Lifting the Corporate Veil: Case Law Analysis
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 also led the software writing team that developed the software for Sam. This is not John’s usual role. 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 Ltd has had other financial problems and has recently collapsed insolvent.
This case refers to lifting the corporate veil. It refers to situations where the judiciary or legislature have decided that the separation of the company’s personality and its members’ should not be maintained.
In this case, it is necessary to determine whether John has any liability to Sam or if the legal personality distinction applies.
One clear example where the logic of limited liability is established is Salomon v Salomon. Salomon transferred his boot-making business, initially a sole proprietorship, to a company (Salomon Ltd.), with himself and his family as members. The price was paid to Salomon via shares and debentures with a floating charge (security against debt) on the company’s assets. Later, when the company failed and went into liquidation, Salomon’s right of recovery (secured through the floating charge) against the debentures took priority over unsecured creditors, who recovered nothing.
To avoid this alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors, alleged the company was a sham, essentially Salomon’s agent. Therefore, Salomon, as the principal, was personally liable for its debt. In other words, the liquidator sought to disregard Salomon Ltd.’s separate personality from its member, Salomon, to make Salomon personally liable for the company’s debt as if he continued as a sole trader.
The case concerned claims from unsecured creditors in Salomon Ltd.’s liquidation. Salomon, the majority shareholder, was sought to be held personally liable for the company’s debt. The issue was whether, regardless of the company’s separate legal identity, a shareholder/controller could be held liable for its debt beyond their capital contribution, exposing them to unlimited personal liability.
The Court of Appeal, declaring the company a myth, reasoned Salomon incorporated the company contrary to the true intent of the Companies Act 1862, and that he conducted the business as his agent, therefore responsible for the debt.
The House of Lords reversed this ruling, unanimously holding that, as the company was duly incorporated, it is an independent person with its own rights and liabilities. “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 the “corporate veil” between the company and its owners/controllers was firmly established by Salomon.
In this sense, and considering Salomon, Box Ltd has its own legal personality, independent from John’s.
Since Salomon, courts have frequently applied the principle of separate legal personality in difficult situations. Sometimes they upheld the principle; other times they did not. Attempts to explain when courts lift the veil of incorporation are unsatisfactory. Some texts categorize veil lifting: where the company is an agent, fraud, tax issues, employment issues, or a group of companies exists. While examples exist in all categories, examples also exist where courts uphold the separateness of companies within these categories.
A similar example is Ord v Belhaven Pubs Ltd, a legal action about a lease. During the action, the group structure of which Belhaven Pubs Ltd was part was reorganized due to a financial crisis. Belhaven Pubs Ltd had no assets or liabilities and could not pay a judgment. Ord applied to substitute the parent company. The High Court allowed the substitution; however, the Court of Appeal held the reorganization was legitimate, not a façade to conceal facts. Assets were transferred at full value, and the motive appeared to be the group’s financial crisis, not an ulterior motive.
This illustrates a classic veil-lifting issue: whether the company reorganization was a legitimate business transaction or intended to avoid liability. If intended to avoid liability, according to the façade exception, the veil could be lifted. If the court lifts the veil (not certain, as Adams takes a strict view of the motives needed), liability could flow to the parent company.
In Adams v Cape Industries Plc (1990), the Court of Appeal examined how courts lifted the veil of incorporation and significantly narrowed the circumstances. The case concerned enforcing a foreign judgment in England. The key issue was whether Cape Industries fell under a US court’s jurisdiction and was subject to its judgment. This could only occur if Cape was present in the US jurisdiction or submitted to it.
Until 1979, Cape, an English company, mined and marketed asbestos. Its worldwide marketing subsidiary was Capasco (another English company). It also had a US marketing subsidiary, NAAC, incorporated in Illinois. In 1974, people sued Cape, Capasco, NAAC, and others in Texas for injuries from asbestos. Cape protested the Texas court’s jurisdiction but settled. In 1978, NAAC was closed, and other subsidiaries were formed to reorganize the US business to minimize Cape’s presence for tax and liability reasons.
Between 1978 and 1979, further similar actions were commenced, and default judgments were entered against Cape and Capasco (who denied jurisdiction but didn’t settle). In 1979, Cape sold its asbestos business and had no US assets. Claimants sought to enforce judgments in England where Cape had most of its assets. The issue was whether Cape was present in the US jurisdiction via its subsidiaries. The court could only find this to be the case if it lifted the veil of incorporation, treating the Cape group as a single entity, finding the subsidiaries a mere façade, or that the subsidiaries were agents for Cape. The court exhaustively examined each possibility.
The court examined “single economic unit” cases where group structures were treated as a single entity. It found these cases involved interpreting a statute or document. The court rejected the argument that the Cape group should be treated as one.
The court then considered the “corporate veil” point. This veil-lifting category is exemplified by Jones v Lipman (1962) and was a well-recognised category. The Court of Appeal quoted Lord Keith in Woolfson v Strathclyde Regional Council (1978), describing 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 circumstances, the motives of those behind the alleged façade could be important. The court looked at Cape’s motives in structuring its US business.
The court considered the “agency” argument. This was a straightforward application of agency principles. If the subsidiary was Cape’s agent, acting within its actual or apparent authority, the subsidiary’s actions would bind the parent. However, without an express agency agreement, establishing agency from conduct is difficult. The court found the subsidiaries were independent businesses, free from the parent’s day-to-day control, with no general power to bind the parent. As none of the three veil-lifting categories applied, Cape was not present in the USA through its subsidiaries.
Adams leaves only three circumstances where the veil of incorporation can be lifted:
(i) If the court interprets a statute or document. This exception is qualified; there must be some lack of clarity about a statute or document to 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,” courts may lift the veil.
(iii) The third exception is not really an exception.
Adams significantly narrowed the ability of courts to lift the veil. Gone are the days when the Court of Appeal lifted the veil “to achieve justice irrespective of the legal efficacy of the corporate structure,” as in Re a Company (1985). The rest of the 1990s was largely dominated by the restrictive approach of Adams (e.g., Yukong Lines Ltd of Korea v Rensburg Investments Corpn of Liberia (1998)), apart from one interesting aberration.
Another relevant case is Williams v Natural Life Health Foods Ltd. Williams v Natural Life Health Foods Ltd closely resembles this scenario, except John may have a special relationship with Sam giving rise to liability.
In Williams v Natural Life Health Foods Ltd (1998), the House of Lords emphasized the Salomon principle in a negligent misstatement claim. The managing director of Natural Life Health Foods Ltd (NLHF) was also its majority shareholder. The company sold franchises for retail health food shops. A franchise was sold to the claimant based on a brochure with financial projections. The managing director provided much of the information. The claimant dealt only with an NLHF employee, not the managing director. The claimant entered a franchise agreement but the shop ceased trading after losing money. He sued NLHF for losses from the negligent information. NLHF ceased trading and was dissolved. The claimant sued the managing director and majority shareholder, alleging personal responsibility.
This claim sought to nullify limited liability protection. The House of Lords held that a director or employee 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, creating a special relationship. There was no evidence of personal dealings conveying that the managing director assumed personal liability. However, if the tort is deceit rather than negligence, courts allow personal liability to flow to a director or employee. An officer may also be personally liable for costs if they pursued an action unreasonably or for an ulterior motive. Williams has been influential where commercial torts are at issue.