Consequences of Incorporation

Question 1

When are company’s incorporated?

Answer 1

When a company is created (ie, brought to life), it is said to be incorporated.

Question 2

How are companys incorporated?

Answer 2

⁃ A company is ‘brought to life’ by a mechanical process of filling in forms and registering the company pursuant to the CA 2006.
⁃ Alternatively you can by a ‘ready made’ company known as an off the shelf company from a lawyer or an accountant. They will have already incorporated the company and they will sell it to you at a profit - it saves the customer the hassle of having to get everything set up.

Question 3

s 51 CA 2006

Answer 3

[NB “pre-incorporation contracts” – personal liability where company not incorporated: see s 51 CA 2006; Kelner v Baxter (1866) LR 2 CP 174; Newborne v Sensolid (Great Britain) Ltd [1954] 1 QB 45; and Phonogram Ltd v Lane [1982] QB 938 (CA). You have dealt with this in agency.]

Question 4

What are the two main consequences of incorporation?

Answer 4

There are two main consequences of incorporation:
⁃ (i) Separate Legal Personality; and
⁃ (ii) Limited Liability (except for unlimited companies).

Question 5

What is the significance of a company as having a separate legal personality?

Answer 5

A company is a separate legal entity, like a natural person. This means, for example, a company can sue, and be sued, in its own name, enter into contracts, and own property. Thus, as a company is separate from its shareholders (owners) and directors (management), subject to certain exceptions below, ie, it has a legal existence, which is separate from those that own it (shareholders) and/or those who run it (directors).

Hence, a company (a juristic person, ie, an “artificial” one) can, like a natural person, own shares in (other) companies.

Some of the other consequences of separate legal personality are that since a company can own property and enter into contracts then it can own shares in other companies:

1. If it owns more than 50% of the shares then it is known as a holding company.
2. Companies whose shares are held by another company, if more than 50% are known as subsidiaries. If the other company owns all the shares then they are known as wholly owned subsidiaries.
3. As a result this gives rise to the corporate group (group of companies).

The key case on separate legal personality is:
⁃ **Salomon v Salomon [1897]

Question 6

**Salomon v Salomon [1897]

Answer 6

[recently reaffirmed in Prest] (the most famous and important case in company law) Must be read!
⁃ Aron Salomon [AS] conducted the business of a leather boot company. He had 4 sons who worked in the business but were not partners. AS decided to incorporate the business under the Companies Act 1862 so as to expand and provide for his family. The business was profitable with assets exceeding liabilities. Also it had been in existence for >30 years. The Act required that a memorandum of association was signed by 7 subscribers with shares in the company.
⁃ The 7 subscribers were AS, his wife, their daughter and their four sons. Each of them initially had a single share. Two of the sons were directors of the company. The assets of the business were sold to the company for ~£40k:
⁃ £20k was paid to AS who gave the money back to the company in exchange for fully paid shares (so he received 20,000 fully paid shares) and
⁃ £10k was paid in debentures (there was a secured loan to the company by AS - this would allow AS to have priority over the other shareholder)
⁃ £1k was retained by AS
⁃ ~£9k was used to pay off the debts of the business
⁃ There was subsequently industrial unrest in the boot and shoe trade. MR AS and his wife made loans to the company. AS cancelled his debenture and had them issued to Broderip for £5k (i.e. the third party paid AS £5k which was secured over the assets of the company). So Broderip was a secured creditor - he was going to get paid out in priority to the other creditors.
⁃ There was a default on the interest payment due to Broderip - he took legal proceedings and the company was already put into liquidation. While there were sufficient assets to pay out Broderip who had security over the company’s assets the unsecured creditors lost out as there were insufficient company assets to satisfy their debts. The unsecured creditors were very unhappy.
⁃ The liquidator tried to make Salomon personally liable for the debts to the company on the following grounds:
⁃ 1) Signatories to the memorandum were mere nominees of AS (mere dummies for AS)
⁃ 2) The company was an alias for AS (AS in another form)
⁃ 3) The company was AS’s agent or trustee (AS had employed the company as an agent and the agent could claim an indemnity against its principal)
⁃ AS was found liable for the company’s debts in the High Court and the Court of Appeal. However on appeal to the HL AS was held not to be liable for those debts on the basis of separate legal personality. The HL held that they were not his debts - they were the company’s debts and the company alone was responsible for those debts. The creditors had traded with the company, not with Salomon himself.
⁃ There were very important speeches in this case [look up on wikipedia if necessary].

Question 7

*Macaura v Northern Assurance [1925]

Answer 7

(company owning property).
⁃ [This case shows how separate legal personality can actually work against a party.]
⁃ Macaura owned timber on an estate in Ireland. He sold the timber to a company called Irish Canadian Sawmills Ltd. The price he paid for the timber was £42k. This was paid for by allotting to Macaura 42k shares in the ICS company worth £1 each. Macaura was also an unsecured creditor to the company in the sum of £19k. The timber was cut and stayed on the ground at Macaura’s estate. Most was later destroyed by fire. Macaura sought to recover the loss under insurance policies which he had taken out in his own name shortly before the fire. The insurers refused to pay out on the basis that he had no ‘insurable interest’ in the timber as a shareholder in or unsecured creditor of the company.
⁃ The HL upheld this view - they held that Macaura could not recover since the timber now belonged to the company and he had no insurable interest in it.

Question 8

*Lee v Lee’s Air Farming Ltd [1961]

Answer 8

(can be major shareholder and sole director, as well as being an employee of company).
⁃ [Separate legal personality worked in favour of a party.]
⁃ This case came before the Privy Council from NZ.
⁃ Mr Lee (GL) the late husband Mrs Lee (L) formed a company Lee’s Air Farming Ltd (LAF) to carry out aerial top dressing. LAF had share capital of £3000 (3000 shares at £1 each). GL had £2999 and L had £1. GL was appointed governing director for life. He was also employed by the company as its chief pilot at a salary which was to be determined. GL was killed while piloting a plane for the company.
⁃ Under the NZ Workers Compensation Act 1922, the issue arose as to whether GL was a ‘worker’ as defined in the legislation and so entitled to compensation from the company for injury in employment. A worker was defined as ‘any person who has entered into or works under a contract of service with an employer whether by way of manual labour, clerical work or otherwise and whether remunerated by wages, salary or otherwise. It was argued by the company that GL was not a worker because, when he had the accident, he was the company’s controlling shareholder and governing director. The NZ courts upheld this view but the Privy Council overturned this view.
⁃ It was held that GL was a worker under the legislation and in the course of his opinion Lord Morris made it clear that this situation was a logical consequence of the decision in Salomon’s case that a person may have dual capacity - they can be the main shareholder and governing director on one hand and an employee on the other hand.
⁃ [S just because you own virtually all the shares in the company doesn’t mean you are precluded from acting as an employee for the company also.]

See also the quotes above from the VTB Capital case (supra); Prest v Petrodel Resources Ltd (supra); and the Standard Chartered Bank case (supra)

Question 9

What is “Limited Liability”?

Answer 9

The second important aspect for businesses in relation to companies, in addition to separate legal personality, is limited liability.

⁃ “Limited liability means that the rights of the company’s creditors are confined to the assets of the company and cannot be asserted against the personal assets of the company’s members (shareholders) … The liability of the company is not limited at all. Creditors’ rights can be asserted to the full against the company’s assets. It is the liability of the members which is limited.”

It means that it is the assets of the company, rather than the shareholders (members), which can be used to satisfy the company’s debts.

The importance of limited liability relates to insolvency, as we saw in Salomon’s case (albeit Salomon’s case is primarily concerned with separate legal personality).

Question 10

What it the limitation of a member’s liability restricted to?

Answer 10

The limitation of a member’s liability is restricted to:
⁃ 1)[ This is the main form of company which will be covered in the lectures.] the amount of the par (or nominal) value of the shares they bought, where a company has share capital, or
⁃ 2) the amount of the guarantee, where the company is one limited by guarantee.

Hence, the liability of a shareholder in a company (which is not unlimited) is restricted or capped. (Cf a partner in a general partnership, where liability for the debts of the firm is unlimited. Thus, as a company has an independence from its owners and managers, it follows that it is the assets of the company which should be used to pay the company’s liabilities.)

Question 11

What is the par value of shares?

Answer 11

The par, (or nominal), value of a share is the value it has when it is first issued to the initial subscriber of that share. It does not change.
⁃ E.g. If you buy 100 shares at £1 each that £100 is the limit of your liability.

The par value of shares is defined in s 542 of the CA 2006.

The par value of shares is different from the share’s market value which can go up or down.

However, If a company does well, the value of the shares may increase and the shareholder may be able to sell his/her/its shares to a buyer, at a higher price. Here, this money goes to the shareholder. Thus, the sale (or market) price of a share is different from its par value.

Question 12

Example: X buys 100 shares in ABC Ltd at a par value of £1.00 each. This money (£100.00) goes to the company, and X receives 100 shares. Five years later, X sells his shares in ABC Ltd, to Y, for £10 each.

Answer 12

Here, the sale proceeds (1,000.00) go solely to X, and Y gets 100 shares in exchange: the company, which has already received the par value for the shares when X subscribed for them, receives nothing. X has, therefore, made a profit of £9.00 per share (£900). However, the company already has the sum of £100 representing the par value of the shares, and so the liability of the shares is limited to the £100, which was paid when the shares were subscribed for. It does not matter that the ownership of the shares has changed. The owner of the shares’ liability is limited to the £100 which was initially paid for the shares. The benefits and detriments follow the shares.

Question 13

Can an initial subscriber ‘partly pay’ for shares?

Answer 13

⁃ It is not essential that an initial subscriber pay the whole of the par value for the shares he/she/it purchases (ie, the shares do not need to be fully paid up), eg, because the company does not need all the money at that time, or to make it more attractive for potential investors to subscribe for the shares.
⁃ Hence, he/she/it may pay part of the par value, eg, 60p per share, instead of £1.00. However, where this happens, the company can make a “call” on the shareholder for the balance of 40p. A creditor can take security over the outstanding sum owed to the company, ie, security over partly called share capital.
⁃ The shareholder’s liability is still limited to £100 - it is just that they don’t pay the full £100 up front.
⁃ NB if you sell partly paid shares, the person buying them will inherit partly paid shares and will then be liable for the balance - the extra liability that the buyer inherits will be reflected in the sale price being lower (so the liability follows the shares).

[See s 547 CA 2006, and s 74 of the Insolvency Act 1986.][ From handout - not sure what this is in reference to exactly.]

Question 14

Example 2 If X subscribes for 100 shares in ABC Ltd, at £1.00 each, X’s total stake is worth £100.00, ie, 100 shares at a par value of £1.00 each.

Answer 14

X’s total liability is, thus, £100.00. If X has paid all of this sum to the company, then X has no further liability (ie, X has fully paid shares). X cannot be asked to pay any more, even if the company has debts of £1million.

Question 15

Example 3 But, if X has not paid for all his shares (partly paid-up shares), then the company may seek the outstanding balance from him to pay creditors.

Answer 15

Thus, if X had only paid 60p for each share, making a stake of £60.00, the company may seek the remaining £40.00 from X to help pay its debts. However, the overall sum of £l00.00 is the total extent of X’s liability. X cannot be asked to pay any more, even if the company has debts of £1 million pounds.

Question 16

Example 4 X purchases 100 shares with a par value of £1.00 each in ABC Ltd. X later sells them all for £1,000 to Y, ie, £10.00 per share.

Answer 16

If ABC Ltd owes a creditor £10,000, but the shares were fully paid up when X sold them to Y, Y’s liability is pegged to the £100.00 already paid by X (which is reflected in the sale price). Hence, Y has no further liability. But if the shares are not fully paid up shares, ie, if X had only paid 60p per share, then Y is liable for the remaining 40p per share (£40.00), but nothing more. The sale price of the shares is irrelevant to Y’s liability. X ‘pockets’ the sale price, with Y now assuming whatever liabilities X had (if any) concerning the par value of the shares.

Question 17

What are ‘rights issues’?

Answer 17

These are something of a hybrid of the par value and the market value. Sometimes a company, with issued share capital and existing shareholders will want, or need, to raise additional share capital (equity, rather than debt (borrowing)). It will do this by means of a rights issue, whereby shares will be offered to existing shareholders (members) in proportion to their existing shareholding, e.g., a 1 for 3 issue, which means for every three shares the member holds, they will be offered a new share. To attract members to take up the offers, the new shares will be issued at above the par value (as you cannot issue shares below the par value, pursuant to CA 2006, s 552), but below the market price. E.g., if the par value of the issued shares is £1.00, and the market value is £3.00, the new shares might be offered for sale at say £2.00

This new inflow of shares is likely to adversely affect the market price of the shares, i.e., they will go down because there are now more shares, representing a stake in the company, e.g., the might fall from £3.00 per share, to £2.50, per share. If the shareholder does not take up the offer, their stake in the company will be reduced as they will hold the same number of shares in the company as before, but there will be more shares in the company. E.g., if X holds 6000 shares and the company has 15,000 shares, then if X takes up the 1 for 3 offer, he will have 8,000 shares out of a total of 20,000 shares (including the new shares). However, if X does not take up the offer, then his stake will be 6,000 shares out of a total of 20,000 shares.

The key points here are that, as the shares are issued by the company, and not sold by an existing shareholder, the money goes to the company, i.e., 2,000 shares x £2.00 = £4,000. Secondly, though the share price is higher than the par value, but lower than the market price. The price at which the new shares are offered to existing shareholders will be affected by the market price (provided it is higher than the par value).

Question 18

What is Under-Capitalisation?

Answer 18

One sometimes hears of so-called ‘£2.00 companies’, where a director/shareholder protects him/her/itself from liability by owning 2 shares of £1 00 each, or £1.00 companies. However, businesses have to be wary of being under-capitalised. The share capital of initial subscribers will be used for things like: paying rent for premises, purchasing stock or raw materials, having renovation work done, paying bills etc. Initial start-up costs can be high, and if a business has insufficient funds to cover its expenses before it makes a profit, then it can become insolvent.

Question 19

As a company acts through human agents, the question is: which agents’ acts or “knowledge” constitutes those of the company?

Answer 19

Although the company may be a separate legal person, because it is an artificial person it’s capable of acting and knowing only if the actions or knowledge of human beings are attributed to it. Thus, one needs to know whose actions or knowledge and in what situations shall be treated as the company’s. [Clearly the tea lady would not have authority to bind a company, but who does?]

The previous test used to be who was the “directing mind and will of the corporation”? This is only suitable in very small companies but it is unsuitable in relation to very small companies.

n the Privy Council case of *Meridian Global Funds v Securities Commission [1995] [Question of “attribution”], the court considered the issue again.

Question 20

*Meridian Global Funds v Securities Commission [1995]

Answer 20

⁃ Facts: K and N were investment managers with Meridian. They were trying to take over another company called ENC. K was described as being the chief investment officer and N a senior portfolio manager. They had a scheme to buy shares at ENC but this fell foul of NZ’s securities laws (they were required to disclose this to the Securities Commission? but didn’t do so). The Securities Commission brought proceedings against Meridian. It was held by the Privy Council that it was the actions of K and N that could be attributed to Meridian who were liable for breaches of NZ security laws. Why did the court come to this conclusion?
⁃ Lord Hoffman explained that one needs to refer to a set of rules to determine whose actions should be considered the actions of the company. He stated that there are two sources of rules:
⁃ The first is the constitutional documents of the company (e.g. the articles of association) which deal with the internal running of the company - these were referred to as ‘primary rules of attribution’.
⁃ Secondly, these are supplemented by general rules of attribution (since the primary rules are insufficient as not everything that is done on the company’s behalf can be expected to be the subject of some directors / shareholders resolution. [ E.g. If every time someone wanted to go any buy a box of staples there had to be a shareholders meeting, business would grind to a halt so these general rules of attribution are necessary.]These general rules concern natural persons and agency principles.
⁃ Lord Hoffman went on to say that normally the primary rules of attribution and the general rules of attribution will be sufficient to help you determine what the company’s rights and obligations are.

Question 21

Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705, 713.

Answer 21

Formerly: “directing mind and will of the corporation”

Question 22

What are the rights of a holding company?

Answer 22

As indicated above, one consequence of a company being a separate legal person (ie, juristic person) is that, like a natural person, it can own shares in (other) companies. The size of these stakes will vary from owning all the shares to a small stake or percentage.

⁃ “Holding company” - s 1159(1) CA 2006 – 3 situations:
⁃ (i) “a company” (“holding company”) has “a majority of the voting rights in” another company (“subsidiary”). (i.e., majority voting rights)
⁃ (ii) “a company” (“holding company”) “is a member of” another company (the “subsidiary”) ‘and’ can “appoint or remove a majority of” the subsidiary’s “board of directors”. (i.e., power re appointment or removal of most of subsidiary’s “board “)
⁃ (iii) “a company” (“holding company”) ‘is a member of’ another company (“subsidiary”) “and controls” by “itself”, or collectively, “a majority of the voting rights in” the other company (“subsidiary”) (i.e., control either alone or with (an)other(s) of most of subsidiary’s “voting rights”).

Question 23

What are the rights of a subsidiary company?

Answer 23

“Subsidiary[ NB obvious point - a subsidiary is a separate legal entity.]” - s 1159(1) CA 2006.
⁃ The reverse of the above three examples. (In essence, where more than 50% of the shares in a company are owned by another company (with the consequent voting consequences)).
⁃ A company can also be a subsidiary where “it is a subsidiary of a company that is itself a subsidiary of another company”: s 1159(1) CA 2006.

E.g. A Ltd owns all the shares in B Ltd, which, in turn, owns all the shares in C Ltd. Here, C Ltd is a subsidiary of B Ltd; B Ltd is a subsidiary of A Ltd.

A subsidiary cannot own shares in its parent company: see s 136 CA 2006.

[As to the meaning of ‘subsidiary’ and ‘member’: see Enviroco Ltd v Farstad Supply A/S [2011] UKSC 16; [2011] 1 WLR 921; [2011] 3 All ER 451. (This case looks at the meaning of these terms under s 736 of the Companies Act 1985, which was the predecessor of s 1159 of CA 2006.) ]

Question 24

What is a “wholly-owned subsidiary”?

Answer 24

• s 1159(2) CA 2006.

⁃ Basically, where one company owns all the shares in another company.

Question 25

What is an “associated company”?

Answer 25

a company with a stake in another company of less than 50% of that other company’s voting rights (but the stake will normally be significant e.g. 40%)

Question 26

s 1159(3) CA 2006, and Sch 6 CA 2006.

Answer 26

Further Definitions/Explanations

Question 27

What rights do ordinary shareholders have?

Answer 27

Ordinary shares give the holder the right to vote on company business at meetings of the company, as well as a dividend (a return on the shareholder’s investment in the company based on the company’s profits). Commonly 1 vote per share, but there can be different classes of shares containing different voting rights, (see later).

Question 28

Adams v Cape Industries plc [1990] Ch 433, 544; [1990] 2 WLR 657; [1991] 1 All ER 929; [1990] BCLC 479

Answer 28

As each company has separate legal personality, this means that a parent company is not liable for the debts of a subsidiary. This is a valid use of the corporate form.

Consequently, a parent company can be “ring-fenced” from the liabilities of its subsidiaries.

Question 29

What are the ‘company groups’?

Answer 29

The combination of subsidiaries and holding companies has led to the phenomenon of the ‘Company Group’.
⁃ Company Groups – this is a phenomenon of the 20th century (and also now 2lst century). It involves a series of companies connected by common ownership, with an ultimate holding company. Each company remains a separate legal entity, though.
⁃ Company groups are attractive as it allows a company to separate into smaller parts so that if one part fails it won’t necessarily mean the whole company group fails (it helps to ring fence the parent company from the liabilities of the subsidiaries)

⁃ Eg 1 A Plc owns all the shares in B Ltd. B Ltd owns all the shares in C Ltd. C Ltd owns all the shares in D Ltd. A Plc is the ultimate holding company.
⁃ Eg 2 A Plc owns all the shares in A Ltd, B Ltd, C Ltd and D Ltd.

Question 30

How are the accounts of the company groups managed?

Answer 30

⁃ The consolidation of company accounts (ie, group accounts), for business purposes and as required under the Companies Acts, does not mean each company in the group ceases to be a separate legal entity: see Industrial Equity Ltd v Blackburn (1977) 137 CLR 567, at p 577, per Mason J (High Court of Australia), who said this consolidation was done for the benefit of shareholders and those who deal with the company in terms of providing information to them, but did not undermine the rule in Salomon’s case:
⁃ ‘It has been said that the rigours of the doctrine enunciated by Salomon v. Salomon & Co. Ltd. have been alleviated by the modern requirements as to consolidated or group accounts introduced in the United Kingdom by the Companies Act 1948 [now the Companies Act 2006] … But the purpose of these requirements is to ensure that the members of and for that matter persons dealing with, a holding company are provided with accurate information as to the profit and loss and the state of affairs of that company and its subsidiary companies within the group, information which would not be forthcoming if all the shareholders received was limited to the accounts of the holding company disclosing as assets the shares which it holds in its subsidiaries. It is for this purpose that the Companies Act treats the business group as one entity and requires that its financial results be incorporated in consolidated accounts to be circulated to shareholders and laid before a general meeting … and requires that the accounts and other documents shall accompany the annual return …’

[There is an obligation on “directors” to “prepare group accounts”: see ss 394, 399 and 404 CA 2006. NB in this regard, the terms: “parent company” “parent undertaking”, and “subsidiary undertaking” are used.

These terms are defined in s 1162 CA 2006 and Sch 7 CA 2006; see too ss 853 and 1173 CA 2006. See, generally, on “group accounts”: Gower and Davies Principles of Modern Company Law (2012, 9th edn), paras 21-7 – 21-8.]

Question 31

What does ‘Piercing the veil of incorporation’ mean?

Answer 31

The metaphor is that ‘incorporation’ is a form of veil that hides the people who own or control a company. In some exceptional circumstances, the corporate veil is ‘lifted’ or ‘pierced’.

Question 32

*Gilford Motor Co v Horne [1933] Ch 935 (CA).

Answer 32

??

Question 33

**Adam v Cape Industries plc [1990] Ch 433; [1990] 2 WLR 657; [1991] 1 All ER 929, [1990] B.C.L.C. 479.

Answer 33

??

Question 34

What happens if the controllers of the company are enemy aliens?

Answer 34

Public policy: if the controllers of the company are enemy aliens

If at time of war you are dealing with a company and are suspicious that it might be a company owned enemy aliens then you can disregard the company’s separate legal personality and go behind it
Daimler v Continental Tyre and Rubber Co. [1916] 2 AC 307.

Question 35

What happens if there has been fraudulent or wrongful trading?

Answer 35

Statutory exceptions: Fraudulent or Wrongful Trading:

⁃ In a liquidation of a company if there has been fraudulent or wrongful trading then the directors of the company can be required, at the court’s discretion to make a contribution to the assets of the company.

⁃ Wrongful trading (s 214 IA[ This is the Insolvency Act] 86)
⁃ This is where a director knew or ought to have known that there was no reasonable prospect[ So if you are a director who keeps trading when you know or ought to have known that the company couldn’t avoid liquidation then this may have been ‘wrongful trading’ and in a liquidation you may be required to contribute to the assets of the company, at the discretion of the court.] that the company would involve insolvent liquidation.
- Contribution by directors
⁃ Fraudulent trading S 213 IA 86
⁃ Fraudulent trading is the same as wrongful trading but in addition dishonest intent must be proved.
- Contribution by directors (also a criminal offence under CA 2006, s 993).

Question 36

When should the directors have concluded that there is no reasonable prospect that insolvent liquidation could be avoided?

Answer 36

The case law is quite difficult here. The case of Re Hawkes Hill Publishing Co Ltd (in liq) makes it clear that precision is required by a liquidator in stating the time that the director(s) should have realised that the company should have ceased trading so as not to defeat creditors.

Question 37

What is the defence of wrongful trading?

Answer 37

2) There is a defence to wrongful trading (s 214(3) IA 86). You are not liable if you have taken every step with a view to minimising potential loss to creditors.

Question 38

What is Piercing the Corporate Veil?

Answer 38

In Prest v Petrodel Resources Ltd [2013] UKSC 34; [2013] 2 AC 415; [2013] 3 WLR 1, para 16, Lord Sumption JSC, said it involves the company’s separate legal personality being disregarded, in instances “which are true exceptions to” Salomon’s case.

Question 39

What is “Lifting the Veil”?

Answer 39

You will sometimes hear the term “lifting the corporate veil”. It tends to be used interchangeably with piercing the corporate veil. The Supreme Court in both Prest v Petrodel Resources Ltd [2013] UKSC 34; [2013] 2 AC 415; [2013] 3 WLR 1; and VTB Capital plc v Nutritek International Corp [2013] UKSC 5; [2013] 2 AC 337; [2013] 2 AC 337; [2013] 2 WLR 378 expressed a preference for piercing the veil.

Cf Lord Neuberger PSC in VTB Capital, ibid, para, 118; and Prest, ibid, para 60, referring to Staughton LJ in Atlas Marine Co SA v Avalon Maritime Ltd (No 1) [1991] 4 All ER 769, at 779.

Question 40

What is the old test in Woolfson v Strathclyde Regional Council 1978?

Answer 40

In Woolfson v Strathclyde Regional Council 1978 SC (HL) 90, 96, it was said, by the House of Lords, the corporate veil could only be pierced where there were “special circumstances” which indicated the veil “is a mere facade concealing the true facts.”

Question 41

What are the cases concerned with No Piercing on Ground of “Justice”?

Answer 41

**Adam v Cape Industries plc [1990] Ch 433, at 536; [1990] 2 WLR 657; [1991] 1 All ER 929, [1990] BCLC 479.

Quoted, without disapproval approval, in Prest v Petrodel Resources Ltd [2013] UKSC 34; [2013] 2 AC 415; [2013] 3 WLR 1, para 21.

Question 42

1. *DHN. Food Distributors Ltd v Tower Hamlets London Borough Council [1976]

Answer 42

**The old law [follow it through chronologically]

⁃ Involved a corporate group of three companies. The first was DHN, the second Bronze Ltd and the third Transport.
⁃ DHN carried on a grocery business and was the parent company of Bronze and Transport (it owned all the shares in them).
⁃ Bronze owned the premises that business was carried on from and didn’t trade. Its sole asset was the premises.
⁃ Transport was a haulage and transport company which worked solely for DHN .
⁃ All three companies had the same directors. The council compulsorily acquired the land that DHN traded from. All three companies sought compensation under the English Land Compensation Act 1961 regarding the land’s value and also for business disruption.
⁃ The land tribunal held that since DHN didn’t own the land its compensation was negligible. And Bronze owned the land but didn’t really carry on a business so was also not entitled to compensation. The three companies went into liquidation. The decision of the land tribunal was appealed to the Court of Appeal which upheld the claim[ I.e. they found in DHN’s favour.]. Unsurprisingly the decision was not uniform.
⁃ Lord Denning regarded the case as involving three companies in one or one group of three companies. He treated the group as being like a partnership and was swayed by the fact that what was involved was a technicality - if the land had been conveyed to DHN then no problem would have arisen and full compensation could have been claimed. He went on to say that as the group was virtually the same as a partnership in which all three companies were partners, there shouldn’t be a separate treatment of the companies (so he was against the rejection of the claim by the land tribunal on a ‘technical point’.)
⁃ Lord Gough also found in DHN’s favour. He was careful to confine his remarks regarding piercing the veil to the facts of this particular case rather than begin of general application. He noted three things: 1) the subsidiary companies were wholly owned 2) the subsidiaries had no separate business operations (other than to service DHN) 3) the nature of the question was highly relevant - that the owners of the business had been disturbed in their possession and enjoyment of the business.
⁃ Lord Justice Shaw also found in DHN’s favour. He seemed to be influenced by the justice of the matter. He noted that both DHN and Bronze had the same directors and the two companies had a common interest in maintaining the group’s business on the premises. He felt that the companies were deserving of compensation. He then went on to talk about the utter and community of interest between DHN and Bronze - he felt it would be a denial of justice if they didn’t get compensation and that this was a ‘case of very special character’.

Question 43

2. **Woolfson v Strathclyde Regional Council 1978

Answer 43

⁃ A similar issue arose as in DHN but with a slightly different corporate structure.
⁃ Company called M&L Campbell Glasgow (“C”) which operated a retail business selling bridal attire in a shop with 5 units. These premises were owned by two owners: Woolfson and SHL. Woolfson owned 3 units, SHL owned 2.
⁃ Woolfson owned 999 out of 1000 shares in C and his wife owned the other 1 share. Woolfson was the sole director of SHL and owned 2/3 of the shares.
⁃ C was the occupier of the premises and although rent was payed to SHL and Woolfson, there was no formal lease arrangement.
⁃ The land was compulsorily acquired under the relevant Scottish legislation. Woolfson tried to argue that himself, C and SHL should be treated as a single legal entity, embodied in himself.
⁃ This argument was rejected by the HL and distinguished the decision in DHN on its facts. But DHN was not overruled.
⁃ The court made several observations about the differences between DHN and the present case:
⁃ 1) In DHN, Bronze owned the land and DHN was in complete control of Bronze; in the present case C had no control over the owners of the land.
⁃ 2) Woolfson didn’t own all the shares in C
⁃ 3) In DHN all the directors were the same in all three companies.
⁃ In relation to the question of piercing the corporate veil the HL set out an (obiter) principal that “ … it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere facade concealing the true facts.”[ This was the old guiding principal!!!!]

⁃ NB. DHN was not a decision of the Scottish courts so would only be at best persuasive authority and [up until recent cases] the Scottish courts would have followed Woolfson.
⁃ Generally the courts have been very reluctant to pierce the corporate veil.

Question 44

3. **Adam v Cape Industries [1990]

Answer 44

⁃ An example of using the corporate form to protect the most valuable assets of a business.
⁃ The case involved 3 companies: Cape, Capasco and NAAC.
⁃ Cape was the parent company of various subsidiaries involved in mining and marketing asbestos. The mines were in SA. Cape was incorporated in England and it was head of a corporate group.
⁃ Capasco was also incorporated in England and was a wholly owned subsidiary of Cape - it was the worldwide marketing subsidiary.
⁃ NAAC was incorporated in Illinois - it was the USA marketing subsidiary. It was also a wholly owned subsidiary.
⁃ NAAC was liquidated. The asbestos mined in SA was used in a Texan factory. An action[ This was the first action.] was brought in Texas by current / former employees of Cape for personal injuries caused by being exposed to asbestos. Cape, Capasco and NAAC were amongst the defendants to the action. The action was settled although Cape and Capasco claimed that the Texan court had no jurisdiction over them as English companies.
⁃ A few months prior to the first action being settled and a second action being started, NAAC was put into liquidation and two new companies were formed called AMC (incorporated in Liechtenstein) and an American company called CPC. CPC shares were owned by a person called M who had been NAAC’s Chief Executive.
⁃ CPC continued the same business as NAAC had for a short period of time until Cape divested itself of asbestos operations. Later a default judgement was entered in the second action in the US (a judgement where a party doesn’t enter the action because Cape and Capasco didn’t take part in the proceedings).
⁃ There was then an attempt to enforce the default judgement obtained in this second action in England. This was unsuccessful:
⁃ Three arguments were put forth:
⁃ 1) That the companies should be treated as a single economic unit
⁃ The Court of Appeal rejected that members of a corporate group lost their identity and were somehow regarded as being one. Legally, all four of the companies were separate legal entities.
⁃ 2) That NAAC was Cape and Capasco’s agent - it had no separate existence of its own.
⁃ The Court rejected this argument and held that NAAC was in every sense its own business, noting various factors to support this claim: it paid rent, it bought and sold asbestos, it paid taxes, it paid dividends and it had its own debtors and creditors.
⁃ 3) Piercing the corporate veil
⁃ The court rejected an argument that the court should ignore or not apply Salomon’s case simply because its application would result in an injustice.[ So the corporate veil cannot be lifted just to avoid an injustice (like it was in DHN)]
⁃ The Court applied the recognised exception from Woolfson (that the corporate veil could only be pierced where “special circumstances exist indicating that it is a mere facade concealing the true facts.”)

⁃ So this was the state of the law for ~35 years following the Woolfson exception (green highlighting above) until 2013 with the case of VTB.

Question 45

How has the law been changed by the new Supreme Court cases?

Answer 45

The law in this area has recently been changed by 2 decisions of the Supreme Court. You must
read these cases.

Question 46

1. VTB Capital plc v Nutritek International Corp [2013] (

Answer 46

(shows doubts about the Woolfson test, without expressly overruling it) (Read judgement of Lord Neuberger PSC, paras 114-148). (This is a case concerned with service of legal process out of the jurisdiction. It concerns allegations of fraud and conspiracy. Ignore the international private law aspects of the case.)
⁃ VTB lent a company RAP $225m with security of about $30-40m. The loan was for RAP to buy some dairy and associated companies from Nutritek. After three payments RAP defaulted on the loan. VTB alleged fraud and conspiracy regarding the loan. VTB attempted to pierce the corporate veil because a Mr M? was the owner of all these companies and thus should be liable.
⁃ The court rejected the arguments, however, the effect of the case was that the Supreme Court was reviewing the ‘piercing of the corporate veil’ for the first time in 35 years and expressing concerns about Woolfson.
⁃ Lord Neuberger believed that the Woolfson test was obiter (and technically it was - the principle set out was not applied in the case because DHN was distinguished on its facts and the veil did not have to be pierced but it was a fairly clear statement from the HL what they believed the test ought to be.) Thus he believed that there was no definitive decision on the point and he was concerned that this whole area of law was unprincipled. He then went on to criticise the imprecise nature of the test (it relied upon metaphors like ‘facade’ and ‘cloaks’ rather than legal principle) which can lead to moral indignation usurping legal principle. However, this case was merely and interlocutory matter (it wasn’t a final judgement) so the court didn’t have to decide the matter.
⁃ [Therefore after this case Woolfson hadn’t been repealed - it was only heavily undermined. The doubts that were expressed here were expressed much more coherently in Prest.]

Question 47

**Prest v Petrodel [2013][ This is the most important modern case.]

Answer 47

Prest followed VTB a few months later:

(new test: “evasion principle”). (Read Lord Sumption JSC, and Lord Neuberger PSC; see also Lady Hale JSC).
- (This case involved a property settlement after a divorce. Companies owned by Mr P held properties which Mrs P wanted to be transferred to her as part of the divorce settlement. An argument that the corporate could be pierced was rejected. However, held, the properties were held on trust for Mr P, and he could be ordered to require companies to transfer properties to Mrs P.)
⁃ This was a matrimonial case involving a divorce. Under the relevant Act you were required to disclose certain facts before divorce so there can be a settlement of property between the parties. After the divorce a sum was awarded to Mrs Prest but Mr Prest didn’t pay up and breached various court orders requiring him to disclose his financial affairs.
⁃ There were various companies which formed part of the Petrodel Group which owned various properties in London. Mr Prest owned these companies. Mrs Prest sought to pierce the veil to get the properties in order to satisfy the sum to be paid to her under the divorce settlement.
⁃ The Supreme Court held that the corporate veil could not be pierced but held that the properties belonging to the Petrodel Group companies were held on trust for Mr Prest and given his control he could require them to transfer the properties to his wife. However, they then went on to discuss the question of piercing the corporate veil.
⁃ Lord Sumption gave the leading judgement. He rejected the ‘facade’ test set out in Woolfson. He said that it was too complicated. But he was concerned about the corporate form being abused and accepted the need to a narrow exception to Salomon’s case - in essence he wanted to preserve the exception allowing piercing of the corporate veil in limited circumstances an intellectual underpinning using the ex turpi causa (fraud unravels everything) doctrine.
⁃ Sumption distinguished between two principles[ All of the justices acknowledged that it may not always be possible to place cases neatly into one of the other - they acknowledged that there would be considerable overlap.]:
⁃ 1) The concealment principle: “the interposition of a company or perhaps several companies so as to conceal the identity of the real actors”. The courts will identify these actors. Here, “the court is not disregarding the ‘façade’, but only looking behind it to discover the facts which the corporate structure is concealing.” [So in these cases the corporate veil cannot be pierced].
⁃ 2) The evasion principle: “…the court may disregard the corporate veil if there is a legal right against the person in control of it which exists independently of the company’s involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement.”
⁃ Look up some more about this case
⁃ It was held that piercing the corporate veil is a remedy of last resort and if there is another alternative doctrine available then it should be used.
What we see in these cases is the re-affirmation of the sanctity of Salomon’s case.

Question 48

What is the concealment principle?

Answer 48

• It involves “a company” or companies being interposed “to conceal … the real actors[’]” “identity” from another party. A court looks “behind” the corporate “‘façade’” to find the real position that is being concealed by the company/companies – the corporate “‘façade’” is not disregarded.

⁃ Examples of the “concealment principle”:
⁃ (i) Company acting as agent for controller of company.
⁃ (ii) Company holding property on trust for controller (as in Prest)
⁃ (iii) Certain remedies, eg, interdict and specific implement, can be granted against controller so he/she/it behaves in a certain way.

Prest, ibid, para 16.

Question 49

What is the “evasion principle”?

Answer 49

In Prest, Lord Sumption JSC (who gave the leading judgement), at para 28, outlined a new test for piercing the corporate veil, called “the evasion principle”. He distinguished this from the “concealment principle” (which does not involve piercing the veil), although he acknowledged there could be overlap. There was general agreement with it.

Cf Lady Hale’s doubts, in Prest, ibid, para 92.
⁃ Examples of the “evasion principle”
⁃ (i) *Gilford Motor Co v Horne [1933] Ch 935 (CA) (use of company to try to get around a restrictive covenant in contract of employment).
- (Ii) Prest, ibid, para 29 (Lord Sumption JSC)
- (Iii) In VTB Capital, ibid, para 134; and Prest, ibid, paras 70-72, Lord Neuberger PSC say this case as being an agency case, or a “concealment” case.

Question 50

How does the evasion principle differ from the concealment principle?

Answer 50

It provides says the corporate veil can be disregarded where the interposition of a company is used by the company’s controller to thwart, or “frustrate”, a third party’s existing legal “right”, i.e., to evade a legal obligation already in existence.

Question 51

How is Woolfson no longer the law?

Answer 51

The “façade”/”sham” test was laid to rest in Prest; having been doubted in VTB Capital, but not overruled.

Rationale

Supreme Court accepted the need for a narrow exception to Salomon’s case. The principle of ex turpi causa (“fraud unravels all”) was used: see Prest, paras 18 (Lord Sumption JSC), and 83 (Lord Neuberger PSC).

“Relevant Wrongdoing”

In Prest, ibid, the court said you needed to identify “the relevant wrongdoing” (para 28; see too para 27).

“Remedy of Last Resort”

Clear from Prest v Petrodel Resources Ltd [2013] UKSC 34; [2013] 2 AC 415; [2013] 3 WLR 1, piercing the veil should only be used where no alternative.

Question 52

Case Notes to possibly look up

Answer 52

(a) VTB Capital Case

(1) C Hare, “From Salomon to Spiliada: Orthodoxy and Uncertainty in the Supreme Court (2013) 72 CLJ 280-284.
(The reference to the Spiliada is to international private law and forum non conveniens, which you should ignore.)

(2) D Vlasov, “To Pierce or not to Pierce: Supreme Court Answers in the Negative: VTB Capital v Nutritek International (2013) 34 The Company Lawyer 248-252.
(b) Prest Case
(1) B Rider, “Exposing the Modesty of Companies” (2013) 34 The Company Lawyer 263-264.
(2) P Bailey, “Lifting the Veil Becomes a Remedy of Last Resort after Petrodel v Prest in the Supreme Court”, Co Law Newsletter, 2013, 336, 1-5.
(c) Both Cases
(1) M Ashe QC, SC, “The veil unlifted” (2013) 34 The Company Lawyer 295-296.

(These case notes are all available on Westlaw.)

[Apart from the new edition of Grier, plus Mayson, French & Ryan (which has a commentary at the front), and the new edition of Sealy & Worthington, none of the textbooks or casebooks will deal with the VTB Capital case, or the Prest case.]

Question 53

What are the cases on holding and subsidiary companies?

Answer 53

These cases were decided under the old law. However, we need to look at them. We will discuss them in terms of what they decided, and the new law.

*DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976]] 1 WLR 852 (where the court went behind “veil of incorporation”. A contentious case).

Distinguished in **Woolfson v Strathclyde Regional Council 1978 SC (HL) 90 (“a mere facade”).

**Adam v Cape Industries plc [1990] Ch 433, at p 544, per Slade LJ, who said a corporate group can be legitimately structured so that “future” liabilities fall on one member of a group, and not another, i.e., the veil cannot be pierced in such a case.

This view would not appear to contradict what was said in Prest, ibid, para 28.

Veil not pierced where company merely “involved in” wrongdoing: corporate “structure” has to be used to perpetrate the wrong.

See Trustor AB v Smallbone (No 2) [2001] 1 WLR 1177, paras 22 and 23, per Sir Andrew Morritt V-C:

This part of the case does not appear to have been overruled in Prest, ibid.

Question 54

International (European) Private Law Cases

Answer 54

Centros Ltd v Erhverus-Og Selskabstyrelsen [2000] Ch 446; [1999] 2 CMLR 551; [1999] ECR I-1459; Re Cartesio Okato es Szolgatab bt (C-210/06) [2008] ECR 1-9641; [2009] 1 CMLR 50.