Thursday, September 27, 2012

VTB Capital: The Consequences of Lifting the Corporate Veil

The Court of Appeal earlier this year gave judgment on an important issue of corporate law: the consequence of lifting the corporate veil, and, in particular, whether the puppet is deemed to have become a party to contracts entered into in the puppeteer’s name (VTB Capital v Nutritek). The issue is of practical importance because an affirmative answer to this question would allow claims to be framed in contract which would otherwise be framed differently, and of conceptual importance because it reveals the nature of the remedy (ie, what courts mean when they “lift” the corporate veil). As we discuss below, the Bombay High Court and the Court of Appeal have given opposite answers to this question, and the UK Supreme Court is scheduled to hear the appeal against VTB Capital on 12 November.

VTB Capital was a dispute that arose out of a loan that was obtained fraudulently. VTB, a company incorporated in England and a subsidiary of a Russian company, was induced to give a loan of about $220 million to Russagroprom LLP [“RAP”] to fund the acquisition of certain dairy companies [“the Dairy Companies”] from Nutritek, a company incorporated in the British Virgin Islands [“Nutritek”]. The loan was made under a Facility Agreement to which the parties were VTB, Nutritek, RAP and RAP’s parent companies as guarantors. The parties to the Share Purchase Agreement (through which RAP bought the Dairy Companies) were RAP, Nutritek and Newblade (the company whose shares were transferred to RAP). The Facility Agreement stipulated that VTB would release funds only after receiving an independent valuation report.

Soon after the loan was made, RAP defaulted, and VTB was left with a considerable shortfall after realising its securities. VTB realised that it had been induced into entering into the Facility Agreement by two fraudulent misrepresentations: (i) that Nutritek and RAP were not under the ultimate control of the same person and (ii) a substantial and deliberate exaggeration of the value of the Dairy Companies, leading to a misleading valuation report. VTB initially brought a claim in contract against VTB, and in tort against Marcap BVI, Marcap Moscow and Mr Malofeev. The allegation was that Marcap BVI, which owned Marcap Moscow, had a substantial stake in Nutritek, and that Mr Malofeev was the controller of all three companies (this was the basis of (i) above). VTB then applied for leave to amend its Particulars of Claim to allege liability in contract against Marcap BVI, Marcap Moscow and Mr Malofeev, on the basis that, once RAP’s veil was pierced, those who controlled it became parties to the Facility Agreement. It is of interest to note that VTB ran this case purely for jurisdictional reasons: a claim in contract would have strengthened its attempt to establish the jurisdiction of the English courts with respect to sue Marcap BVI, Marcap Moscow and Mr Malofeev.

In VTB Capital, Mr Snowden QC argued that the legal consequence of lifting the corporate veil is that the controller is regarded as an additional party to contracts entered into in the name of the company he controls. This, it was argued, was not a matter of “discretion” or a “remedy” devised by the court to do justice, but simply the logical consequence of ignoring the fact that the puppet is a separate legal entity. The outstanding submissions of counsel and the Court’s equally outstanding analysis repay careful study, for these trace the development of the corporate veil as a remedy from the time it was devised to the way in which it is used today, and consider analogies, if any, with the law of undisclosed principals. What follows here is no more than a brief summary of this analysis. Burton, J, in two decisions (Antonio Gramsci and Alliance Bank), had accepted this argument, but Arnold, J, in the judgment under appeal, held that those cases were wrongly decided. Mr Snowden relied on the Court of Appeal’s well-known judgment in Gilford Motor Co v Horne [1933] Ch. 935. In that case, the claimant obtained an injunction restraining Mr Horne and JM Horne & Co from carrying on competing business. Mr Horne had entered into a contract which restrained him from doing this, but JM Horne & Co had not. Mr Snowden’s case in VTB was that no injunction could have been granted against JM Horne & Co except in support of an independent cause of action against it; that cause of action could have only been that JM Horne & Co was deemed, once the corporate veil was lifted, to have become a party to Mr Horne’s contracts. Lloyd LJ rejects this reading of Gilford, and holds that the Court of Appeal granted an injunction against the company only because it was “practically convenient” to do so; an injunction against Mr Horne alone would have sufficed, since there was a finding that he was in breach of the covenant through the company, but it was convenient to grant this remedy against the company as well. Jones v Lipman, Trustor and other cases were similarly explained.

It was also suggested that there is an analogy with the law of undisclosed principals, which allows a third party to sue the undisclosed principal even though he did not know of his existence when he entered into the contract; it was said that a case where a controller deceives a contracting party into thinking that the puppet is not a puppet is identical because it is also a case where the controller acts through another without the knowledge of the other party to the contract. Lloyd LJ rejected this submission because the third party is allowed to sue an undisclosed principal only if the agent entered into the contract within the scope of his actual authority, and, in a corporate veil case, the controller by definition does not authorise the puppet to enter into a contract on his behalf.

In the course of its careful review of the authorities, the Court of Appeal also made two other important points: first, “lifting the corporate veil” does not ignore the existence of the company, but allows the court to provide a remedy that would otherwise be available only against the company (as opposed to the controller, or vice versa); secondly, there is no requirement that the corporate veil can be lifted only if it is necessary to do so (ie, that there is no other remedy) and Dadourian and Hashem v Shayif, to the extent they suggested there is, are incorrect.

The Bombay High Court, in a case we have discussed on this blog, cited Burton J’s judgment in Gramsci for the proposition that a contract may be enforced against the puppet as well as the puppeteer. Unfortunately, the Court did not consider this issue in detail, or the arguments against Burton J.’s interpretation of Gilford Motor Co. This case is now before the Supreme Court.

There is no doubt that this is a difficult issue as to which there is more than one reasonable view. The strongest argument in favour of the appellants in VTB Capital appears to be the reasoning in Gilford Motor Co v Horne. The strongest argument to the contrary is that (as the Court of Appeal points out) it is difficult to reconcile this proposition with the principle that a contract, construed objectively, creates rights and obligations only between parties (subject to certain exceptions that are irrelevant here). Another difficulty with the argument is that the controller will be deemed to have become a party to the puppet’s contracts even if the fraud he perpetrated was not that the puppet was not controlled by him. In VTB, this issue did not arise because the allegation (assumed to be true) was that Mr Malofeev had fraudulently represented that Nutritek and RAP were controlled by different entities.

The Supreme Court’s decision in VTB Capital is keenly awaited.

1 comment:

vswami said...

Following are the observations, in the order of general significance or interest:
1.In the judgment, in a particular context, there is a concept of -"substantial question of fact or law or both" referred to. It seems to be strikingly distinct from the commonly known concepts (as often gone into in decided Indian tax cases) of - "question of law","mixed question of law and facts"; and now, under the modified code-"substantial question of law".
Further, so far as could be seen (subject to correction),the court does not seem to have dealt with or given any specific finding on this aspect.
2. The judgment being one of an English court makes for somewhat a laborious/time consuming reading; typical of its kind, in that, because of the given natural gift of language, the judiciary has never had any difficulty in handing out such long winding judgments, though to the delight of the domestic lawyers, if not to their brethren abroad, or to the litigants as a class.