The concept “Lifting the veil of incorporation” essay
By using real life examples, discuss and explain why the concept of «Lifting the Veil of Incorporation» is of imperative importance.
Legal entity is separate, independent from its founders (the ability to own property, enter into commitments and act as a plaintiff, defendant in court). Immanent feature of independent nature of the legal entity defines limited liability of its founders: they are not liable for the obligations of a legal entity (ie, under the “veil”). Development and complication of civil law led to the need of development of a list of exceptions to this principle, mainly to counteract the abuse of law. This doctrine is known as the doctrine of “lifting the veil of incorporation” or “piercing the veil of incorporation” and is present in the corporate law of many countries, including France, Germany, the UK and the USA. English law is one of the most developed in this sphere. Basic principles of the independence of the legal person were laid at the end of 19th century and since then they have been constantly actively developed and refined.
In the UK, the concept of joint – stock company, which is separate from its shareholders, was first introduced to the law by the Act of 1844 (Maltby 1998). Companies received limited liability later in 1855 (Cameron 2013). In 1862, there was adopted the first Companies Act (Pulbrook 1865), which has become a progenitor of Companies Act of 2006 (The National Archives 2007).
Under the current law, companies are separate legal entities, and the responsibility of their participants may be limited (Bishop &, Kleinberger 2008). That means that the company is not liable for the obligations of its members and directors, and members, as well as director – for the obligations of a limited liability company.
There are few legislative exceptions to this rule. Thus, the insolvency law provides certain cases, when the director of the company or other responsible person may be compelled by a court to contribute to the assets of the company as a punishment for his illegal actions (Wormser 2001). In addition to regulations, rules established by case law are an important part of English law.
Content and origin of the doctrine
The doctrine of “lifting the veil of incorporation” admits the fundamental possibility of imposing liability for company’s obligations to its controlling person. There can be an opposite situation, when the penalty for a person or entity is drawn to the assets the company under control. Sometimes shareholder himself requires “piercing the veil of incorporation”. This usually it concerns not obligations, but the rights of company, which shareholder wishes to have.
“Lifting the veil”, in fact, means that for the purposes of the dispute (and only for this purpose), the Court acknowledges that the company is not separate entity from the controlling person, and attributes obligations and (or) rights of company to this person (Macmillan 2000). However, “lifting the veil” is allowed only in certain exceptional circumstances, which are discussed below.
Perhaps for the first time at a high judicial level the issue of removing the corporate veil was discussed in 1897 in the classical case of Salomon v A. Salomon & Co Ltd from (Vast Blue Sky 2011). Majority owned 20001 share of the company, and his wife and children owed six more (under the law of time, company had to have at least seven shareholders). Despite the fact that the majority shareholder was in full control of the company (shoe factory), which later went bankrupt, the House of Lords, acting as a court of last resort, refused liquidator to entrust the shareholder liable for the debts of the company. The court took quite a formalistic position, stating that all the requirements of the law regarding the establishment of a limited liability company had been met, and the court had no right to add any additional requirements (Mann 2012).
Present state of the issue
Speaking about more modern precedents, we should remember the case of DHN Food Distributors v. Tower Hamlets London Borough Council (Kershaw 2002) in 1976. It was quite unusual in the sense that it controlling person of the company demanded “lifting the veil”. The parent company wanted to take the place of its sub-company. In this case, a piece of land in London was a subject for the compulsory buy for public needs. The land was formally owned by the company, which was part of DHN group – holding company that owned grocery stores. Warehouse of DHN store was just on that land, and, by agreement with the sub-company, DHN had a right of perpetual lease. Its withdrawal led to the cessation of DHN business, and it could claim for damages if it owned the land. DHN applied to the court for “lifting the veil of incorporation”, referring to the fact that it completely controlled its sub-company. Namely, (1) it participated in the capital of the sub-company of 100%, (2) the directors of both companies were the same people, and (3) sub-company was used exclusively for holding land and did not conduct any independent activity. The Court agreed with the arguments of the plaintiff and the “lifted the veil”, allowing DHN receive compensation for withdrawal of the land instead of its sub-company (Dine 2005).
Woolfson v Strathclyde Regional Council from 1978 was a very similar case, which ended with an opposite result (Talbot 2008). Commercial property in Glasgow, where there was a wedding dress shop, was forcibly bought for public use (highway construction). Since the case took place in Scotland, the trial courts were not British but Scottish, and the House of Lords became final authority. If the court recognized that the property belonged to the same person, leading retail business, that person would receive additional compensation “for the deprivation of business.” However, the plaintiff, who really controlled the whole business, organized asset ownership in a too complicated way. His share in the company, which owned real estate was 50%, while the share in the company leading business – 99.9% (the remaining shares were owned by the wife of the plaintiff). Those circumstances did not allow the courts, following the logic of DHN case (it was not formal precedent for the courts of Scotland), pronounce judgment for plaintiff (Talbot 2008).
In the important case of Adams v Cape Industries in 1990 (Thompson 1991), the Appeals Court considered the issue of “lifting the veil of incorporation” for jurisdictional purposes, ie for the purpose of determining the competent court. British company sold asbestos in the United States (before 1970) through its affiliated corporations in the United States. Subsequently, the workers of American factory sued a number of defendants including the British company for damages caused to the health of the plaintiffs when working with asbestos. Lawsuit for millions of dollars was satisfied by Texas court. However, the English court refused to enforce the decision of the American court, finding that the British company, which is not active in the USA, does not fall under the jurisdiction of the US court. And the reasons for “lifting the veil” (ie to make British company responsible for the obligations of American sub-company) were absent, because the affiliate in the United States was not a “facade” of the British company.
In the same case, there was discussed the possibility of prosecution parent company to the liability for the obligations of its subsidiary on several other grounds, when the subsidiary is recognized as an agent of the parent company. Indeed, parent company is responsible for transactions made in his interest by the agent. However, you must prove the actual existence of the agency relationship, which, according to the Court, in this case has not been made. Control of one company over another does not mean the presence of the agency relationship between them. The court in this case distinguishes “lifting the veil of incorporation” and imposing responsibility for subsidiary. In the latter case there is no need of deprivation status of a separate legal entity, ie the “corporate veil” remains in place.
The present state of the doctrine of “lifting the veil” in England can be found in pretty exotic case of the High Court of England and Wales Hashem v Shayif in 2008 (Bainbridge 2010). It was between a citizen of Saudi Arabia and one of his wives under sharia law about real estate in England. Although the dispute relates generally to family law, it also touches issues of corporate law. The family property legally belonged to a legal entity – a company in Jersey. The question was whether the wife after divorce could take that property, as if it belonged to her husband directly. The court eventually found that she could not. The main role was played by the fact that her husband owned only 30% stake in the company, and 70% were issued for his children (Mann 2012).
This case describes in detail the grounds for applying the doctrine of “lifting the veil of incorporation”. Judge James Manby formulated the following items of the case law applicable to this case (Bainbridge 2010).
Ownership and control are not sufficient criteria to remove the corporate veil.
The Court can not remove the corporate veil only because it is in the interests of justice.
Corporate veil can be removed only if there is impropriety.
Impropriety itself is not enough. It should be associated with the use of the corporate structure to avoid or conceal liability.
In order to remove the corporate veil, it is necessary to prove the presence of control, and the presence of impropriety, that is, the use of the company as a “facade” to hide violation of law (Gevurtz 2006).
The problem of transition contractual obligations
Doctrine of “lifting the veil” received further development in the case Antonio Gramsci v Stepanovs (2011) (Nyombi 2014). The principle of “lifting the veil of incorporation” is often used for transition tort liability from the company to its owner. In those cases there was an issue of transferring contractual obligations the same way. English courts have traditionally carefully treated the principle of privity of contract, according to which no one other than the parties of the contract have rights or obligations under this contract. Can a private nature of the contract be removed together with corporate veil? The courts in these two cases gave the opposite answers to this question, and ultimately it had to be addressed in the UK highest court (Nyombi 2014).
The essence Antonio Gramsci v Stepanovs is the following. Latvian businessman S., being one of the directors of the Latvian Shipping Company leased the ships of his company through an offshore company, which was controlled by him and other directors of the shipping company. The offshore company accumulated profit. Subsequently, the Latvian Shipping Company initiated a lawsuit to recover lost profit. Freight agreement between shipowners and offshore companies contained prorogation clause that disputes had to be considered by the courts of England. The plaintiff appealed to the High Court to apply the doctrine of “lifting corporate veil” and bring to justice not only offshore companies, but also the entrepreneur based on solidarity.
Judge Michael Burton determined that the removal of the corporate veil provides an opportunity to recognize an individual responsible for contractual obligations of the company he controlled. As a result, the judge found that the Latvian businessman is a party of contract signed by offshore company. The court found it possible to consider a claim for the entrepreneur, though he didn’t sign prorogation agreement (Palmiter 2006).
Criminal legal context
Above we discussed the principle of “lifting the veil of incorporation” only in the context of civil proceedings. Criminal cases have their own specifics. In the case of R v Seager (Bishop & Kleinberger 2012) (2009) the dispute was about whether to consider the entire income of the company illegal and subject to confiscation income of its director, if the latter ran the company in spite of an injunction. Judge of Appellate Court Richard Aikens formulated the following specifics.
“In the context of criminal cases, courts have identified at least three situations when the corporate veil can be lifted. First, if the offender is trying to hide behind the corporate facade, or a veil to hide his crime and benefits from it. Secondly, if the offender commits an act on behalf of the company, which constitutes criminal offenses leading to his conviction. Third, if the transaction or commercial structures are “device”, “cloak” or “sham”, ie it an attempt to disguise the true nature of the transaction or structure to defraud third parties or the courts” (Kershaw 2002).
Conclusion
Development of civil law led to development of a list of exceptions to the principle that legal entity is separate and independent from its founders. This doctrine is called “lifting the veil of incorporation”. It is present in the corporate law of many countries, including the UK, the USA, France, and Germany. English law is one of the most developed in this sphere. Basic principles of the independence of the legal person were laid at the end of 19th century and since then they have been constantly actively developed and refined.
In the paper, we considered real life examples from the history of law and the cases of recent past. They show that the concept of «lifting the veil of incorporation» is of imperative importance. And it is used not only in civil law, but can have criminal legal context too.
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