INTRODUCTION
Company is one of the most viable and successful innovation in law and perhaps the greatest single discovery of modern times[1] because compare with other business organizations[2] which offers unique status to the corporation and its members and also contributes to the economic development of a state.
This paper explores, the doctrine of separate corporate personality which was established in Salomon case[3], how Courts disregard this doctrine under the fraud exception with support of comparative analysis of UK and Sri Lankan jurisdiction and also tries to recommend some solutions to overcome contemporary demerits.
THE DOCTRINE OF SEPARATE CORPORATE PERSONALITY (hereafter the “’DSCP’’)
‘’the fiction of separate corporate personality and the company is the whole foundation of English company and insolvency law’’[4]
The DSCP means upon the incorporation, a company should be treated as a separate juristic person distinct from its shareholders/directors/promoters thereby both natural persons and artificial person have different rights and liabilities, shareholders are not responsible for the company’s obligations.
The rationale behind this doctrine is that, the perpetuity of a company namely the company can survive continuously even in the event of death of the shareholder or transfer of shares. If we compare with a partnership which will be dissolved in the situation of death or bankruptcy of a partner[5].
The DSCP was constructed in the celebrated case of Salomon v Salomon[6] which as being the centre of company law for following cardinal reasons.
House of Lords clarified the effect of registration that DSCP should be applied to all registered companies whether it is a public company or small private company or even a one man company notwithstanding the factual reality of business. Prior to this judgment this doctrine had been applied to only large companies, Courts of first instances also in Salomon case concluded that factually it was a sole trader’s business not a company.
Moreover the court held that debts of the company remained the liability of the company and not its shareholders so Salomon was not liable for the company’s debts, and also recognized that a shareholder can become a creditor of his company furthermore if he is a secured creditor he will has preference over unsecured creditors. In Salomon case Salomon was the debenture holder of Salomon Co ltd thereby court held that he was entitled to claim his money at winding up.
Under the modern company law it is also possible to incorporate a one man company[7] which also enjoys the DSCP.
In Lee v Lee’s Air Farming Ltd[8] deceased was the sole director and shareholder of a limited company, court held that deceased’s wife could claim compensation on the ground that her husband was an employee of his company.
In Macaura v Northern Assurance Co Ltd[9] court held that (sole)shareholder had no insurable interest on company assets. This judgment was based on the Salomon case videlicet, company is a distinct (legal)being which required its own insurance.
This case raised questions regarding ownership of shareholder namely if we ask ‘’who owns the company’’, company law will answer without exception, that it is the shareholder. Macaura can be the sole owner of his company but not the owner of the assets of that company?
Current position is that shareholders are the owners of the company but owners only of title to dividend and voting rights. Thus the ideology of shareholder ownership sits uncomfortably with logic of the DSCP but it allows company law to both promote investor interests and give them the limited liability protection[10].
THE CONCEPT OF LIMITED LIABILITY (hereafter the “’LL’’)
One of the main advantage of the DSCP is LL which is the keystone of the company law. Main objective of the LL is that, attract/induce the traders to initiate new ventures without fear, and also an incentive of the investment of the public.
If a company registered as a limited company shareholders/directors may enjoy LL namely shareholder will not be liable for the company’s debts or any obligation, their liability only limited to their contribution(shares). Even in the insolvent situation of a company the company’s creditors cannot extend their hands to the personal property of the shareholders. Simply LL functions as an asset protection mechanism of the shareholders’ personal properties.
On other hand LL creates injustice to the creditors when collect their money from insolvent company.
JUSTIFICATIONS/ADVANTAGES OF LL
‘’investors might sleep more easily in nights, their rest less frequently disturbed by dreams of bankruptcy and destitution’’[11]
LL, encourages the traders to start the risky ventures(example shipping companies) and ordinary businesses, induces the public to invest their money in companies because their liability is limited by shares no need loss their personal assets.
Above said matters lead to incorporate new companies, through that employments and Gross Domestic Product(GDP) will be increased finally that contributes to the national development.
LL enables the free transfer of shares(absence of the LL nobody want to purchase shares) which increases the efficiency of stock markets. If it is unlimited liability share price would fluctuate.
THE CONCEPT OF CORPORATE VEIL
The legal separateness and LL which creates an artificial veil between the company and its shareholders/directors or holding company and subsidiary company which is known as the corporate veil (a metaphysical veil created by law).
This veil prevent third parties(creditors) to reach shareholders or see behind the veil which functioning as a protecting shield of the personal assets of the shareholders/directors at the time of company’s insolvent liquidation.
LIFTING/PIERCING THE VEIL OF CORPORATE ENITY
‘’treating the rights and liabilities or activities of a company as the rights and liabilities or activities of its shareholders/directors’’[12]
General rule is that the corporate veil does not allow the law to penetrate through in it[13]. Nevertheless when the corporate veil is used by the shareholders/directors, to abuse the corporate personality, to do fraudulent activities, and to evade their liabilities, the court will not hesitate to ignore the privileges provided by the LL then shareholders/directors become personally liable for the obligations of the company which is known as the lifting/piercing corporate veil.
Thus veil lifting is an exceptional rule which is a counter measure to the doctrine of LL.
It is suitable to quote the Griffins argument regarding the different between lifting of veil and totally removing the veil.
“Where the veil is not completely removed, but only lifted, the separate legal existence will subsist but in the cases of group of companies, the veil of subsidiary company may be removed completely, and that will be treated as a division of holding company not as a separate legal entity.’’[14]
Recently in 2013, the judgment of Prest v Petrodel[15] has changed the approach on lifting veil. Many think that the both terms ‘’lifting’’ and ‘’piercing’’ have same meaning but Lord Sumption in Prest case drawed a distinction between those terms through two theories such as,
Concealment theory– when facts of the case being unclear, the court simply lift the veil to ascertain or know informations which were concealed by a company, not for the purpose of imposing personal liability.
Evasion theory– when there is a deliberate wrong doing by shareholders/directors the court use some sort of legal force to pierce through the veil in order to impose personal liability on wrongdoers. There must be a deliberate wrong doing unless court can’t pierce the veil.
Moreover the Prest case has concluded that, the piercing of veil should be a last resort if any alternative remedies are available the court cannot pierce the veil and, the veil may be pierced only to prevent the abuse of DSCP which includes evading legal obligation/liabilities and frustrate its enforcement because Salomon’s principle which enables the court in very limited circumstance to pierce the veil.
To validate the piercing of corporate veil several grounds have been developed by the Courts and statutes.
| Common Law Grounds | Statutory Grounds |
| Public interest Fraud/Façade Group structure For the sake of Justice Agency | Failure to satisfy solvency test Directors’ breach of duty on insolvency Fraudulent trading Failure of directors on allotment of shares |
Moreover, Courts use Alter ago theory(directors’ mind will be treated as the mind of company) to impose liability on corporation, particularly criminal liability and tortious liability.
However, yet there is no common, unifying and clear cut principles to pierce the veil there by it is difficult to predict when the court will lift the veil.
RATIONALE BEHIND THE LIFTING/PIERCING CORPORATE VEIL
This performs as a compensatory function to creditors who could be either voluntary and involuntary(tort) creditors[16].
Prevention of unjust enrichment of the shareholders which is the equitable principle by which one, who has been enriched at the expense of another, whether by mistake or otherwise, is under duty to return what he has received unjustly. This principle will apply when the shareholders have misappropriated corporate assets, hence leaving insufficient assets to satisfy the creditors.
Deterrence for future improper conducts.
PIERCING THE CORPORATE VEIL UNDER FRAUD EXCEPTION
‘’when the conception of corporate entity is employed to defraud creditors, to evade existing obligations, to circumvent a statute, to achieve fraudulent purpose by its shareholders or directors, the courts will disregard the corporate veil and impose personal liability on them’’[17]
Still there is no unambiguous definition to the concept of fraud under the veil lifting/piercing because this term cannot be restricted to a strict definition which depends on the each fact and circumstances of a case thereby courts use several names such as, façade, sham, cloak, puppet and instrument(problem in interpretation).
Why the concept of fraud as being a one ground of pricing/lifting the veil?
To protect the sanctity of the DSCP, namely prevent the protection of the corporate veil to fraudsters who abuse the corporate structure.
To impose personal liability on fraudsters to indemnify the claimant.
VEIL PIERCING/LIFTING IN UK UNDER FRAUD EXCEPTION
UK follow the common law tradition, the judges decide when and how the court will lift/pierce the corporate veil.
Instances where corporate veil has been pierced when a company has been used by a defendant to escape from contractual obligations.
In Gilford Motor Co Ltd v Horne[18], a former employee(director) was bond by a contract not to solicit after he left the company but he founded new company to compete. The court held that new company was mere façade in order to avoid Horn’s obligation.
In Jones v Lipman[19], the court held that new company was formed to transfer the land in order to avoid obligation so it was a sham.
Justice theory and the concept of fraud
Sometimes the court had used the fraud exception in order to achieve justice(primary ground) however recent judgments show that courts have refused to pierce the veil in the interest of justice.
In Re a Company[20] case, the court held that veil could be pierced in order to achieve justice.
Nevertheless in Adams v Cape Industries[21], held that, court can’t simply ignore the DSCP for the reason that justice requires, moreover the finding of a façade is necessary.
Similarly in Re Polly Peck International Plc[22], the holding company raised funds by way of issuing bond with the guarantee that its subsidiary will repay, court refused to lift the veil in the interest of justice.
Recently in Trustor AB v Small bone[23], held that generally courts have no power to lift the veil in the interest of justice further held that mere façade/shame is not sufficient there must be a link between the impropriety and façade.
Requiring mental element and its degree
In Tunstall v Steigmann[24] held that, mere façade was sufficient to lift the veil but which failed to define the term façade.
However in Hilton v Plustile ltd[25] held that, deceptive intention of the defendant is necessary that means defendant must intend to deny a pre-existing legal right of the claimant.
In Kensington International ltd v Republic of Cango[26]the court held that, there must be a dishonesty on the part of the defendant.
In Milliam v Print Factory(London)[27] held that, clear evidence of shame is necessary to pierce the veil.
Recently in Prest v Petrodel[28] Lord Sumption has concluded that,
‘’there is a principle(DSCP) of English law which enables a court in very limited circumstances to pierce the veil. It applies when a person is under an existing legal obligation or liability or legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control’’.
Thus contemporary approach is that, UK Courts require the deliberate wrongdoing(deliberately evade obligations and frustrate corporate personality) with dishonesty and clear evidence to pierce the veil under fraud exception which shows that the Courts are strictly following the DSCP.
VEIL PIERCING/LIFTING IN SRI LANKA UNDER FRAUD EXCEPTION
Current company law[29] of Sri Lanka is entirely based on the New Zealand company law however Sec 3 of Civil ordinance enables the application of the English commercial law into domestic legal system.
The DSCP is enshrined by sec 2(1) of Companies act. Sec 3 defines the concept of LL moreover sec 87 makes the shareholders free from the any act/defaults/obligations of the company. Thus amalgamation of above said sections have reaffirmed the decision of Salomon case.
In Visuvalingam v Liyanage[30] court expressed that,
‘’corporate veil will be lifted when the companies’ conduct is so illegal, so convenient or so much in pursuit of money that it would be unconscionable to not to lift the veil’’
Sri Lankan Courts have made significant judgments in the cases of Parate execution, have lifted the veil to prevent the directors to defraud banks(creditors). However there was no express mention that courts have used the ground of fraud to lift the veil.
In Chellia Raachandran V HNB[31] court held that loan was obtained by the company(borrower) however mortgaged properties were the personal properties of its directors(3rd parties) thereby bank cannot sell that properties by parate execution even the company defaulted to settle the loan. The court applied the DSCP.
It is proper to quote the minority judgment of Shirani Bandaranayake J,
‘’the judiciary is the guardian of the individual liberty, including the economic rights of the individuals, it is mandate to the judges to adopt the broader interpretation to the statutory provisions in order to uphold such rights’’
The recent case of HNB Ltd v Samathapala Jayawardana[32]has overruled the Ramachandran case and the court allowed the bank to sell the mortgaged property of 3rd parties where 3rd party was a director of the debtor company who fully owned and controlled the company for benefit for him in other words court lifted the veil and treated the director’s property as a company’s asset.
Nihal Jayasinghe j concluded that,
‘’the directors cannot hide behind the corporate veil, while being the ‘’alter ego’’ of that company. Although the DSCP has been recognized by the courts since the Salomon case, courts have in appropriate circumstances lifted the veil. In particular, courts have been vigilant not to allow the corporate veil to be used for some illegal/improper purpose or as a device to defraud creditors’’.
The Sri Lankan courts have not stated the clear instances when the veil should be lifted under fraud exception yet because parameter or criteria of the concept of fraud still is in ambiguous position.
Even where there is a clear evidence regarding the fraudulent activities, the courts are reluctant to lift the veil, in Golden key credit card company issue there were clear evidences of fraudulent misrepresentation, concealing and misappropriation on the management board, however the court didn’t give important to lift the veil under fraud exception, unfortunately this case also was filed under FR jurisdiction.
Moreover companies act itself also permit the court to lift the veil under sec 375, if a company has been carried on with intent to defraud creditors or fraudulent purpose when winding up. Defect of this section is that, it can be invoked only at winding up.
This paper suggests that, current approach(requiring the deliberate wrong doing) of UK regards the piercing veil which is suitable to Sri Lanka because Sri Lanka is a developing nation, contribution of the company(LL) is necessary for the economic development. If the courts frequently lift the veil traders and public will reluctant to invest money due to the fear of unlimited liability. But on other hand the Courts have to lift the veil in the situations of grave malpractices.
CONCLUSION AND RECOMMANDATIONS
LL is inevitable to encourage the economic investment which directly contribute to the economic development of the country thereby courts respect the sanctity of the DSCP/LL. But on other hand court should not allow to abuse/misuse the doctrine of LL, however extreme judicial approach towards the veil piercing would eliminate the objectives of LL. Thus where there is a clear deliberate wrongdoing/abuse of the corporate structure, the court can pierce the veil under fraud exception as evidence in Prest case[33].
It is clear that the legislature/judiciary has still not precisely addressed the instances where the veil should be lifted under fraud exception. Legislature should lay down definite parameters of fraud exception.
Some statutory grounds of SL Companies Act are vacuum because they are only invoked at winding up or lack of possibility to impose personal liability, thereby increasing the possibility to impose personal liability on the directors regarding fraudulent activities during the life of the company which will be a message of deterrence to the business community.
To ensure the operations of lawful dealing on the part of directors, Sri Lanka should develop an effective system of corporate governance which will help to promote corporate fairness, transparency and accountability[34].
(Examples) Sec172 of UK companies act provides the clear instances(links) where the directors have to act bonafide in the best interest of the company.
UK Courts broadly interpret the rights of the shareholders (can prevent the fraudulent acts of directors) in the case oppression and mismanagement[35].
Sec 375 of SL companies act provides that, fraudulent trading only can be invoked at winding up, sec 2 provides that, a company can carry/do/undertake any business/transection, in order to regulate fraudulent activities sec 2 may be amended(expressly prevent fraudulent purposes). The courts not only depend on the veil piercing/lifting, may use other principles to make proper decision. (Example) In prest case[36] the court has refused to pierce the veil but has applied the concept of resulting trust for amicable solution.
[1] Roger E.Meiners, et al., Piercing the veil of Limited Liability, 4 Del.J.Corp.L.351.
[2] Partnership and sole trader are not a legal person in law.
[3] (1897) AC 22.
[4] Lord Smption in Prest v Petrodel (2013) 3 WLR.
[5] Sec 33 of Partnership Act 1890.
[6] (1897)AC22.
[7] Sec 4(2) of No 7 of 2007 Companies Act of Sri Lanka.
[8] (1961)AC12.
[9] (1925)AC619.
[10] LETalbot‘’Critical company law’’2008pNo29.
[11] WilliamJ. Reader,’’Reflections on the History and Nature of the Limited Liability’’1982.
[12] Staughton J in (1991)4AER769.
[13] WalterWoon on Company Law(pg62,3rdEdition).
[14] Griffin Stephan,Company Law,3rd,ED2000,pn10.
[15] (2013),3,WLR.
[16] ChengThomas K.,‘Form and substance of the doctrine of piercing the corporate veil’,Vol. 80,No.2,2010,p.530
[17] Maurice Wormser,Piercing the Veil,12,COLUM.L.REV.496,517(1912).
[18] (1993)CH,935.
[19] (1962)1WLR832.
[20] (1985)BCLC333.
[21] (1990)Ch,433.
[22] (1996)2,ALL,ER,433.
[23] (2001),1,WLR,1177.
[24] (1962),2QB,593.
[25] (1988)3,ALL, ERR,1051.
[26] (2006)2,BCLC,296.
[27] (2007)EWCA,Civ,322.
[28](2013),3,WLR.
[29] No7 of 2007 Companies Act.
[30] (1983)SLR,Vol2.
[31] (2006)1,SLR,393.
[32] (2007)1,SLR,169.
[33] Supra.
[34] Expressed by the president of the word bank-J,Wolfensohn.
[35] Lloyd v Casey,(2002),1BCLC454.
[36] Supra.
The Shape of Law 