1.Sam is a customer of Box Ltd, a computer software supplier. John is the managing director and major shareholder of Box Ltd and has always dealt with Sam personally because he was such an important customer. John has also led the software writing team that developed the software for Sam. John does not normally do this. The software supplied to Sam by Box Ltd has caused significant damage to Sam’s business and he is suing Box Ltd for damages amounting to £1 million. Box has had other financial problems and has recently collapsed insolvent.

This case refers to the veil lifting. It refers to the situations where the judiciary or the legislature have decided that the separation of the personality of the company and the members is not to be maintained.

In this concrete case, it would be necessary to determine whether John has any liability before Sam or there is a legal personality distinction.

One clear example where the logic of limited liability is established is Salomon v Salomon. Salomon transferred his business of boot making, initially run as a sole proprietorship, to a company (Salomon Ltd.), incorporated with members comprising of himself and his family. The price for such transfer was paid to Salomon by way of shares, and debentures having a floating charge (security against debt) on the assets of the company. Later, when the company’s business failed and it went into liquidation, Salomon’s right of recovery (secured through floating charge) against the debentures stood a prior to the claims of unsecured creditors, who would, thus, have recovered nothing from the liquidation proceeds.

To avoid such alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors, alleged that the company was sham, was essentially an agent of Salomon, and therefore, Salomon being the principal, was personally liable for its debt. In other words, the liquidator sought to overlook the separate personality of Salomon Ltd., distinct from its member Salomon, so as to make Salomon personally liable for the company’s debt as if he continued to conduct the business as a sole trader.

The case concerned claims of certain unsecured creditors in the liquidation process of Salomon Ltd., a company in which Salomon was the majority shareholder, and accordingly, was sought to be made personally liable for the company’s debt. Hence, the issue was whether, regardless of the separate legal identity of a company, a shareholder/controller could be held liable for its debt, over and above the capital contribution, so as to expose such member to unlimited personal liability.

The Court of Appeal, declaring the company to be a myth, reasoned that Salomon had incorporated the company contrary to the true intent of the then Companies Act, 1862, and that the latter had conducted the business as an agent of Salomon, who should, therefore, be responsible for the debt incurred in the course of such agency.

The House of Lords, however, upon appeal, reversed the above ruling, and unanimously held that, as the company was duly incorporated, it is an independent person with its rights and liabilities appropriate to itself, and that “the motives of those who took part in the promotion of the company are absolutely irrelevant in discussing what those rights and liabilities are”. Thus, the legal fiction of “corporate veil” between the company and its owners/controllers was firmly created by the Salomon case.

In this sense, and taking into account Salomon’s case, we could affirm that Box Ltd has its own legal personality, independent from John’s.

Since the Salomon decision the courts have often been called upon to apply the principle of separate legal personality in what might be called difficult situations. In some cases they have upheld the principle and in others they did not. Over this time various attempts have been made at providing explanations for when the courts will lift the veil of incorporation; none however are really satisfactory. Some texts attempt to explain veil lifting by categories: where the company is an agent of another, where there is fraud, or tax issues, or employment issues or a group of companies exists the courts will lift the veil. While it is possible to find examples of veil lifting in all these categories it is also possible to find examples of the courts upholding the separateness of companies in these categories.

A very similar example as the one we are discussing is Ordand Belhaven Pubs Ltd which was engaged in a legal action about a lease. During the course of the action the group structure of which Belhaven Pubs Ltd was a part was reorganised because of a financial crisis within the group. As a result of the reorganisation Belhaven Pubs Ltd had no assets or liabilities and would therefore have nothing with which to pay any judgment against it. As the litigation regarding the lease was still continuing Ord applied to have the parent company of Belhaven Pubs Ltd substituted. The High Court judge who first heard the case allowed the substitution. The Court of Appeal however took the view that the reorganisation of the group was legitimate and not merely a façade to conceal the true facts. The assets were transferred at full value and the motive appeared to be the group’s financial crisis rather than any ulterior motive.

This is an illustration of a classic veil-lifting issue, that of whether the reorganisation of the company was a legitimate business transaction or the motive was to avoid liability. If the motive was to avoid liability then according to the façade exception there was the possibility of lifting the veil. If the court takes the view that the veil should be lifted (and this is by no means certain as Adams takes a very strict view of the types of motives needed) then liability can flow to the parent company.

In Adams v Cape Industries Plc(1990) the Court of Appeal took the opportunity to examine at great length the way the courts have lifted the veil of incorporation in the past and narrowed significantly the way in which the courts could do so in the future. The case concerned the enforcement of a foreign judgment in England. The key issue for the Court was whether Cape Industries could be regarded as falling under the jurisdiction of a US court and therefore be subject to its judgment. This could only occur if Cape was present within the US jurisdiction or had submitted to such jurisdiction.

Until 1979, Cape, an English company, mined and marketed asbestos. Its world-wide marketing subsidiary was another English company, named Capasco. It also had a US marketing subsidiary incorporated in Illinois, named NAAC. In 1974, some 462 people sued Cape, Capasco, NAAC and others in Texas, for personal injuries arising from the installation of asbestos in a factory. Cape protested at the time that the Texas court had no jurisdiction over it but in the end it settled the action. In 1978, NAAC was closed down by Cape and other subsidiaries were formed with the express purpose of reorganising the business in the USA to minimise Cape’s presence there for taxation and other liability issues.

Between 1978 and 1979, a further 206 similar actions were commenced and default judgments were entered against Cape and Capasco (who again denied they were subject to the jurisdiction of the court but this time did not settle). In 1979 Cape sold its asbestos mining and marketing business and therefore had no assets in the USA. The claimants thus sought to enforce the judgments in England where Cape had most of its assets. At issue in the case was whether Cape was present in the US jurisdiction by virtue of its US subsidiaries. The only way that could be the case in the court’s view was if it lifted the veil of incorporation, either treating the Cape group as one single entity, or finding the subsidiaries were a mere façade or that the subsidiaries were agents for Cape. The court exhaustively examined each possibility.

The court first examined the major ‘single economic unit’ cases where group structures were treated as being a single entity. It found that the cases all involved the interpretation of a statute or a document. The court therefore rejected the argument that the Cape group should be treated as one.

The court then turned to what they termed the ‘corporate veil’ point. This category of veil lifting is exemplified by the case of Jones v Lipman (1962, above) and was, in the court’s view, a well-recognised veil lifting category. The Court of Appeal quoted with approval the words of Lord Keith in Woolfson v Strathclyde Regional Council (1978) where he described this exception as ‘the principle that it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere façade concealing the true facts’. In these special circumstances the motives of those behind the alleged façade could be very important. The court looked at the motives of Cape in structuring its US business through its various subsidiaries.

The court then considered the ‘agency’ argument. This was a straightforward application of agency principle. If it could be established that the subsidiary was Cape’s agent and acting within its actual or apparent authority then the actions of the subsidiary would bind the parent. However, if there is no express agency agreement between the subsidiary and the parent, establishing such an agency from their conduct is very hard to achieve. The court found that the subsidiaries were independent businesses free from the day-to-day control of the parent with no general power to bind the parent. Thus as none of the three veil-lifting categories applied Cape was not present in the USA through its subsidiaries.

The judgment of the Court of Appeal in Adams leaves only three circumstances in which the veil of incorporation can be lifted:

(i)if the court is interpreting a statute or document. This exception to maintaining corporate personality is qualified by the fact that there has first to be some lack of clarity about a statute or document which would allow the court to treat a group as a single entity.

(ii)Where ‘special circumstances exist indicating that it is a mere façade concealing the true facts’ the courts may lift the veil of incorporation.

(iii)The third exception is not really an exception to the Salomon principle but rather a straightforward application of agency principle. Therefore, the question is just the same as it would be for two human beings ‘have they entered into an express agency agreement or could an agency be implied from their conduct?’ Parent companies and their subsidiaries are unlikely to have express agency agreements. They are even less likely to have express agreements if avoidance of liability was the reason for setting the subsidiary up in the first place, as it was in Adams. Proving an implied agency will also be very difficult as Adams sets the bar very high. An implied agency would need evidence that day-to-day control was being exercised over the subsidiary by the parent.

As you can see from the above, Adams significantly narrowed the ability of the courts to lift the veil of incorporation. Gone are the wild and crazy days when the Court of Appeal would lift the veil ‘to achieve justice irrespective of the legal efficacy of the corporate structure’ as it did in Re a Company (1985). The rest of the 1990s was largely dominated by the restrictive approach of Adams (for example see Yukong Lines Ltd of Korea v Rensburg Investments Corpn of Liberia (1998)) apart from one interesting aberration which we now turn to examine.

Another relevant case in order to understand Sam’s position is Williams v Natural Life Health Foods Ltd. The key case of Williams v Natural Life Health Foods Ltd closely resembles this scenario except that in this exam question John may have a special relationship with Sam that gives rise to liability.

In Williams v Natural Life Health Foods Ltd (1998) the House of Lords emphasised the Salomon principle in the context of a negligent misstatement claim. The managing director of Natural Life Health Foods Ltd (NLHF) was also its majority shareholder. The company’s business was selling franchises to run retail health food shops. One such franchise had been sold to the claimant on the basis of a brochure which including detailed financial projections. The managing director had provided much of the information for the brochure. The claimant had not dealt with the managing director but only with an employee of NLHF. The claimant entered into a franchise agreement with NLHF but the franchised shop ceased trading after losing a substantial amount of money. He subsequently brought an action against NLHF for losses suffered as a result of its negligent information contained in the brochure. NLHF subsequently ceased to trade and was dissolved. The claimant then continued the action against the managing director and majority shareholder alone, alleging he had assumed a personal responsibility towards the claimant.

The reality of this claim was to try to nullify the protection offered by limited liability. The House of Lords considered that a director or employee of a company could only be personally liable for negligent misstatement if there was reasonable reliance by the claimant on an assumption of personal responsibility by the director so as to create a special relationship between them. There was no evidence in the present case that there had been any personal dealings which could have conveyed to the claimant that the managing director was prepared to assume personal liability for the franchise agreement. However, if the tort is deceit rather than negligence the courts will allow personal liability to flow to a director or employee. An officer of the company may also be personally liable for costs if they pursued an action unreasonably or for an ulterior motive. The Williams case has subsequently been influential where commercial torts are at issue.