Uncertainty Unravels Nothing: A Comment On The English Interpretation Of `piercing` The Corporate Veil

Limited liability and separate legal personality provide company members security from the company s debts and has contributed to the advancement of commercial relations. The two notions allow shareholders to invest in higher risk developments without being personally liable and encourage them to invest more frequently in different transactions at the same time with adequate security for their personal solvency. However, separate legal personality had given rise to several problems deriving from its abuse, such as the creation of companies for fraudulent purposes, the creation of unsecured creditors and the ability of company members to escape liability in cases of default without redeeming creditors debts. Such abuses led to the realization that limited liability should exist only in situations where shareholders and corporate managers will manage the business with due regard, meaning that the law is in need to provide the appropriate mechanisms for imposing liability when such abuses occur. However, it is still unclear when, and under what circumstances, the courts are willing to `lift`, or `pierce`, the corporate veil and impose liability to any corporate associates.

INCOHERENCE IN VEIL-PIERCING RULES

After Salomon v Salomon (1896), where separate legal personality was recognized as a result of limited liability, the English Courts through the years struggled to develop a coherent basis for ascertaining when the corporate veil should be pierced. The first reported cases concerned whether the veil could be pierced if an individual controls the company so as to impose liability. In Apthorpe v Peter Schoenhofen Brewing Co (1899), Smith LJ stated that a parent company should not be considered distinct from the subsidiary when the heads and brains of the subsidiary s undertakings were the officers of the parent company. However, in Gramophone and Typewriter v Stanley(1908), the Court of Appeal rejected such an argument on the facts of the case, as the subsidiary in question was never regarded in evidence a cloak or a sham to escape liability, or that the parent was carrying on the business under the name of the subsidiary. It is doubtful if these cases have a correct application towards imposing an abuse of the corporate personality because they are regarded to be developed independently from the Salomon ruling as there was no consideration of the case in their reasoning. These decisions though pointed to the direction that an abuse of corporate personality could be found in cases where the company was used as a sham or a cloak to escape liability.

However, it was difficult to ascertain when a company is a sham. In Gilford Motor Co v Horne (1933), a case concerning a company establishment by a trader to evade the effect of a restrictive covenant, Lord Hanwoth held that the company was considered a cloak or a sham, as the company was used by the defendant trader to obtain the advantages of the plaintiff company s customers for his own benefit. Despite the fact that Gilford s principle was conceptually sound, it was regarded to be restricted only in cases where a trader attempts to evade his contractual liabilities by forming a company. Russell J though in Jones v Lipman (1962) applied Gilford s reasoning as a general rule, as His Lordship was of the opinion that the principle was to be applied more forcible in more cases. In Woolfson v Strathclyde (1978) on the other hand, Lord Keith casted his doubts that the sham exception applied in cases where the subsidiary and parent company were regarded a single economic entity, and held that a court will be justified to pierce the veil where it was necessary to give legal effect to the realities of the situation in business, by indicating that the Salomon principle will be set aside in very special circumstances when limited liability was used as a fa ade concealing the individual. However, there was not an indication when exactly the principle is to be disregarded, leaving the exception s application unclear.

Slade LJ tried to resolve this in Adams v Cape (1990). His Lordship identified two grounds where the courts are permitted to pierce the veil. The first was the sham or fa ade ground, which arises when individuals use a company as a device to protect themselves from pre-existing liabilities under a contract, tort or statute. The second ground is the agency , where the company s personality will be disregarded in the exceptional case when a subsidiary is totally under the control of its parent to the extent that the subsidiary cannot be said to be carrying on its own business in distinction from its parent. However, his Lordship stated that the fact that a parent company carries on the business of its group as a de facto single economic entity will not suffice on its own to give rise to an agency relationship, as His Lordship stated that a particular statute or document is needed to justify such an approach.

With this reasoning, His Lordship made the sham exception as the only general basis for piercing the corporate veil. This is understandable practically, as clear definition and minimisation of the range of possible instances of corporate personality abuses upholds the integrity and autonomy of the corporate personality without completely depriving the possibility for the doctrine to be curbed in economically and morally harmful abuses. At the same time, his Lordship, being in favour of solid principles concerning potential subversive considerations regarding fairness and policy, safeguarded the possibility of over-litigation because of the moralisation of veil-piercing. Nevertheless, his Lordship had failed to develop more sophisticated principles that may have been better succeeded when having in consideration socially-accepted standards of commercial morality. His Lordship s reasoning seems to suggest that the outcome of a case related to the abuse of the corporate veil is based on a thin line of winning or losing the case, with the success or failure to be hinged upon the arbitrary, mechanical and morally doubtful test of whether the defendant`s conduct is a dishonest evasion from his liabilities through the making of a sham company, or an opportunistic avoidance of his potential liabilities through a de facto real company.

RECENT DEVELOPMENTS AND PREST V PETRODEL

The uncertainty on the issue attracted the courts attention recently and an attempt was made to clarify veil-piercing rules. In Antonio Gramsci Shipping Corp v Recoletos Ltd (2011), Burton J found that it was arguable that the company controllers could be treated as a party to the contract entered into by the company, even when they are not party to the contract. However, on similar facts, Lord Neuberger in VTB Capital Plc v Nutritek International Corp (2013) rejected such an approach and was of the opinion that even if the court has the capacity to pierce the corporate veil, the courts had no justification to pierce the corporate veil, as such an extension of the principle would be inconsistent with the Salomon principle and the notion of privity of contract. VTBconfirmed that the courts remain reluctant to extend the doctrine s limits, as the veil cannot be pierced in order to make the controller liable on the company`s contract based on the absence of mutual intention for the controller to be bound and on the lack of precedential authority supporting this contention. Lord Neuberger however did not offer a clear test for piercing the corporate veil and declined to resolve whether piercing was to be regarded under common law at all, leaving the issue unresolved once more.

The above abstract situation was sought to be resolved by the Supreme Court in Prest v Petrodel Resources Limited (2013). Firstly, it was considered whether the courts have jurisdiction to pierce the corporate veil. Lord Sumption indicated that most advanced legal systems allow veil-piercing with some limits imposed to govern any likely implications that would undermine corporate personality. His Lordship further stated that this is based on the concept of abuse of rights in cases of corporate fraud. His Lordship held that the corporate veil may be pierced when the company s personality is abused for some wrongdoing by using the principles in English law that provide the same result, such as the principle of honesty in commercial transactions. Furthermore, His Lordship stated that the underlying principle of finding corporate personality abuse is the prevention of abuse where obligations were sought to be deliberately evaded or frustrated. This derives from the principle that fraud unravels everything . Although this principle was approved by the other Lords, it nevertheless requires to look beyond the company to its controller at the outset by already disregarding the corporate personality. The principle will not allow a transaction to be vitiated against the company but to entitle a party to claim to look behind the company. This will assume that the controller s acts are relevant where the corporate personality would mean they are not, leading to the paradox that such acts will only be relevant if the company s personality is first disregarded because without it they will be irrelevant, since the company is party to the transaction. Such a principle is capable of bringing much uncertainty. As it will be shown below, the rule that fraud unravels everything may not be appropriate to apply in several occasions, leading to question whether this is the correct basis for looking at what wrongdoings are abuses of corporate personality.

Secondly, Lord Sumption provided two grounds where the court can pierce the corporate veil. The first is the concealment principle. His Lordship stated that this applies in cases where a party establishes a company to conceal his identity. It was stated that the veil will not be disregarded, as the courts will look behind it to discover what the company really conceals. This was also accepted by Lord Neuberger who stated that concealment cases involve the application of conventional legal principles in a transaction where a company disguised its true nature. Under this then, a number of situations relevant to veil piercing will be considered, including when a company is said to be the alter ego of the controller as it is used in the USA jurisprudence and as it was outlined in the case of Gencor. However, the use of the term concealment might be proved confusing. This is because concealment is not a principle that imposes liability, which leaves cases that might fall under it to be subject to extensive judicial scrutiny, as they may be considered under other applicable rules such as agency rules which impose liability for the controller s relation with the company. The principle thus may be just regarded as a means for the court to determine the real facts of the controller s relationship with the company in order to allow the court to have regard whether the other ground for piercing applies.

The second ground is under the evasion principle, where an individual has a legal right against him which exists independently from the company, but he interposes it in order to use its personality to escape liability. Lord Sumption stated that the court will pierce the veil under this where a person deliberately seeks to evade liability or frustrate the right s legal effect by imposing the company. Nevertheless, the veil will be lifted if two requirements are met. The first is that corporate personality will be disregarded in order to deprive the company or the controller of the advantage that separate legal personality provides when it will be considered necessary. This was identified after His Lordship had considered the cases of Gilford and Jones v Lipman as classic examples on when the application of such an occasion will occur. However, it is difficult to square this reasoning with the recognition that the principle outlined in Gilford might be reasonable on more conventional grounds and the fact that the evasion principle will apply strictly in exceptional circumstances when necessary. This was identified by Lord Neuberger, who was of the opinion that the principle outlined by Lord Sumption might well have been applied in more cases, as it encompasses a broader jurisdiction to lift the veil for many kinds of fraudulent transactions. This restrictive formulation comes at odds with the principle that fraud unravels everything which his Lordship imposed as basis, as such a conclusion substantially minimises the circumstances in which a case might fall under it, which constitutes that even recognising that fraud is an abuse of the corporate personality, the veil will not be pierced if the case will not fall under the exceptional cases that Lord Sumption posed as examples.

The second requirement is that the veil will not be pierced when the facts show other legal relationship between the company and the controller which will make it unnecessary to lift the veil, meaning that the court, after satisfying the strict criterion of evasion, will only pierce the veil when there is no other legal method to provide a remedy. This was drawn from the case of Ben Hashem v Al Shayif [2009], where the court refused to pierce the veil because the claimant could have an alleged claim against the controller in fraud. This requirement has been accepted by Lords Mance, Clarke and Nueberger, and it seems to be consistent with the approaches of other countries as well, such as in South Africa. However, it is questionable whether the authorities used inPrest support this strict reasoning. This is because, Munby J in Ben Hashem stated that the veil-piercing in cases of fraud will occur not when there is no other resort, but when necessity requires to impose liability. This was also the view of Lloyd LJ in the Court of Appeal s decision of VTB Capital, which was rejected by the Supreme Court. His Lordship interpreted Gilford and Jones v Lipman as cases where it was convenient and necessary to make an order against the company directly, allowing them to pierce the corporate veil. Since necessity for the Supreme Court in other cases does not necessarily mean a last-resort remedy, it can be argued that the authorities put in Prestdo not support that the evasion principle should be sought as a matter of last resort. Although justifiable in terms of upholding public policy and safeguarding separate legal personality, this will limit the availability of having a remedy as a result of piercing the corporate veil. Such an approach will result in some peculiarities in further clarifying the principle due to the strictness this test imposed for cases to succeed, and is considered counter to previous practice which suggested that a similar result would have been achieved through the use of a more conventional route to impose liability. What Prest therefore suggested, is that under common law, the courts will pierce the corporate veil in exceptional and rare circumstances.

Therefore, although Prest established that corporate veil piercing should exist, the basis and the grounds to do so remain questionable and problematic. Lords Sumption and Neuberger gave a poor justification for the doctrine s existence that fraud unravels everything due to the reliance on an uncertain course of cases for indicating its existence instead of placing a coherent basis to apply it. In addition, their Lordships, apart from Lord Sumption, were concerned to retain the doctrine as a device to undo wrongdoings in exceptional circumstances where there is no other principle and have not disclosed situations when the principle is appropriate to be applied. It is though questionable whether the doctrine s preservation as such justifies the uncertainty upon which the court continues to build upon. On the other hand, it should be born in mind that any broad opening of the test would be inconsistent with the principle of Salomon ruling. It is on these premises where there has been an argument that the principle should instead be regarded under the established rules of fraudulent misrepresentation and conveyance. However, these instances may not adequately address the problem, as they would not reach all circumstances where company associates use the company mechanism as a way that will offend public policy if there is no actual misrepresentation or false statement that will provide such a conclusion.

What is needed therefore is the creation of a well-settled veil-piercing approach that will respect limited liability as long as company associates manage the business in a financially responsible way. It is suggested that a better approach would be to consider corporate personality and its limitations in the context behind incorporation rather than relying on the principle of fraud. Under this, the courts, when interpreting the company rules related to the separateness of corporate personality, will reach to the conclusion that it is implicit to impose limits on its application. To determine these limits, the idea of abuse is appropriate to possibly establish at least which instances are not regarded as appropriate dealing with the corporate personality. On this basis, the recognition of a limited exception to the corporate personality will be consistent both with the grant of corporate personality and the legislation s objectives of granting limited liability.

UNCERTAINTY UNRAVELLS NOTHING

The principle of piercing the corporate veil plays an integral part towards finding when limited liability and corporate personality should be set aside when they are abused by company controllers. However, the UK Courts implementation on finding specific rules for applying it had created over the years much uncertainty about its correct application. Despite the efforts of the Law Lords in Prest to clarify the principle, its application was established to be fairly restrictive and with no clear requirements as to what constitutes an abuse of corporate personality, leaving again the problem created through the years to be unresolved. A need for clarifying the principle is imperative, as the rule as it currently stands is unreachable and uncertain for subsequent cases outcomes.

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