Corporate personality: Doctrine vs Justice

Corporate personality: Doctrine vs Justice
2019-06-06

This blog post is a condensed version of an article that is available online at the website of the Journal of the Law Society of Scotland, where it is noted that it is hard to discern when a UK court is likely to allow piercing of the so-called “corporate veil”, despite a conflict with the approach taken at a European Union level.

The corporate veil is a key part of company law in the UK and beyond. The “corporate veil” is the term used to describe the separate legal personality accorded to a company; a personality that enables a company to enter contracts and allows it (and only it) to sue and be sued for matters relating to it, and also means that a company’s shareholder(s) will not be held personally liable for the actions of the company. 

That being said, company law also allows for the setting aside, or piercing, of the corporate veil in certain circumstances. The piercing of a corporate veil takes place when a court decides to disregard the separate legal entity doctrine. This doctrine exists to allow companies to act and be treated as separate legal persons, distinct from their shareholders. Piercing of a corporate veil can therefore result in shareholders of a company being personally liable for a delictual loss caused by that company, allowing involuntary creditors, such as those who have unwillingly suffered loss at the hands of a company despite the fact they have not entered into contracts with that company, to collect a company’s debts from those shareholders' personal assets. Piercing the veil can also disregard the separate entity of individual companies within a group, allowing either for parent corporations to be held liable for their subsidiaries, or for groups of companies to be treated as a single economic unit. Although the courts recognise that the separate entity doctrine often causes injustice, their formulations for setting aside the doctrine fail to go far in dealing with the issues that the doctrine has created in regard to groups of companies and conflicts with the law of delict (aka tort, in English terminology), and thus can be described as perhaps fainthearted as they do not force or even encourage parent corporations to answer for the debts and losses caused by their subsidiaries, even in cases where subsidiaries can be described as dormant.

The agency argument 

Being unable to ignore the unsatisfactory nature of the consequential reality of the application of the doctrine, courts have not been strictly against piercing a veil in order to hold that a subsidiary is an agent of its parent, an example of this being Firestone Tyre and Rubber Co v Llewellin [1957] 1 WLR 352 (HL). However, it is difficult to predict what approach that the courts will take in each case, as it seems that for each case when a subsidiary is found to be an agent, there is a matching case where the courts have not found so.

Importantly however, the agency exception does not apply automatically in regard to wholly owned subsidiaries, though in such cases the agency argument will have a slightly greater chance of success. Although the Salomon principle – a principle named after the nineteenth century House of Lords case of Salomon v Salomon & Co Ltd [1897] AC 22 that confirmed a company had a distinct personality from its shareholders – ought to be disregarded in order to deal with injustice, injustice alone will not necessarily oblige the court to find a relationship of agency. Although “doing justice to the facts” had been stated to be a relevant consideration in previous cases, this was held to be incorrect in Adams v Cape Industries [1990] Ch 433. This demonstrates that this exception is weak in protecting victims, as the situations when a company may be acting as an agent may be few.

 The single economic unit argument 

This category has received no firm backing and is thus not considered to be an independent category for when the veil may be pierced. Slade LJ in Adams v Cape Industries had explained that the cases in which the veil was disregarded in order to hold that groups of companies were single economic units, on the justification that “justice so requires” or it is required by “the business realities”, fell “on the wording of particular statutes and contracts”. This explanation, although it may be true in regard to some cases, cannot be used as a generalisation for all cases. 

For example, in DHN Ltd v Tower Hamlets LBC [1976] 1 WLR 852, Lord Denning had concentrated on the fact that the subsidiaries were “bound hand and foot” to the parent company (at 860). He therefore took the approach that the three corporations should be treated as one, single economic unit. However this approach was later criticised in Woolfson v Strathclyde Regional Council [1978] SC (HL) 90,making the point that the Court of Appeal in DHN had made no mention of the principle that the veil would only be pierced “where special circumstances exist indicating that [the company] is a mere façade concealing the true facts” (at 96). The Lords therefore emphasised this principle but regrettably did not clarify the meaning of “special circumstances”, leaving room for subsequent cases to deviate once again. 

The leading case in the UK on the issue of corporate personality and limited liability relating to corporate groups is Adams v Cape Industries plc, in which the court rejected the single economic unit argument made in the DHN case, and also the approach that the court will pierce the corporate veil if it is necessary to achieve justice. In taking the same approach as the one taken in Salomon v Salomon & co Ltd [1896] UKHL 1, the court powerfully reasserted the application of limited liability and the separate legal entity doctrine in regard to corporate groups, leaving hundreds of current and future victims uncompensated, whilst assisting those who seek to minimise their losses and liabilities through manipulation of the corporate form, particularly in relation to groups of companies. 

The disregard for these victims demonstrates that a thorough re-examination of the law is strongly required. It is one thing to advocate for the protection of individual shareholders as natural persons; however the concept has been taken too far by not compelling entirely solvent parent companies to provide compensation to victims that have suffered loss at the hands of their subsidiaries. 

In Adams v Cape Industries the Court of Appeal also acknowledged the fact that the rigid doctrine differs radically from the European Court of Justice’s approach. Advocate General Warner in Istituto Chemioterapico Italiano SpA and Commercial Solvents Corporation v EC Commission (Joined Cases 6/73 and 7/73) [1974] ECR I-0223, in considering whether a parent and subsidiary were separate “undertakings” within the definitions of articles 85 and 86 of the Treaty of Rome, found that “it would be inappropriate to apply rigidly in the sphere of competition law the doctrine referred to by English lawyers as that of Salomon v Salomon & Co Ltd – i.e. the doctrine that every company is a separate legal person that cannot be identified with its members”, and also that “to export it blindly into branches of the law where it has little relevance, could, in my opinion, serve only to divorce the law from reality” (at para 263). 

Therefore, the approach taken by the Advocate General supports the proposition that the separate entity doctrine has been stretched too far by having been rigidly applied to groups of companies. A further leading UK case is Prest v Petrodel Resources Ltd [2013] UKSC 34. In this case the Supreme Court provided clarity, as it affirmed that the approach taken in Adams v Cape Industries and it also stated that there is a further requirement for dishonesty by a shareholder before piercing can take place, further limiting its scope. This therefore means that the circumstances in which the veil will be pierced are limited to those where there is an evasion of existing legal obligations by a member. It was also stated that the established approach could not be used whenever convenient in order to do justice.

It is therefore clear that the European Court of Justice’s approach differs drastically from the UK’s approach, as the principles of Salomon require that each subsidiary be viewed and treated as a separate legal entity unless reasons can be shown as to why this should be ignored, whereas the ECJ’s approach is to presume the opposite, that a subsidiary and parent are one until it is proved otherwise. Although the Advocate General’s reasoning regarding subsidiaries acting in accordance with the wishes of their parent corporations is credible, convincing and successful in holding parent companies to account, it regrettably did not influence the UK’s approach. Any dissatisfaction with the UK maintaining a different approach from that of the ECJ would be mitigated with the UK’s planned exit from the EU, further diminishing the likelihood of influence.

Interaction with the law of delict 

Progress has arguably been made in regard to groups of companies under delictual law, where parent companies may be subject to a duty of care, allowing the involuntary creditors to bring an action against the parent company, as evidenced in Chandler v Cape plc [2012] 1 WLR 3111 (CA). This will be possible when the threefold test stipulated by Lord Bridge in Caparo Industries plc v Dickman [1990] 2 AC 605 (HL) at 618 is satisfied. This is namely that, the damage should be foreseeable, there should exist a relationship of proximity or neighbourhood and it should be fair, just and reasonable to impose a duty of care. Both agency and duty of care, however, provide a very limited amount of liberation and relief to victims, as they are of minor assistance regarding enormous multinational corporations which have a vast number of subsidiaries operating in hundreds of countries worldwide. 

Overall, two of the most evident and fundamental objectives of delict law are to compensate victims and discourage engagement in harmful and negligent activities, each of which is obstructed by the application of limited liability. It has been demonstrated that if a company becomes insolvent and cannot compensate its involuntary creditors, the scope for shareholder liability is extremely narrow. The rationalisation that limited liability supports risk-taking contradicts the social need to deter negligent or harmful activities. Therefore, even those people who advocate for shareholder primacy must surely be able to accept that the profit maximisation should only be achieved within the framework of external laws.

 

Emma Wills recently completed her Diploma in Professional Legal Practice at the University of Aberdeen and is commencing a traineeship in 2019.

Published by School of Law, University of Aberdeen

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