Piercing the Corporate Veil

It is important to remember that one of the main advantages of forming a company is that it has limited liability- one can only lose what they put in. However, in certain circumstances, the Court will be willing to disregard this separate legal personality of the company and will hold the individuals running the company personally liable.

In the Salomon case, the Court acknowledging that disregarding the separate legal personality of a company was a possibility. Some referred to it as piercing the corporate veil.

Separate legal personality can be disregarded in three ways; by agreement, by the Courts, or by a Statute or act of the Oireachtas

Although the Salomon case laid down a broad principle of segregation of the company from its owners, there are statutory and other qualifications to that principle, especially in regard to wholly owned subsidiaries.

Courts, exercising full and broad discretionary powers afforded to them by the Companies Acts and by other legislation often take full account of the fact that the company in question is owned by particular individuals or groups and treat the company as if it were its actual owner or owners.

Separate legal personality will be disregarded where reckless or fraudulent activity has occurred or if proper books of account are not kept and the court are satisfied that this failure contributed to the company’s downfall. The principle may also be disregarded by virtue of the provisions of the tax acts.

The Court often begins by identifying who controls the company. This need not necessarily be a managing director. Gilford Motor Co v. Horne is an important case in this regard. It gives an example of when courts will treat shareholders and a company as one, in a situation where a company is used as an instrument of fraud. Mr EB Horne was formerly a managing director of the Gilford Motor Co Ltd. His employment contract stipulated (clause 9) not to solicit customers of the company if he were to leave employment of Gilford Motor Co. Mr. Horne was fired, thereafter he set up his own business and undercut Gilford Motor Co's prices. He received legal advice saying that he was probably acting in breach of contract. So he set up a company, JM Horne & Co Ltd, in which his wife and a friend called Mr Howard were the sole shareholders and directors. They took over Horne’s business and continued it. The company had no such agreement with Gilford Motor about not competing, however Gilford Motor brought an action alleging that the company was used as an instrument of fraud to conceal Mr Horne's illegitimate actions. Lord Hanworth of the court of Appeal, granted an injunction, so that Horne was forced to stop competing through the company and stated;

‘’I am quite satisfied that this company was formed as a device, a stratagem, in order to mask the effect carrying on of a business of Mr EB Horne. The purpose of it was to enable him, under what is a cloak or sham, to engage in business which, on consideration of the agreement…’’

In Roundabout v Beirne, a company, Marian Park Inns Ltd operated a pub. Most of the staff of the pub joined a trade union at the same time. The controllers of the company were unwilling to employ unionised staff and so dismissed them all. In response, the union picketed the pub. The controllers of the company then set up a new company, Roundabout Limited, and leased the pub from the Marian Park Inns Limited to it. Three non-union barmen were appointed directors of the new company. The new company could not be classed as an employer because all of the staff were directors therefore it could not be subject to a trade dispute. Roundabout then sought an injunction restraining the strikers from picketing the premises. Dixon J granted the injunction in the High Court stating: • The new company is in law a distinct entity, as is the old company. Each company is what is known as a legal person. I have to regard the two companies as distinct in the same way as I would regard two distinct individuals. I must, therefore, proceed on the basis that a new and different person is now in occupation of the premises and carrying on a business there. It was stated that though this was a legal subterfuge, it was an effective one.

Also, in the case Cummins v. Stewart (1911)  the defendant tried to escape a liability to pay royalties to the plaintiff, under a license agreement, by transferring the licence to another company, formed especially for that purpose. As a consequence, the corporate veil was lifted and Meredith MR concluded: 'It would be strange indeed [if the Companies Acts] could be turned into an engine of destruction of legal obligations and the overthrow of legitimate and enforceable claims.'

The Courts will also take into account equitable principles when deciding whether or not to exercise their discretionary power and pierce the corporate veil. In Re: Bugle Press two shareholders held more than 90% of the issued shares of the company. To get rid of the holder of the remaining shares, they incorporated another company for the purpose of acquiring all the shares of the company. The acquiring company offered to purchase the company’s shares at a proper value. The majority shareholders accepted the offer but it was refused by the minority shareholder. The acquiring company gave notice of intention to exercise the statutory power of compulsory acquisition under the section. The minority shareholder applied that the transferee company was neither entitled nor bound to acquire his shares on the terms offered notwithstanding the approval of 9/10ths of the shareholders. The minority said the offer undervalued his shares. The majority shareholders did not file any evidence verifying their valuation.
Held: The court made the declarations sought. In circumstances where the assenting 90% majority were unconnected with the offeror the normal burden of proof rested on the dissenting minority to show grounds why the court should ‘order otherwise’, but that did not apply where there was a connection between the assenting majority and the offeror, in particular, where the acquiring company was simply the alter ego of the assenting majority.

The Courts will not allow the corporate form to be misused to avoid legal obligation. Jones v Lipman is a case concerning piercing the corporate veil. It exemplifies the principal case in which the veil will be lifted, that is, when a company is used as a "mere facade" concealing the "true facts", which essentially means it is formed to avoid a pre-existing obligation. Mr Lipman contracted to sell a house to Mr Jones for £5,250. He changed his mind and refused to complete. To try and avoid a specific performance order, he conveyed it to a company formed for that purpose alone, which he alone owned and controlled. Justice Russell ordered specific performance against Mr Lipman and the company and stated;

‘’The defendant company is the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity’’

Another exception to the doctrine of separate legal personality is known as the agency exception. The separate legal personality of two companies may be disregarded by the Courts where they decide to infer that an agency relationship exists between the two. The general rule is that a company is not an agent of its shareholders. In the absence of na specific agency agreement. The test for agency was set down in the case of Smith Stone & Knight v. Birmingham Corp by Justice Atkinson. He stated that;

Were the profits treated as profits of the parent?
(b) Were the persons conducting the business appointed by the parent?
(c) Was the parent the head and brain of the trading venture?
(d) Did the parent govern the venture, decide what should be done and what capital should be embarked on the venture?
(e) Did the parent make the profits by its skill and direction?
(f) Was the parent in effectual and constant control?’

Some say that most of Atkinson’s test concentrates the issue of control and that this is too broad a test- and possibly even incorrect. Courtney staets that if such criterion is to be applied to every case in which the day-to-day affairs of the company are controlled by a member, then a significant number of companies may be regarded as agents of their members and the principle of separate legal personality would thus become an exception, rather than a rule.

As a result, Justice Laffoy, in Fyffes plc v DCC plc did not endorse it for this reason, stating that the test was not helpful because if they were all applied the test would be too broad.

However, the Courts are more likely to apply the agency principle where not to do so would facilitate tax avoidance. Justice Keane has stated that in certain cases, where no actual misuse of the privilege of incorporation is involved, the courts may nonetheless infer the existence of an agency... if to do otherwise would lead to injustice or facilitate the avoidance of tax.

In the case of Re FG Films, the company, FG Films made a film called “Monsoon”. The company had no premises except its registered office and no employees. Film Group Incorporated (FGI), an American company was the one who provided the finance and all the facilities necessary to make the film. FG Films sought to have the film registered as a British Film. This is a sham or facade as the company was not the maker of the film. Therefore, the courts are willing to lift the company veil when fairness and justice are demands so that to make FG Films prohibited from enjoying the benefits given by British government as the film was not made by the company themselves, it is just a sham of the Film Group Incorporated (FGI).

It is thought that the Courts might view such a case differently today. The incorporation of limited companies for tax purposes is a reality of commercial life, is within the law and as such is not something to be frowned upon or complained of as a ‘mere travesty of the facts’

Another important case is that of Firestone Tyre and Public co v Llewellyn. An American company formed a wholly-owned subsidiary company in Brentford, England to manufacture and sell its brand of tyres in Europe.  The distributors sent their orders to the subsidiary direct and the orders were met without any consultation with the American company.  The subsidiary received the money for the tyres sold to the distributors and after deducting its manufacturing expenses pus 5 percent, it forwarded the balance of the money to the American company.  All the directors resided in England except one who was the president of American company and they managed the subsidiaries affairs free from day-to-day control by the American company.

It was held that the American company was carrying on business in England through its English subsidiary ‘acting as its agent’ and it was consequently liable to pay UK tax.

The Lords states tat the effect of the agreement between the two companies was to set up standing arrangements whereby Brentford agreed to hold goods of its own at the disposal of Firestone and to sell the same on Firestone’s behalf to customers approved by Firestone and further, to account to Firestone for the proceeds of the sales less the cost of the goods sold plus five per cent.

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The single economic entity approach is one that has caused considerable controversy throughout the years. First enunciated in the 1970s, it was doubted almost straight away, before being abolished in England in the 1990s. The Irish Supreme Court disapproved of it in 1997 but it still exists to some extent in this jurisdiction.

The idea that the corporate veil should be pierced if unfairness would otherwise result was an idea that first formed in DHN Food Distributors Ltd v Tower Hamlets London Borough Council.DHN imported groceries and provision and had a cash and carry grocery business. Its premises are owned by its subsidiary which is called Bronze. It had a warehouse in Malmesbury Road, in Bow, the East End of London. Bronze’s directors were DHN’s. Bronze had no business and the only asset were the premises, of which DHN was the licensee. Another wholly owned subsidiary had the vehicles. In 1970 Tower Hamlets London Borough Council compulsorily acquired the premises to build houses. As a result, DHN had to close down. Compensation was already paid to Bronze, one and a half times the land value. DHN could only get compensation too if it had more than a license interest. The Lands Tribunal held no further compensation was payable. The Court of Appeal held that DHN and Bronze were part of single economic entity. Therefore as if DHN had owned the land itself, it was entitled to compensation for the loss of business. Lord Denning stated that

‘’this group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point. They should not be deprived of compensation which should justly be payable for disturbance. The three companies should, for present purposes, be treated as one.’’

It could be argued that the law was set aside in favour of what was perceived as a fair outcome. Nevertheless, this approach was adopted into Irish law in Power Supermarkets Ltd v Crumlin Investments.

However, the DHN approach was doubted in Woolfson v Strathclyde Regional Council. In this case, A bridal clothing shop at 53-61 St George’s Road was compulsorily purchasedby the Glasgow Corporation. The business in the shop was run by a company called Campbell Ltd. But the shop itself, though all on one floor, was composed of different units of property. Mr Solomon Woolfson owned three units and another company, Solfred Holdings Ltd owned the other two. Mr Woolfson had 999 shares in Campbell Ltd and his wife the other. They had twenty and ten shares respectively in Solfred Ltd. Mr Woolfson and Solfred Ltd claimed compensation together for loss of business after the compulsory purchase, arguing that this situation was analogous to the case of DHN v Tower Hamlets LBC.^[1]

The Land Tribunal denied it on the basis that Campbell Ltd was the sole occupier. Lord Keith upheld the decision of the Scottish Court of Appeal, refusing to follow and doubting DHN v Tower Hamlets BC. He said that DHN was easily distinguishable because Mr Woolfson did not own all the shares in Solfred, as Bronze was wholly owned by DHN, and Campbell had no control at all over the owners of the land. The one situation where the veil could be lifted was whether there are special circumstances indicating that the company is a ‘mere façade concealing the true facts’.

However, in the early 90s, the concept of single economic entity was finally put to rest. Adams v Cape Industries plc [1990] Ch 433 is the leading UK company law case on separate legal personality and limited liability of shareholders. The case also addressed long-standing issues under the English conflict of laws as to when a company would be resident in a foreign jurisdiction such that the English courts would recognise the foreign court's jurisdiction over the company. Cape Industries plc was a UK company, head of a group. Its subsidiaries mined asbestos in South Africa. They shipped it to Texas, where a marketing subsidiary, NAAC, supplied the asbestos to another company in Texas. The employees of that Texas company, NAAC, became ill, with asbestosis. They sued Cape and its subsidiaries in a Texas Court. Cape was joined, who argued there was no jurisdiction to hear the case. Judgment was still entered against Cape for breach of a duty of care in negligence to the employees. The tort victims tried to enforce the judgment in the UK courts. The requirement, under conflict of laws rules, was either that Cape had consented to be subject to Texas jurisdiction (which was clearly not the case) or that it was present in the US. So the question was whether, through the Texas subsidiary, NAAC, Cape Industries plc was ‘present’. For that purpose the claimants had to show in the UK courts that the veil of incorporation could be lifted and the two companies be treated as one.

Scott J held that the parent, Cape Industries plc, could not be held to be present in the United States. The employees appealed.

The Court of Appeal unanimously rejected (1) that Cape should be part of a single economic unit (2) that the subsidiaries were a façade (3) any agency relationship existed on the facts. Slade LJ (for Mustill LJ and Ralph Gibson LJ) began by noting that to ‘the layman at least the distinction between the case where a company itself trades in a foreign country and the case where it trades in a foreign country through a subsidiary, whose activities it has full power to control, may seem a slender one…’ But approving Sir Godfray’s argument, ‘save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon… merely because it considers that justice so requires.’ On the test of the ‘mere façade’, it was emphasised that the motive was relevant whenever such a sham or cloak is alleged, as in Jones v Lipman. A company must be set up to avoid existing obligations, not future and hypothetical obligations which have not yet arisen. The court held that one of Cape's subsidiaries (was in fact a façade, but on the facts this was not a material subsidiary such as to attribute liability to Cape.

This judgement in Cape paved the way for the Irish case of Allied Irish Coal Supplies Ltd. v. Powell Duffryn. This is the leading Irish case in the area. The facts of the case were as follows; the correct defendant had been sued, but the plaintiff soon discovered that they had no funds and so tried to add a related, and less financially challenged company to the proceedings on the basis that they were a single economic entity. Justice Laffoy stated that this was so fundamentally at variance with the Salomon principles that it was wholly unstateable. This approach was accepted by the Supreme Court. However, they did not completely disregard the Single Economic Entity principle which had been set down in Powers Supermarkets case.

Taking all of the above, the following may be said in relation to the whether the Court will pierce the corporate veil. First, they will not do it simply because of who owns the company. It will be necessary to show control, but proof of such will not be enough in itself to justify a piercing. Secondly, the Court cannot pierce the corporate veil merely because to do so would be in the interests of justice. Thirdly, the Courts may only pierce the veil if there is some form of impropriety involved. Finally, it is essential to note that such impropriety alone is not enough but must be connected to the corporate structure.

There is still ambiguity in relation to the idea of single economic entity in Ireland. In Fyffes plc v DCC plc for example, the Court stated that as a matter of law, two companies could be treated as a single entity for the purpose of preventing an injustice. Thus is may still be said that the single economic entity approach exists in Ireland, albeit to a very small degree.

The single economic entity was the treatment applied to a group of companies. They were viewed as a single economic entity because of their aligned interests / members etc. This was mostly done in cases  “where justice requires”. It was very common in the 70s and 80s though once its dangers were recognised, its uses was limited to the grounds identified in the Salomon case.

In Re Polly Peck International Plc Justice Walker said that the Courts must look at legal substance, not economic substance, regardless of any perceived injustice.

There are also statutory provisions in this country which may allow separate legal personality to be disregarded. These mostly come from the Companies Acts 1963-1990 and include several instances which power the court to disregard separate legal personality. Usually the provisions have the affect of making Directors or other officers personally liable although sometimes the owners / members are liable.

Section 297A(1)(a) can render an officer of the company personally liable for debts of the company where he was knowingly a party to reckless trading. Section 297A (1) (b) can result in any person being personally liable for such debts where they are knowingly a party to any fraudulent trading. There is an important distinction to be made between fraudulent and reckless trading.

Reckless Trading can result in the unlimited personal liability of any officer who was knowingly a party to the carrying on of the business of the company in a reckless manner.  While this may sound like a useful tool of the Courts it is seldom used. In the case of Re PSK Construction Ltd ; Kavanagh v Killeen and Higgins [2009] IEHC for example, Justice Finlay Geoghan  rejected argument that a Director  who held junior position in the company had been knowingly a party to carrying on company’s business in reckless manner. It seems that knowledge that the company was involved, on a temporary basis, in tax evasion is not sufficient per se to justify finding of deemed recklessness. An action based on reckless trading therefore is difficult to predict with any degree of certainty.

Fraudulent trading on the other hand, is a far more serious crime and thus is viewed much more harshly by the courts. It can result in unlimited personal responsibility of any person who was knowingly a party to …. With intent to defraud or for  any fraudulent purpose. This is a subjective test and the courts have discretion on who can come under the scope of the term ‘any person’.

 s.251 of the Companies  Act, 1990 allows the Court to assess damages against the Directors. Note that this is only in the case of liquidation of a company.