Monday, October 20, 2008

British decision on lifting the corporate veil: Clarity or more confusion?

Considerable difficulty arises in trying to find a coherent set of principles to govern issues related to 'lifting the corporate veil'. Courts have relied upon several factors in deciding whether to ignore the existence of the corporate entity – ‘fraud’ or ‘sham’, ‘single economic entity’, ‘agency’, ‘tax evasion’, ‘determination of nationality’ etc.


In the early 1990s, in a landmark judgment in Adams v. Cape Industries [1991] 1 All ER 929, the Court of Appeal rejected the argument of ‘single economic entity’. The Court refused to ignore the legal form to look at the economic substance. In a recent judgment in Hashem v. Shayif, Justice Munby of the England and Wales High Court considered in depth several cases on the corporate veil issue, and concluded that for the veil to be lifted; that defendant must have control of the entity, and there must have been some impropriety.


Now, although Adams v. Cape rejected the ‘single economic entity’ argument, it left open the door for agency-based arguments. In this context, ‘agency’ would mean not just a formal contractual relationship but also a ‘factual’ agency. It needs to be considered, then, whether the Justice Munby’s judgment closes the door on agency-type arguments as well because of the insistence on impropriety. Further, at times, Courts have relied on an “interests of justice” rationale to lift the veil. Hashem v. Shayif categorically rejects this approach.


The important conclusions reached by the Justice Munby are as follows [in paragraphs 159 to 164 of the judgment]:

  1. Ownership and control of the company are not sufficient to justify the piercing of the corporate veil.
  2. The Courts cannot pierce the corporate veil merely because it is thought to be in the interests of justice.
  3. The veil can be pierced only if there is some impropriety.
  4. Again, mere existence of impropriety is also not sufficient. The impropriety must be linked to the use of the company structure to avoid or conceal liability.
  5. It is essential to show both control and impropriety in the sense mentioned in point 4.
  6. The test for lifting the veil is – is the company a façade at the relevant time? Whether it is a façade or not is determined by factors 1 to 5. If the answer is “no, it is not a facade”, the veil cannot be lifted at all.


Further, Justice Munby notes that whenever the Courts have lifted the corporate veil, “… the wrongdoer controlled the company, which he used as a façade or device to facilitate and cover up his own wrongdoing … in each of these cases there were present the twin features of control and impropriety.” Thus it would appear that the only way in which the veil can be lifted in by proving the existence of a façade. Agency-type arguments (such as “the company so habitually acts according to the wishes of the defendant that it is should be treated as an alter-ego”) are not sufficient to lift the veil because of the element of “impropriety”. Indeed, specific agency-based arguments were raised before the Court – Justice Munby however said that for any question of lifting the veil, the above factors were the essential test.


It would appear that the judgment has at least one good element – it brings in an amount of certainty in an area where rational principles harmonizing all the cases are hard to find. But, does it restrict too far the understanding of when the veil can be lifted? If so, to what context should the principles derived in the judgment be restricted? Leading authorities including Gower, Palmer and Pennington suggest several grounds on which the veil has been lifted. These include ‘evasion of obligations’, ‘protection of public interest’, ‘abuse of corporate form’, ‘countering fraud, sharp practice and oppression’, ‘disguise of the controlling hand’, ‘substance over form doctrines’ etc. Can all these categories be collapsed into a single category of ‘fraud/sham’?


Also, Courts are often unclear when they use the phrase “lifting the corporate veil”. In a seminal article in the Modern Law Review (May 1990), Prof. S. Ottolenghi characterized judicial action in “corporate veil” cases to be of four types:

  1. Peeping behind the veil – merely for the purpose of looking at the controlling persons and for nothing more. This is done in seeing whether a company is a “wholly-owned subsidiary”, an “associated enterprise” etc.
  2. Penetrating the veil – for the purpose of fastening liability on the shareholders for the acts of the company or for granting shareholders direct interest in a company’s assets. This does not mean that the company is treated as non-existent; but that despite the company being existent, certain factors require the Court to directly look at the shareholders.
  3. Extending the veil – lifting the veil over one company and then pulling it down to include another entity in the same veil. This is the approach in both ‘single economic entity’ and ‘factual-agency’ arguments.
  4. Ignoring the veil – entirely ignoring the existence of the company as a ‘façade’ or a ‘sham’.


There would be nothing wrong with Justice Munby’s approach if the case dealt with only the 4th category – nonetheless, the arguments made before him required him to look at all the categories listed above. Accordingly, he claims to lay down principles which would cover all these categories. But, does the existing case law justify this approach? Or has Justice Munby sacrificed correctness at the altar of clarity?


I will try to answer these questions in a separate post shortly. The judgment itself is available here. A discussion is available on the British Corporate Law and Governance blog here.


8 comments:

kabir said...

"Considerable difficulty arises in trying to find a coherent set of principles to govern the principles related to lifting the corporate veil."..."In the early 90s", when the citation says 1991...and throughout your post...y is the tone so self-important? y not let the reader recognize the content as serious? y put or try to put an air of seriousness around an otherwise useful discussion that can interest many non lawyers too? even judges everywhere are simplifying their langauge and tones to adapt to more contemporary styles. isn't that a healthy trend? should we not support it. specially in blogs if not in more formal journals with academic pretensions. to be infair to them, in fact many journals around the world, too, are going easy on the oh-so-serious sentence constructions. please keep light and easy. Excellent Insight though! thanks a lot for the post. and i hope the blog author approves or disapproves and doesn't edit!! or this my last peep in.

Mihir Naniwadekar said...
This comment has been removed by the author.
Mihir Naniwadekar said...

Hi, thanks for the comments.

If the objection is to "principles to govern the principles", thanks for pointing that error out - my mistake, should have said "considerable difficulty arises in trying to find a coherent set of principle governing the concept of lifting the corporate veil". I am editing that part. But if the objection is to the "considerably difficulty" part, unfortunately there is considerable difficulty although Courts often portray the issues to be clear.

I'm not quite sure what the problem is with mentioning "In the early 1990s" - how exactly those four words damage the style. I don't see any harm in writing that despite the citation. Also, not quite sure where it is "self-important" though. But point taken - will try to be less legalistic :-)

And thanks for your other comments, glad you liked it otherwise.

Regards,

Mihir

Anonymous said...

Hi,

Well, for me, the content makes up for any problems with the style, with all the new student contributors if I may say so! And I don't really think the more formal style is bad though.

Perhaps just different things which different readers prefer, but in any case as Mr. Kabir also said, really nice insight by all of you too.

I look forward to Mr. Umakanth's posts and also to posts of the new contributors!

Umakanth V said...

While Kabir's point is well taken, it seems difficult to avoid technicalities and jargon altogether in a legal blog like this, especially when analysing a case or a provision of a statute or regulation. The trick is to find a suitable balance so that the content is pitched appropriately to cater to legal professionals, but at the same time is equally comprehensible to others as well, and the effort will certainly be in that direction.

Jorge said...

Hello,

although i read this blog regularly and enjoy it, I have not commented so far. But I felt that given a few of the other comments, I must say that I enjoyed this post very much. And I am a non-lawyer (business student); non-UK 'layperson'. Thank you for the wonderful post.

The last sentence of the post indicates that there will be another post on the topic. May I request that if possible the position in other common law countries (particularly US, India, Australia or Canada) and the position in the EU can be discussed if possible?

Just a request - I understand the tremendous effort you must already be taking. But would love to read whether this British approach is being followed elsewhere, or are the British courts borrowing from elsewhere?

Thanks

Kailash said...

hi just wondering do you think the reluctance of ther UK courts to lift the veil is healthy ...and why?

Mihir Naniwadekar said...

Hello,

Thank you for the comments.

As far as the question of whether the British position on lifting the veil is desirable as a matter of policy, I would say that Adams v. Cape seems to be the best outcome.

Where as a matter of law an agency (contractual) exists, it is clearly permissible to hold the parent liable for the acts of the subsidiary for acts within the authority of the agent. Insofar as factual agency is concerned, the high burden of Adams is justified by the fact that this is a ground additional to contractual agency, and more analogous to concepts related to holding out or estoppel.

Insofar as facade is concerned, where the facade is established (i.e. say it is proved that the company is created to evade legal obligations), it appears to me to be justified to treat the company and the shareholder as one. Note that the facade must be established as a matter of fact.

That leaves us with the questions of 'control' and 'single economic entity'. I do not think that the veil ought to be lifted in these cases. If two companies in a group are neither facades nor agents, then why should the legal form not be accepted? When a person creates a company, he relies to some extent on the assurance provided by law that the company will be treated as a separate legal person. From the interests of certainty as well as business convenience, I believe that this assurance should be respected.

As far as public interest is concerned, again assuming that there is no facade, I believe that the legal form should be respected unless a statute clearly provides a lead towards lifting the veil. A perfectly legitimate creature of law cannot (or should not) be ignored on grounds of 'public interest' unless there is a specific mandate of a statute. (Note that while this appears to be too "anti-public interest", in reality, a pure public interest argument is hardly ever raised - the argument mostly goes along with 'facade', where I agree that the veil should be lifted)

Allowing lifting the veil on 'single economic entity' or 'public interest' grounds will create too much uncertainty in the law. Once we accept the separate legal personality of the company, we must have strong reasons for ignoring that personality. Those strong reasons may be based on established principles of law (agency) or on abuse of the corporate personality (facade). Beyond that, in my opinion, it is hard to find a principled basis for lifting the veil.