The Veil Doctrine in Company Law - A Glimpse at how Anglo-Saxon courts apply the principle
by: Forji Amin George
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Doctoral Research Fellow, International law, Kent & Helsinki universities
I- The Veil Doctrine in Company Law
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.[1] In other words, a corporation is a
juristic person that in most instances is legally treated as a person, and
empowered with he 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. [2]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).[3]
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.”[4]
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.[5]
The alter-ego theory considers if there is in distinctive nature of the boundaries between the corporation and its shareholders. [6]
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.[7]
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.[8] 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 it's 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, 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.[9]
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.[10] Evidently, corporations exist in part, in
the first place to shield their shareholders from personal liabilities for the
debts of that corporation.[11]
The concept of limited liability was
invented in
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.[12]
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"[13]
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.[14] In this sense, the
conception of a corporation is analytical and ideological, descriptive and
prescriptive.[15]
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,[16]
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."[17]
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.[18] 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.[19]
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.[20] 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
Anglo-Saxon Jurisdictions
Under Anglo- Saxon jurisdictions, the
doctrine of piercing the veil remains one of the primary method through which
the courts mitigate the strenuous demands of the logical fulfilment 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. [21]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. [22]
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. [23]
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.[24]
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,
[25]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 effecting 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.”[26]
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[27], 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…”[28]
II-The 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)[29]
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.”[30]
Young
J, in Pioneer Concrete Services Ltd v Yelnah Pty Ltd,[31]
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.”[32]
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. [33]
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.[34]
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.”[35]
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”. [36] That claim has
been earlier backed up by Rogers AJA, a year ago in the case of Briggs
v James Hardie & Co Pty[37] 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.”[38]
Another scholar in the person of M. Whincop in his own piece: ‘Overcoming Corporate Law:
Instrumentalism, Pragmatism and the Separate Legal Entity Concept’[39], 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.”[40]
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. [41]
It’s worth
re-iterating that the piercing of the corporate veil remains one of the most
litigated issues in English company law.[42] There are
however a number of general factors 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.[43]
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:
2.2.1Fraud
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.[44] These were the facts in issue in the
case of Re Edelsten ex parte Donnelly,[45] 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 the
VIP 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
About the Author
Amin George Forji
Kastevuorenkuja 3 L 179
02360 Espoo, Finland
amingeorges@yahoo.co.uk
Tel:+358414867079
+358445867079
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