Week 2 Legal Personality & Limited Liability

What did Viscount Haldane LC state about companies in Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705 p713?

- ' a company is an abstraction. It has no mind of its own any more than it has a body of its own...'

What is the doctrine of 'piercing' or 'lifting' the corporate veil?

- 'Piercing' (also referred to as 'lifting') the corporate veil refers to situations in which the courts may go behind the corporate framework and the company's separate legal personality to make the shareholders of a company liable. - This is an exception to the rule that shareholders' liability is limited to any unpaid amount owing on their shares.

What is meant when we say that a company has a separate legal personality?

- A company is a legal entity that is distinct from its owners - the shareholders - as well as from its directors, creditors and employees. - It has a separate legal personality. - The concept of separate corporate personality and the related issue of limited liability are fundamental to company law. - Directors, in general, owe their duties to the company, not to the shareholders. - Shareholders usually have rights against the company, rather than against the directors, and 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 and/or directors change.

What problems might creditors encounter regarding small private companies?

- Creditors of companies and claimants in court actions risk being unable 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 represent the current position. - Small private companies' accounts do not give much information.

What do sections 59 and 60 of the CA 2006 specify?

- Creditors will be aware that they are contracting with a limited company as the requirements of s 59 and s 60 CA 2006 are that all company names must end with 'Ltd' (for private limited companies) or 'Plc' (for public limited companies).

How can creditors check the financial viability of a company?

- Creditors will be aware that they are contracting with a limited company as the requirements of s 59 and s 60 CA 2006 are that all company names must end with 'Ltd' (for private limited companies) or 'Plc' (for public limited companies). - Creditors are therefore on notice and also have the opportunity of assessing the financial viability of a company by checking the publicly filed documents at Companies House.

What does Section 74 of the Insolvency Act 1986 state?

- Enshrines the concept of limited liability - Confirming that the shareholders of a limited company are, generally speaking, not liable to a liquidator in the event of the company's insolvency. - Note that it is possible to incorporate unlimited companies and also there are limits to the doctrine of limited liability.

What do directors do?

- Have day to day control of the company under Model Article 3. - As a company is inanimate, it must act through human beings.

If a company becomes insolvent, what happens to shareholders?

- If their company becomes insolvent, shareholders will be liable to lose the money that they have invested in subscribing for the company's shares. - If applicable, they are also liable to make payment for any shares they have not fully paid for, but that is the extent of their liability.

Explain how single economic entity might allow the lifting of the veil.

- It is now established that parent companies are NOT liable for their subsidiaries other than in specific statutory circumstances - There have been arguments before the courts concerning group structures, where claimants have sought to make parent companies liable for the debts or obligations of their subsidiaries. - However, it is now clear in the case law that the single economic entity argument is not a basis for piercing the corporate veil.

What is the significance of limited liability?

- Limited liability is the quality that has caused companies to become such useful commercial tools. - The personal assets of shareholders are entirely separate from the assets of the company.

What are the key facts of Salomon v A Salomon & Co Ltd [1897] AC 22?

- Mr Salomon (S) was a sole trader who specialised in manufacturing leather boots. - For many years he ran his business as a sole proprietor. - In 1892 S decided to incorporate his business as a limited company, A. Salomon & Co. Ltd (the 'Salomon Company') and sell the sole trader business to the Salomon Company for almost £39,000. - S was paid £9,000 in cash, £20,000 in shares and £10,000 by way of debenture for the business. - At this time incorporation was governed by the provisions of the Companies Act 1862, which required that at least seven people subscribe as shareholders of a company. - The incorporation satisfied these requirements. - The members were S, his wife, daughter and four sons. Each had one share. The family did not have any formal or active role in running the business. From the outset, S was a shareholder, director and creditor. Following incorporation there was a decline in boot sales, in part as a result of strikes which forced the government (a major customer) to cancel some contracts. - The company ran into financial difficulty and S sold his debenture for £5,000 to Mr Broderip (B). - The company then went into insolvent liquidation and B therefore could not enforce the full extent of his debenture against the company due to a lack of funds. - B therefore brought a claim against S claiming that he was personally liable to B. - The company went into liquidation and the liquidator took over the litigation before the House of Lords on behalf of the creditors collectively, seeking to dispute the validity of the debentures. - The Salomon case was appealed. At first instance and at the Court of Appeal, it was held that S was liable to B, but for different reasons.

Explain how tort links to the lifting of the corporate veil.

- 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 corporate veil.

What is the concept of limited liability fundamental to ?

- Passive investment - shareholders can invest in a company following an assessment of the risks of losing that investment, knowing that the rest of their personal assets are safe and without having to take an active role in management - Why many entrepreneurs seek to conduct business through the medium of a limited liability company - 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 creditors of the riskier companies.

What do shareholders do?

- Pay for their shares and are entitled to profits (dividends) dependent on their shareholding but have no entitlement to the company's property. - Shareholders "own" the company but do not have day to day control.

Prior to the Supreme Court decision in Prest v Petrodel, what was the case law regarding the doctrine of piercing the corporate veil?

- Prior to the Supreme Court decision in Prest v Petrodel Resources Ltd (see below), there was some uncertainty and inconsistency in the case law and even as to whether the doctrine of piercing the corporate veil in fact existed. - The Supreme Court in Petrodel however clarified that the doctrine does exist and can be invoked on public policy grounds but in extremely narrow circumstances where there is no alternative remedy. - Although there are past cases where members have been found liable, all of these can in fact be explained on general legal principles without the need for the corporate veil to be pierced. - Following Petrodel, the law is clearer. - The court may pierce the corporate veil only where a person under an existing legal obligation or restriction deliberately evades or frustrates that obligation or restriction by setting up a company. Historical development - Historically, prior to Petrodel, there was a lack of coherence in the case law as to whether and when the court can look behind the corporate veil. - What is clear, however, is that the ability of the courts to look behind the corporate veil has always been a very narrow jurisdiction, and used sparingly so as to maintain certainty and respect the principle of separate legal personality encapsulated in Salomon. - Even when the courts have concluded that the corporate veil should be pierced, the members have been found liable only to the extent required to right the wrong.

What does Section 16 of CA 2006 confirm?

- Section 16 CA 2006 confirms that a company comes into existence as a separate legal person on the date of incorporation (date of issue of certificate of incorporation). ​

Section 16 CA 2006: What does this section state?

- Sets out clearly that a company becomes a body corporate (so a legal person) capable of exercising the functions of an incorporated company from the date of incorporation (the date on which the Registrar issues the certificate of incorporation). - From this date, the company has its own existence and personality.

Do shareholders have limited liability?

- Shareholders have limited liability. Their liability is limited to the amount of their shares even when a shareholder in reality is the controlling mind of the company (eg sole shareholder and sole director).

What is the social justification for limited liability?

- The justification behind limited liability is that it encourages investment and encourages businesses to take risks, which generates money and therefore benefits the wider community.

What does it mean when we say that a company's liability is limited?

- The liability of shareholders to pay debts incurred by the company is limited. - This means that shareholders are not liable to pay debts which the company owes to its creditors because it is the obligation of the company (usually through a contract) to pay its creditors. - So the creditors to whom the company owes money must claim against the company. - If the company has insufficient funds to meet its liabilities, creditors cannot pursue their claims against the shareholders.

How might statutes or statutory examples allow the members of a company to become liable in certain situations?

- There are a number of instances in which statutes allow the members of a company to become liable in certain situations. - These are not examples of piercing the corporate veil, rather they are instances in which those behind a company can be treated by statute as liable in specific circumstances.

What are the consequences that follow from the fact that a company is an independent legal person?

1) Company can own its own property 2) Company enters into own contracts 3) Company sues and is sued on its own liabilities

What two principles did Lord Sumption highlight in Prest v Petrodel?

1) Concealment principle This doesn't involve piercing the corporate 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 (1933) Ch 935. Lord Sumption concluded that the corporate veil can only be pierced to prevent the abuse of corporate legal personality where someone deliberately frustrates the enforcement of an alternative remedy by putting a company into place. He stated: "I conclude that there is a limited principle of English law which applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. 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." If there is another legal remedy then piercing corporate veil will not be necessary or available. In Prest there was no impropriety in the company holding the properties for tax purposes so piercing the corporate veil was not necessary. However, he held that the properties were held by the company on trust for husband as beneficiary, so an order was made for the sale of the property and for the money to be given to the wife. The Supreme Court in Prest confirmed that piercing the veil may exist as a matter of law but it seems that it would be extremely rare that the principle will be invoked. The Supreme Court reviewed the historic cases where the courts had pierced the veil and stated that in each case, liability could in fact be established under general principles without the need for the corporate veil to be lifted. In summary, where other routes to infer liability on shareholders are available, such as tortious liability or the law of trust or agency, which do not ignore the company's separate legal person, the courts will infer liability on these principles.

What are three statutory categories of when the members of a company can be liable?

1) Taxation - tax legislation recognises that group structures need to be treated differently for disclosure and financial reporting purposes e.g. s 399 CA 2006 requires parent companies to produce group accounts and s 409 requires parent companies to provide details of the names of subsidiaries and the shares they hold in a subsidiary. 2) Employment - the Employment Rights Act 1996 protects employees' statutory rights when transferred from one company to another within a group, maintaining continuity of employment. 3) Corporate insolvency - s 213 - 215 Insolvency Act 1986 provide offences of fraudulent trading and wrongful trading where those involved in a company may in certain circumstances be liable to contribute to the debts of an insolvent company.

What is meant when we say that a company owns its own property? Give the case authority.

1. The company owns its own property - The property of a company belongs to the company itself and not to the shareholders. Macaura v Northern Assurance Co [1925] AC 619 - Macaura (M) was the owner of the Killymoon estate in County Tyrone, Ireland. - He sold the whole of the timber on the estate to a company which he set up, in consideration of the allotment to him of 42,000 fully paid £1 shares. - M and his nominees owned all the shares in the company, and M was also a creditor of the company in the amount of £19,000. - M took out insurance policies in his own name with Northern Assurance Co, covering the timber against fire. - Two weeks later a fire destroyed almost all the timber. - M brought a claim on the insurance policy. - The House of Lords held that the timber 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.

What is meant by saying that a company enters into its own contracts? Give the case authority.

2. The company enters into its own contracts - A company enters into contracts on its own behalf and the benefits and liabilities under the contract belong to the company, not to the shareholders or directors. - This is true even where the contract is between the company and its sole director and shareholder. Lee v Lee's Air Farming Ltd [1961] AC 12 (Privy Council) - Mr Lee (L) incorporated Lee's Air Farming Ltd in New Zealand in 1954. - The nominal capital of the company was £3,000 divided into 3,000 shares of £1 each. L held 2,999 shares and the final share was held by a solicitor (as the New Zealand legislation at the time required companies to have two shareholders). - L was also the sole director of the company and was appointed as an employee (the chief pilot) in the company's articles. - In 1956 L was killed in a plane crash whilst working, leaving a widow and four infant children. - L's widow brought a claim under the Workers' Compensation Act 1922. - The Privy Council found that the company and L were distinct legal entities and therefore L under his contract of employment was a 'worker' as defined under the Act. - The widow therefore was entitled to compensation and it was irrelevant that L was also the vast majority shareholder and sole director.

What is meant when we say that a company sues and is sued on its own liabilites? Give the case authority.

3. The company sues and is sued on its own liabilities Adams v Cape Industries plc [1990] Ch 433 (Court of Appeal) - Cape, an English company, was the parent company of a group of wholly owned subsidiaries, some of which mined asbestos in South Africa and others marketed the asbestos in other countries, including the US. - The employees of the Texas subsidiary company NAAC became ill with asbestosis and sued Cape and NAAC in the Texas court. - Judgment was entered for breach of duty of care. - The issue before the Court of Appeal was whether the judgment could be enforced against the much wealthier parent company, Cape, in the English court, since Cape's assets were all based in England. - NAAC had by that time been closed down by Cape. T - he requirement for this was either that Cape consented to the Texas jurisdiction (which it did not) or that Cape was 'present' in the US in Texas. - The claimants argued a) that Cape and its subsidiaries should be treated as a single economic unit b) that the subsidiaries were used as a façade concealing the true facts and that c) an agency relationship existed between Cape and NAAC. - The Court of Appeal rejected all these arguments and held that the judgment could not be enforced against Cape. Note that this case was a leading authority on 'piercing the corporate veil' prior to the 2013 case of Prest v Petrodel.

How does Adams v Cape Industries relate to tort?

Adams v Cape Industries PLC [1990] Ch 433: you will be familiar with the facts of this case from the previous element. As you know, in this case the Court of Appeal refused to allow the corporate veil to be lifted to allow the judgment to be enforced against the parent company.

What were the key contrasts between Adams v Cape Industries PLC [1990] Ch 433 and Chandler v Cape plc [2012] EWCA 525 CA?

Adams v Cape Industries PLC [1990] Ch 433: you will be familiar with the facts of this case from the previous element. As you know, in this case the Court of Appeal refused to allow the corporate veil to be lifted to allow the judgment to be enforced against the parent company. However, in the related case of Chandler v Cape plc [2012] EWCA 525 CA, the parent company was held to be liable in tort for asbestos related injuries suffered by the employees of the foreign subsidiary company, since the parent was held to owe a duty of care to the subsidiary's employees through its control over the subsidiary's health and safety policy. It was held that four conditions were needed for such liability: a) both companies were in the same line of business, b) the parent company had much experience in the industry and superior knowledge of health and safety, c) the subsidiary's system of work was unsafe and the parent company knew this, and d) the parent company ought to have foreseen that the subsidiary and its employees would rely on the parent company's superior knowledge for protection. Clearly such liability will be very rarely established in practice.

What happened in Adams v Cape Industries PLC [1990] Ch 433 relating to single economic entity?

Adams v Cape Industries PLC [1990] Ch 433: you will be familiar with the facts of this case from the previous element. The Court of Appeal here refused to allow the corporate veil to be lifted to allow the judgment to be enforced against the parent company. A consequence of the separate legal entity principle is that enterprises may purposely use company group structures to place more risky ventures / liability in (foreign) subsidiary companies removed from the parent company, as was the case here.

What happened in DHN Food Distributors Ltd v Tower Hamlets [1976] 1 WLR 852 relating to single economic entity?

DHN Food Distributors Ltd v Tower Hamlets [1976] 1 WLR 852: Denning LJ held that group of companies is a single economic unit and should be treated as such.

What happened in Gilford Motor Co Ltd v Horne (1933) Ch 935 relating to facade/sham?

Gilford Motor Co Ltd v Horne (1933) Ch 935: a former employee who was bound by a restrictive convenant not to solicit customers from his former employers set up a company to do so. The court held that the company was merely a front or sham and issued an injunction preventing trading.

What happened in Jones v Lipman [1962] 1 WLR 832 relating to facade/sham?

Jones v Lipman [1962] 1 WLR 832: L had entered into a contract with J for the sale of land, but later changed his mind and did not want to complete the sale. He formed a company in order to avoid the transaction and transferred the land to the company, claiming that he could not 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. Jones had to procure that the company would be sold to Lipman - court injunction/specific performance.

Explain how agency might allow the lifting of the veil.

Liability based on law of agency not lifting corporate veil - Although it is possible that the company may act as an agent for its parent company or shareholder and therefore the parent company or shareholder may be found liable on this basis, there is no presumption that this is the case. - Cases will turn on their facts and are based on the common law of agency, not the doctrine of lifting the corporate veil. - A company has the power to act as an agent for its parent company or its individual shareholders if authorised. - However, there is no presumption that this is the case and in the absence of express agreement, it is very difficult to establish liability of the shareholder or parent on this basis. - Even where such liability has been established, the argument in these cases is based on the law of agency and therefore is not a true example of a situation in which the court has ordered the piercing of the corporate veil. - The House of Lords judgment in Salomon considered and expressly disregarded this ground on the facts of that case.

How many directors are needed to form a private limited company under the CA 2006?

One

What were the key facts of Prest v Petrodel Resources Ltd [2013] 2 AC 415?

Prest v Petrodel Resources Ltd [2013] 2 AC 415 Facts: - This was a family law case concerning distribution of assets on a divorce. - The husband wholly owned and controlled a group of companies which owned a number of residential properties worth over £50 million, including the matrimonial home. The wife sought an order to transfer the properties to her on the basis that they were held by the companies on trust for her husband. - Lord Sumption gave the leading judgment in the Supreme Court. He started off by affirming the key principle in Salomon, that a company is a legal entity distinct from its shareholders and its property belongs to the company, not to the shareholders. He went on to discuss that the concept of piercing the veil refers to a true exception to the law in Salomon, where the court will look behind the separate legal personality of a company to hold its shareholders liable.

What was the significance of Salomon v Salomon?

Significance: - Following this judgment, it is clear that a company is a separate person and not the agent or trustee of its controller. - The fact that some shareholders 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.

Have subsequent cases followed the principle in Prest v Petrodel?

Subsequent cases have followed the principle in Prest eg Antonio Gramsci Shipping Corpn v Recoletos Ltd [2013] EWCA Civ 730. In this case a company had entered into a contract containing an exclusive English jurisdiction clause. The Court of Appeal, following Prest, held that the corporate veil could not be pierced to regard the company's controller as having consented to the jurisdiction of the English courts on this basis.

What three broad categories of the cases up to 2013 relating to piercing the corporate veil are there?

The cases up to 2013 can be divided into three broad categories: 1) Application of statute 2) Common law 3) Application of a contractual term (intention of parties - rare). We will not consider this category further

What was the decision of the Court of Appeal in Salomon v Salomon?

The decision of the Court of Appeal - Lindley LJ: the company as a trustee for S as beneficiary - a trustee improperly brought into existence. Due to the requirements of the legislature not being complied with (ie 7 active members) the company was created for an illegitimate purpose. It must therefore follow that the company did not exist.

What was the decision of the High Court in Salomon v Salomon?

The decision of the High Court - Vaughan Williams J: agent-principal analysis (the company was an agent of S) with S being required to indemnify the company for the losses sustained.

What was the decision of the House of Lords in Salomon v Salomon?

The decision of the House of Lords - Lord Macnaghten delivered the leading judgment, but all were in agreement that a literal interpretation of the Companies Act 1862 should be used and as such the company was validly incorporated and therefore had a separate legal personality. - S was liable neither to the Salomon Company nor to creditors of the Salomon Company. The debentures were validly issued. - The House of Lords noted that after registration of a company, although the business may be the same as before and the same hands receiving profits, in law the company is not an agent of the subscribers or members. - Once the memorandum is signed and registered correctly the company 'attains maturity on its birth'. - He stated that there is nothing in the Act requiring the shareholders to be independent or unconnected. - From the moment it is incorporated the company is at law a separate legal entity and not the agent of the subscribers or trustee for them.

Explain how facade or sham might allow the lifting of the veil.

There are a number of cases which have been determined on the basis of this principle, some of which are set out below. - Company - a deliberately created façade - Shareholder - liable

In Common Law, what are the 4 categories of cases which the court has been requested to allow the lifting of the veil for?

There is little consistency in the case law prior to 2013 and many commentators disagree about the correct interpretation of the cases. However, the cases in which the court has been requested to allow the lifting of the veil can be categorised as follows: 1) Façade or sham 2) Single economic entity 3) Agency 4) Tort

What happened in Trustor AB v Smallbone (No 2) [2001] 2 BCLC relating to facade/sham?

Trustor AB v Smallbone (No 2) [2001] 2 BCLC: S was the former managing director of T and had transferred various sums of money (approximately £20m) to a company he owned and controlled. T applied to the court to pierce the corporate veil and treat receipt by the second company as receipt by S on the grounds that the company had been a sham created to facilitate the transfer of money in breach of duty, the company had been involved in the improper acts and that the interests of justice demanded this result. The court found here that the company was indeed a sham and the device through which the impropriety was conducted and therefore, because of this improper motive, the court could lift the veil and find S liable.

What happened in VTB Capital plc v Nutritek International Corp and others [2013] UKSC 5 relating to tort?

VTB Capital plc v Nutritek International Corp and others [2013] UKSC 5: The claimant (VTB) lent Russagroprom LLC (RAP) money to fund the acquisition of six Russian dairy plants and three associated companies from the first defendant (Nutritek). RAP defaulted on the loan. VTB claimed it only lent the money on the basis of misrepresentations made by Nutritek for which the other defendants were jointly liable. It claimed that RAP was in fact under the control of the defendants and that once the corporate veil was pierced, the defendants could be seen to have been parties to the contract, on the agency argument. This was rejected by the court. In this case the court left open the question of whether there exists any principled basis on which courts can pierce the veil, but refused to pierce the veil in this case, as it found that VTB could claim damages against the other defendants on the basis of the tort of fraudulent misrepresentation. The veil was not pierced in this cacse because of the existence of the alternative remedy in misrepresentation. The issue of whether there is a principled basis for piercing the veil was tackled shortly after by the Supreme Court in the case of Prest v Petrodel

What happened in Woolfson v Strathclyde Regional Council [1978] SLT 159 relating to single economic entity?

Woolfson v Strathclyde Regional Council [1978] SLT 159: The House of Lords doubted Denning's decision in DHN and held that 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.

Will a private limited company continue to exist if directors or shareholders change?

Yes