Corporate Personality and Lifting the Corporate Veil

Question 1

Limited liability

Answer 1

• The liability of shareholders of a company to pay debts incurred by the company is limited.
• Shareholders are not liable to pay debts which the company owes to its creditors because it is the obligation of the company to pay its creditors
• The creditors to whom a company owes money must claim against the company. If the company has insufficient funds, creditors cannot pursue their claims against the shareholders.
• If the company becomes insolvent, shareholders will be liable to lose money they have invested in subscribing to the company’s shares.
• They are also liable to make payment for any shares they have not yet fully paid for, but this is the extent of their liability.

Question 2

Where is the concept of limited liability enshrined?

Answer 2

s. 74 Insolvency Act 1986

Question 3

The separate personality of a company

Answer 3

A company is a legal entity distinct from its owners as well as from its directors, creditors and employees.

• Directors owe their duties to the company, not to the shareholders
• Shareholders usually have rights against the company, rather than against the directors
• Third parties with whom the company does business contract with the company, even though they negotiate with the directors.
• A company continues to exist even if its shareholders or directors change.

Question 4

Significance of limited liability

Answer 4

• Limited liability is the quality that has caused companies to become useful commercial tools because the personal assets of shareholders are separate from the assets of the company.
• This is fundamental to:
• (1) Passive investment: shareholders can invest based on whether they want to risk losing that investment, but knowing that the rest of their personal assets are safe
• (2) Why many entrepeneurs seek to conduct business through the medium of a limited liability company;
• (3) Why groups of companies have developed - riskier business divisions can be conducted through separate companies within the group without the less risky companies becoming vulnerable to the creditors of the riskier companies.

Question 5

Salomon v Salomon

Answer 5

The company was validly incorporated and therefore had a separate legal personality. Salomon was liable neither to the Salomon Company nor to the creditors of the Salomon Company. In law, the company is not an agent of the subscribers or members. From the moment it is incorporated, it is at law a separate legal entity.

The fact that some members may take no part in the management of the company is irrelevant. Companies can therefore be validly used by individuals to carry on what is in economic reality the business of an individual.

Question 6

Consequences of separate legal personality

Answer 6

(1) The company owns its own property
(2) The company enters into its own contracts
(3) The company sues and is sued on its own liabilities

Question 7

The company owns its own property

Answer 7

Macaura v Northern Assurance: The House of Lords held that timber destroyed in a fire belonged to the company and not to M, therefore he was unable to claim on the insurance policy, despite owning almost all the shares in the company.

Question 8

The company enters into its own contracts

Answer 8

Lee v Lee’s Air Farming: L was the sole director of the company and also an employee. He was killed in a plane crash while working. L’s widow brought a claim under the Workers Compensation Act 1922. Privy Council found that L and the company were distinct legal entities and therefore L under the contract of employment was a ‘worker’ as defined by the Act.

Question 9

The company sues and is sued on its own liabilities

Answer 9

Adams v Cape Industries: Issue was whether liability for asbestos by subsidiary company NAAC could be enforced against the parent company since all of Cape’s assets were based in England. The Court of Appeal rejected all arguments and held that the judgment could not be enforced against Cape.

Question 10

Legal personality - current position

Answer 10

s. 16 CA 2006: a company becomes a body corporate (a legal person) exercising the functions of an incorporated company from the date of incorporation (when the Registrar issues the certificate of incorporation)
- a private company can be formed with just 1 director and 1 shareholder. The company will continue to exist even when they change.
- shareholders pay for their shares and are entitled to profits but have no entitlement to the company’s property.
- directors have day to day control of the company under MA 3.

Question 11

Justification of limited liability

Answer 11

• It encourages investment
• It encourages businesses to take risks, which generates money and benefits the wider community
• Creditors will be aware they are contracting with a limited company due to the requirements to put ‘Ltd’ and ‘Plc’ at the end of the name
• creditors are therefore on notice and have the opportunity of assessing the financial viability of a company by checking publicly filed documents at Companies House

Question 12

Issues of limited liability

Answer 12

• creditors of companies and claimants in court actions risk being able to receive monies due to them as the concept prevents them from going behind the corporate structure to seek monies from those controlling the company.
• accounts are only filed once a year so may not reflect the current financial situation
• small private companies accounts do not give much information

Question 13

Piercing the corporate veil

Answer 13

Situations in which the court may go behind the corporate framework and the company’s separate legal personality to make the shareholders liable.

Question 14

Prest v Petrodel Resources Ltd: General Summary

Answer 14

• clarified that the doctrine of piercing the corporate veil does exist and can be invoked on grounds of public policy but only in narrow circumstances where there is no alternative remedy
• the court may pierce the corporate veil only where a person under an existing legal obligation or restriction deliberately evades or frustrates the obligation or restriction by setting up a company

Question 15

Prest v Petrodel: Facts

Answer 15

wife sought an order to transfer properties to her on basis that they were held by companies on trust for her husband

Question 16

Prest v Petrodel: Concealment principle v evasion principle

Answer 16

(1) Concealment principle - doesn’t involve piercing the veil. It describes cases where the corporate structure conceals the real actors, where the court will look behind the corporate structure to discover the real facts.
(2) Evasion principle - the court may pierce the corporate veil if a person deliberately attempts to evade an existing legal obligation he is under by interposing a company which he controls. This was the case in Gilford Motor Co Ltd v Horne - the court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller of the advantage that they would otherwise have obtained by the company’s legal personality.

Question 17

Pre - Prest and Petrodel cases in which the courts were asked to lift the corporate veil

Answer 17

(1) Façade or sham
(2) Single economic entity
(3) Agency
(4) Tort

Question 18

Façade or sham

Answer 18

• The courts have lifted the veil in these instances.
• Gilford Motor Co v Horne: former employee who was bound by a restrictive covenant not to solicit customers from his fellow customers set up a company in order to do so. The court held that the company was merely a front/sham and issued an injunction preventing trading
• Jones v Lipman: L formed a company to avoid a transaction with J and transferred the land to the company so that he could claim he couldn’t comply with the contract as he was no longer the owner of the land. The court found that the company was merely a façade and granted an order for specific performance.

Question 19

Single economic entity

Answer 19

• now established that parent companies are not liable for their subsidiaires, so this is not a basis for piercing the corporate veil
• Woolfson v Strathclyde: the veil of incorporation will be upheld unless it is a sham or façade created specifically for the purposes of avoiding liability, thereby confirming that each company in a group is its own distinct entity, and that a group of companies is not a single economic entity.

Question 20

Agency

Answer 20

This is based on the law of agency and not lifting the corporate veil.

Question 21

Tort

Answer 21

Parent companies may be liable to those dealing with their subsidiaries on the basis of tort, but again this is not an example of lifting the veil.

VTB Capital v Nutritek International: VTB could claim damages on the basis of the tort of fraudulent misrepresentation. The veil was not pierced because of the existence of the alternative remedy of misrepresentation.

Chandler v Cape: the parent company was held to be liable in tort for asbestos-related injuries suffered by the employees of the subsidiary company, since the parent was held to owe a duty of care to the subsidiary’s employees through its control of the subsidiary’s health and safety policy.

Question 22

Following Prest v Petrodel

Answer 22

• piercing the veil may exist as a matter of law but it seems it is extremely rare for the principle to be invoked
• where other routes to infer liability on shareholders are available e.g. tortious liability or the law of trust/agency, which do not ignore the company’s separate legal personality, the courts will infer liability on these principles instead