with and making intelligible the treatment of organisations as legal actors. In this sense, the conception of a corporation is analytical and ideological, descriptive and prescriptive.
One scholar in the person of Blumberg has pointed out that the law's conception that the company is at law a different person- in some ways seems proper and satisfying, but then, the problem is far more complex. He argues that "in the law, concepts have a life of their own because their ability ex ante to influence the thinking of judges and ex post to be invoked by judges to justify their conclusion."
1.4: The Concept of Limited Liability
The main idea behind that the legal personality of a company is separate from that of it's members. The most important ingredient that flows from he separate legal personality clause is that of limited liability. It is aimed at giving investors minimum insurance in their business over their own private lives. Thus, the most a member in the company can lose is the amount paid for the shares themselves and thus the value of his/her investment. Thus, creditors who have claims against the company may look only to the corporate assets for the satisfaction of their claims as creditors and generally cannot proceed against the personal or separate assets of the members. This has the potential effect of capping the investors' risk whilst, consequently, their potential for gain is unlimited.
It is obvious that corporations exist in part, in the first place to shield their shareholders from personal liabilities for the debts of that corporation.
The concepts was invented in the 17th century, and prior to this date, people were scared to invest in companies because any partner in a general partnership could be held responsible for all the debts of the corporation. As the capital needed to finance the largest projects grew, and along with it the necessity of raising money, investors were reluctant to invest because of the risk involved in essentially guaranteeing the entire debt of the business entity.
In fact, the concept of separate legal personality goes hand in hand with the doctrine of limited liability. The main importance of the limited liability concept is that it protects the company and its members, as well as to facilitate commercial ventures in which the company may be interested. The principle further act to attract and encourage corporate investment, much needed in any society to speed up development. It is believed to be the springboard to raise managerial standards in a corporate organization. It goes without saying that it facilitates better investment strategies by the company question.
1.5.1: The Courts' treatment of Separate Legal Personality under Common Law Jurisdictions
Under Common Law jurisdictions, the doctrine of piercing the veil remains one of the primary method through which the courts mitigate the strenuous demands of the logical fulfillment of the separate legal personality concept.
The problems with finding some thread of principle through all the various court decisions basically stem from the false unity of the cases which, while involving vastly different underlying issues, are still linked under the metaphor of the 'veil' concept.
Blumberg has written that the conceptual standards of entity law are frequently regarded as Anglo-Saxon principles and applied indiscriminately across the entire range of the law. In other words, the application of the doctrine of separate personality in Anglo-Saxon jurisdictions is at the discretion of the judges and the courts. This is no surprising, given that Anglo-Saxon law is basically Judge-made law.
The function of much of the Anglo-Saxon courts' work in this area is to delineate the legitimate uses of the corporate form.
1.5.2: An Illustration of the Conceptual interpretation of Limited Liability versus lifting the veil:
The decision in Salomon V. Salomon & Co.
The case of Salomon V. Salomon & Co., commonly referred to as the Salomon case, is both the foundational case and precedence for the doctrine of corporate personality and the judicial guide to lifting the corporate veil.
The House of Lords in the Salomon case affirmed the legal principle that, upon incorporation, a company is generally considered to be a new legal entity separate from its shareholders. The court did this in relation to what was essentially a one person Company, which is Mr Salomon.
1.5.2.a: Facts and decision of the Salomon Case
Mr Aron Salomon was a British leader merchant who for many years operated a sole proprietor business, specialized in manufacturing leather boots. In 1892, his son, also expressed interest in the businesses. Salomon then decided to incorporate his businesses into a limited company, which is Salomon & Co. Ltd.
However, there was a requirement at the time that for a company to incorporate into a limited company, at least seven persons must subscribe as shareholders or members. Salomon honored he clause by including his wife, four sons and daughter into the businesses, making two of his sons directors, and he himself managing director. Interestingly, Mr. Salomon owned 20,001 of the company's 20,007 shares - the remaining six were shared individually between the other six shareholders. Mr. Salomon sold his business to the new corporation for almost £39,000, of which £10,000 was a debt to him. He was thus simultaneously the company's principal shareholder and its principal creditor.
At the time of liquidation of the company, the liquidators argued that the debentures used by Mr. Salomon as security for the debt were invalid, and that they were based on fraud. Vaughan Williams J. accepted this argument, ruling that since Mr. Salomon had created the company solely to transfer his business to it, the company was in reality his agent and he as principal was liable for debts to unsecured creditors.
The lord justices of appeal variously described the company as a myth and a fiction and said that the incorporation of the business by Mr. Salomon had been a mere scheme to enable him to carry on as before but with limited liability.
However, the House of Lords later quashed that Court of Appeal (CA) ruling, upon critical interpretation of the 1862 Companies Act. The court unanimously ruled that there was nothing in the Act about whether the subscribers (i.e. the shareholders) should be independent of the majority shareholder. The company was duly constituted in law, the court ruled, and it was not the function of judges to read into the statute limitations they themselves considered expedient. The 1862 Act created limited liability companies as legal persons separate and distinct from the shareholders.
In other words, by the terms of the Salomon case, members of a company would not automatically, in their personal capacity, be entitled to the benefits nor would they be liable for the responsibilities or the obligations of the company. It thus had the effect that members' rights and/or obligations were restricted to their share of the profits and capital invested.
1.5.2.b: Significance of the Salomon Case
The rule in the Salomon case that upon incorporation, a company is generally considered to be a new legal entity separate from its shareholders has continued till these days to be the law in Anglo-Saxon courts, or common law jurisdictions. The case is of particular significance in company law thus:
Firstly, it established the canon that when a company acts, it does so in it's own name and right, and not merely as an alias or agent of it's owners. For instance, in the later case of Gas Lighting Improvement Co Ltd v Inland Revenue Commissioners, Lord Sumner said the following:
"Between the investor, who participates as a shareholder, and the undertaking carried on, the law interposes another person, real though artificial, the company itself, and the business carried on is the business of that company, and the capital employed is its capital and not in either case the business or the capital of the shareholders. Assuming, of course, that the company is duly formed and is not a sham...the idea that it is mere machinery for affecting the purposes of the shareholders is a layman's fallacy. It is a figure of speech, which cannot alter the legal aspect of the facts."
Secondly, it established the important doctrine that shareholders under common law are not liable the company's debts beyond their initial capital investment, and have no proprietary interest in the property of the company. This has been affirmed in later cases, such as in The King v Portus; ex parte Federated Clerks Union of Australia where Latham CJ while deciding whether or not employees of a company owned by the Federal Government were not employed by the Federal Government ruled that:
"The company…is a distinct person from its shareholders. The shareholders are not liable to creditors for the debts of the company. The shareholders do not own the property of the company…""
2. Piercing of the veil by Common Law Courts
2.1: How do Common Law courts pierce the veil?
Lifting the veil of incorporation or better still; "Piercing the corporate veil" means that a court disregards the existence of the corporation because the owners failed to keep one or more corporate requirements and formalities. The lifting or piercing of the corporate veil is more or less a judicial act, hence it's most concise meaning has been given by various judges. Staughton LJ, for example, in Atlas Maritime Co SA v Avalon Maritime Ltd (No 1) defined the term thus:
"To pierce the corporate veil is an expression that I would reserve for treating the rights and liabilities or activities of a company as the rights or liabilities or activities of its shareholders. To lift the corporate veil or look behind it, therefore should mean to have regard to the shareholding in a company for some legal purpose."
Young J, in Pioneer Concrete Services Ltd v Yelnah Pty Ltd, on his part defined the expression "lifting the corporate veil" thus:
"That although whenever each individual company is formed a separate legal personality is created, courts will on occasions, look behind the legal personality to the real controllers."
The simplest way to summarize the veil principle is that it is the direct opposite of the limited liability concept. Despite the merits of the limited liability concept, there is the problematic that it can lead to the problem of over inclusion, to the disadvantage of the creditors. That is to say the concept is over protected by the law. When the veil is lifted, the owners' personal assets are exposed to the litigation, just as if the business had been a sole proprietorship or general partnership.
Common law courts have the lassitude or exclusive jurisdiction "lift" or "look beyond" the corporate veil at any time they want to examine the operating mechanism behind a company.
This wide margin of interference given common law judges has led to the piercing of the corporate veil becoming one of the most litigated issues in corporate law.
But it should be worthy of note that a rigid application of the piercing doctrine in common law jurisdictions has been widely criticized as sacrificing substance for form. Hence, Windeyer J, in the case of Gorton v Federal Commissioner of Taxation, remarked that this approach had led the law into "unreality and formalism."
As aforementioned, when the judges pierce the veil of incorporation, they accordingly proceed to treat the company's members as if they were the owners of the company's assets and as if they were conducting the companies business in their personal capacities, or the court may attribute rights and/or obligations of the members on to the company.
The doctrine is also known as "disregarding the corporate entity".
In his 1990 article, Fraud, Fairness and Piercing the Corporate Veil, Professor Farrar remarked that the Commonwealth authority on piercing the corporate veil as "incoherent and unprincipled". That claim has been earlier backed up by Rogers AJA, a year ago in the case of Briggs v James Hardie & Co Pty thus:
"There is no common, unifying principle, which underlies the occasional decision of the courts to pierce the corporate veil. Although an ad hoc explanation may be offered by a court which so decides, there is no principled approach to be derived from the authorities."
Another scholar in the person of M. Whincop in his own piece: 'Overcoming Corporate Law: Instrumentalism, Pragmatism and the Separate Legal Entity Concept' argued that the main problem with the Salomon case was not so much the argument for the separate legal entity, but rather the failure by the English House of Lords to give any indication of "What the courts should consider in applying the separate legal entity concept and the circumstances in which one should refuse to enforce contracts associated with the corporate structure.
2.2: Basis for court lifting of the veil of incorporation under Anglo-Saxon Jurisdictions
As aforementioned, common law courts are empowered to; under limited circumstances ignore the limited liability rule, and "pierce the corporate veil", so that the members of the company in question may become liable for the actions of the company, in spite of the limited liability rule that the two have separate identities.
It's worth re-iterating that the piercing of the corporate veil remains one of the most litigated issues in English company law. There are however a number of generalfactors that Anglo-Saxon would normally take into considering before piercing the veil, since as much as possible, the courts will like to maintain the preserve of companies to keep separate identity from its owners.
By and large, the separate legal personality of a company will be disregarded only if the court deems that there is, in fact or in law, a partnership between companies in a group, or that there is a mere sham or facade in which that company is playing a role, or that the creation or use of the company was designed to enable a legal or fiduciary obligation to be evaded or a fraud to be perpetrated.
In a nutshell, common law courts have ever since the Salomon case recognized a number of discrete factors that would prompt them to piercing the corporate veil. The most outstanding factors would be examined hereunder:
2.2.1: Fraud
English courts would allege fraud where its owners of a corporation merely used it as a window dressing to evade either fiduciary or legal obligations. This will most notably be the case where the company owner intentionally used it to deny the creditors pre-existing legal rights. These were the facts in issue in the case of Re Edelsten ex parte Donnelly, even though the court could not ascertain fraud on a company owner who had apparently denied his obligations towards his creditors on the grounds of limited liability. The court was faced with the question of ascertaining whether the company was incorporated and then used for the purpose of evading a legal obligation or perpetrating a fraud, as argued by the trustee. The court ruled thus.
"The argument of fraud is, of course circular. It can only succeed if the argument of sham succeeds, because if no property was acquired by, or devolved upon, Edelsten, no duty capable of being evaded could arise under the Act…The submission that theVIP Group had been used to perpetrate a fraud was coincident, and stood, or fell, with the submissions which sought to have the transactions, by which the VIP Group acquired property, treated as shams.
In other words, the court could not ascertain fraud for the reason that the corporation had not been created out of sham, and had merely taken adequate steps to ensure that any property acquired after bankruptcy did not fall into the hands of any of the trustee in bankruptcy.
It has been said that the more conspicuous the sham, the more likely it would be for the Anglo-Saxon courts to ascertain that fraud had been perpetrated. In the 1997 Australian case of Re Neo, the Immigration Review Tribunal took this view in a case where a decision to refuse an application for a visa by an employee, where sponsorship had been arranged by a company formed on the same day that the application was lodged, and interestingly, the company never carried out any business.
The Australian Immigration Review Tribunal ruled thus:
"The company was merely a vehicle used to circumvent Australian migration law. It was only a façade, its true purpose being to allow the applicants to remain in the country.
2.2.2: Agency
The doctrine of separate legal entity that the company is a legal entity with a different identity from that of its members means that a company does not exist to become an agent for its shareholders. Where this is the case, Anglo-Saxon courts would not hesitate to pierce the corporate veil. In Rowland J, in Barrow v CSR Ltd, where the court found out that a parent company was responsible for the actions of a subsidiary in relation to an employee, it did not hesitate to lift he veil. The court stated:
"Now, whether one defines all of the above in terms of agency, and in my view it is, or control, or whether one says that there was a proximity between CSR and the employees of ABA, or whether one talks in terms of lifting the corporate veil, the effect is, in my respectful submission, the same."
But Anglo-Saxon courts do not have any unique judicial approach to determining whether the company acted as an agent. Hence, it is a bit too difficult to rationalize the judgments. For instance, the court refused to pierce the veil in The Electric Light and Power Supply Corporation Limited v Cormack: a one-man company that had contracted with the plaintiffs to use their power supply for his work during two years, and not to install any other alternative source of energy power during that period of time. But within that period, the defendant sold his company to another company of which he was both the manager and the main shareholder. The new company thereupon installed energy power other than he one contracted with the plaintiffs. The court refused to pierce the veil, considering the act as a personal undertaking. Lord Rich AJ found no evidence that the sale of the business by the defendant was done with the object of evading his personal obligations.
It has been remarked that Anglo-Saxon courts are generally less prepared to pierce the separate legal status, in the case of very small companies, such as the one business. In the case of small businesses, they are rather more prepared to apply agency principles. This is particularly the case where control was absolute, that is where the business was an integral part of it's owner, such that the company itself can properly be seen as a mere agent for the shareholder. Hence in Ampol Petroleum Pty Ltd v Findlay, Fullagar J. was only willing to pierce the veil, only after the owner of a small private company sought the lifting of the veil himself to demonstrate that the losses of the company were in fact his losses. The learned judge stated:
"If the defendant does embark on establishing loss of profits (or capital or goodwill) at an enquiry as to damages, I consider on the present state of the evidence that the "corporate veil" may be pierced for these purposes, that is to say, I consider that the defendant will be entitled to include losses to his company or companies flowing from the breach, provided he establishes (in addition to causation) that the loss to the company was his loss. The evidence presently before me strongly suggests that the defendant wholly controlled the relevant companies and their monies and other assets, and dealt with the monies and assets as though they were his own."
In a nutshell, it can be said that the main reason while Anglo-Saxon courts in he case of small companies tend to prefer agency principles is because they want to reduce the severity of a penalty as a consequence of piercing the corporate veil.
2.2.3: Unfairness
One other serious ground under which Anglo-Saxon courts would be so ready to pierce the corporate veil is in cases where it is deduced that there was unfairness on the part of the company in question. The plaintiff may for example pray the court to pierce the corporate veil on the grounds that doing so would help bring a fair and just result. Such was the case in the Australian case of RMS Glazing Pty Ltd v The Proprietors of Strata Plan No 14442, where a body corporate bringing in an action against a defendant company argued that he veil be pierced because it's Managing Director, Mr. Lo Surdo had play a very active role in the court proceedings and would normally not have done so if the company was in effect not just a "a body of straw". The court in he pronouncement of Cole J. rejected this argument, finding that with the company's record of profitable trading it could not be said to be a body of straw. Cole J. said thus:
"Quite apart from that I am not satisfied that justice would require the making of such an order. The Body Corporate dealt with RMS over a period of more than a decade. It was prepared to deal with the company rather than Mr Lo Surdo personally and to enter into contractual relationships with the company resulting in the payment of many millions of dollars. I do not think that the interest of justice requires that it now be permitted to simply disregard the corporate veil."
2.2.4: Group Enterprises
The argument of group enterprises is to the effect that in certain cases, some companies that act as a corporate group, may operate to hide behind the advantages of limited liability to the disadvantage of their creditors. They may operate in a way that the parent entity is not clearly distinguishable from the subsidiaries. The argument in favor of piercing the corporate veil in these circumstances is to ensure that a corporate group which seeks the advantages of limited liability must also be ready to accept the corresponding responsibilities. This was the opinion of Doyle CJ in the 1998 case of Taylor v Santos Ltd.
The most outstanding instance however where Anglo-Saxon courts would most probably pierce the corporate veil on the ground of group enterprises is where there exists a sufficient degree of common ownership and common enterprise. In the case of Bluecorp Pty Ltd v ANZ Executors and Trustee Co Ltd (supra), the following Lord Justices identified the main grounds under which Anglo- Saxon courts would be prompt to pierce the corporate veil as a result of group enterprises. The court stated thus:
"The inter-relationship of the corporate entities here, the obvious influence of the control extending from the top of the corporate structure and the extent to which the companies were thought to be participating in a common enterprise with mutual advantages perceived in the various steps taken and plans implemented, all influence the overall picture.
The above hints notwithstanding, the common law courts may hesitate to pierce the corporate veil where the outcome would produce a different result.
2.2.5: Sham or Façade
An argument that the company under scrutiny is a sham or a façade is one of he strongest points that would prompt a common law court to lift the veil of incorporation. The argument is quite close to he argument of fraud, but usually stands on it's own. In short, to say a company was merely a façade or a sham means the corporate form was incorporated or merely used as a mask to hide the real purpose of the corporate controller. In the English case of Sharrment Pty Ltd v Official Trustee in Bankruptcy, Lockhart J, stated that:
"A 'sham' is…something that is intended to be mistaken for something else or that is not really what it purports to be. It is a spurious imitation, a counterfeit, a disguise or a false front. It is not genuine or true, but something made in imitation of something else or made to appear to be something which it is not. It is something which is false or deceptive.
To say the least, a fraud argument is usually dependent upon a sham argument, and common law jurisdictions have indicated over the years that no fraud can be perpetrated where he corporate form is real and not a façade.
2.3: Recent Development of the Doctrine in Common law jurisdictions (Resume)
The doctrine of piercing the corporate veil is apparently in a transitory state in many common law jurisdictions. Current practice by Her Majesty's courts demonstrates that the courts are increasingly becoming as interested with legal and equitable principles as they are with the traditional fraud requirement. In other words, what the Common law courts typically consider is injustice and impropriety. Where this is the case, the only motive of the courts in lifting he veil is the restoration of equity.
The fraud requirement however remains of very vital importance in many common law jurisdictions. But other courts such as in the United States have adopted a more liberal approach to veil piercing in favor of tests such as for instance: what is the veracity in the shareholder control of the corporation? The shareholders' improper conduct in controlling he corporation and the causal link between improper conduct and the plaintiff's injury.
CONCLUSION
The act of piercing the corporate veil until now remains one of the most controversial subjects in corporate law, and it would continue to remain so, even for the years to come. By and large, as discussed in the essay, the doctrine of piercing the corporate veil remains only an exceptional act orchestrated by courts of law. Courts are most prepared to respect the rule of corporate personality, that a company is a separate legal entity from it's shareholders, having it' own rights and duties, and can sue and be sued in it's own name.
As we move from jurisdiction to jurisdiction across the globe, it's application narrows down to how that system of the law appreciates the subject. Common law jurisdictions are examples par excellence where the piercing of the corporate veil has gained notoriety, and as the various cases indicate, courts under this system of the law generally appreciates every case by it's merits.
The above notwithstanding, there are general categories such as fraud, agency, sham or façade, unfairness and group enterprises; which are believed to be he most peculiar basis under which the common law courts would pierce he corporate veil. But these categories are just a guideline and by no means far from being exhaustive.
0 comments:
Post a Comment