Thursday, June 13, 2013

Petrodel v Prest: Lord Sumption’s Masterly Analysis of the Corporate Veil

When the history of the corporate veil is written, the year 2013 will perhaps be given as much prominence as the year 1897. Today, the UK Supreme Court allowed Mrs Prest’s appeal against the judgment of the Court of Appeal that seven properties in London owned by the Petrodel group of companies are not properties to which the sole controller of the group is ‘entitled, in possession or reversion’. The judgment of Lord Sumption contains a masterly analysis of this difficult area of law and is likely to become the definitive authority on the corporate veil in the years ahead. Along with (and perhaps even more than) VTB Capital v Nutritek Corporation, this is the most important judicial analysis of the corporate veil in recent times. We have commented on the decisions in VTB (Court of Appeal and Supreme Court) and Petrodel, to which readers may refer for an account of the facts and the background. In short, after Mr and Mrs Prest divorced, Moylan J. awarded Mrs Prest a sum of £17.5 million as a fair division of Mr Prest’s assets. In part satisfaction of this sum, the judge ordered three Petrodel group companies to transfer the seven properties in question to Mrs Prest. It was established, inter alia, that Mr Prest was the controller and sole person interested in the Petrodel companies and that he had used the assets of the company to defray personal expenses. The question was whether the court was empowered to grant this order.

At an early stage of his judgment (para 9), Lord Sumption identifies three (and no other) possible bases on which such an order can be validly made against the corporate defendants: (1) ‘piercing the corporate veil’ in order to give effective relief; (2) section 24(1)(a) of the Matrimonial Causes Act, 1973 and (3) the Petrodel companies hold the London properties on trust for the husband (not simply because he is the controller). Our interest here is (1) but we note in passing that Lord Sumption (correctly, it is submitted) rejected the proposition that section 24(1)(a) authorises the court to ignore the corporate entity simply to make a fairer distribution of assets.

Lord Sumption’s analysis of the corporate veil contains so many important propositions of law that it is best to summarise them, and then consider two or three of them in more detail:

  1. The corporate veil has been described as a fiction but it is a fiction which is the whole foundation of the English law of company and insolvency. It also clearly accords with the commercial understanding of companies although, as Goff LJ rightly said, the courts are here “concerned not with economics but with law” (para 8);
  2. In some cases, some rule of law has the effect of attributing to the controller the knowledge of the company, or in some other way treating (without ignoring the separate legal entity of the company) as the act of the company an act of some other person. These are not, and should not be, considered as instances of piercing the corporate veil. That is done only when the corporate personality of the company is disregarded (para 16);
  3. Most advanced legal systems recognise corporate personality but adopt different ways of introducing some limits to its logical consequences. The civil law countries use the doctrine of ‘abuse of rights’ but the common law knows no such general principle: instead, “it has a variety of specific principles which achieve the same result in some cases”, one of which is that the law, in defining the incidents of a legal relationship, assumes that persons who engage it deal honestly with each other: if not, the same incidents may not necessarily apply (para 18);
  4. Much of the case law on the corporate veil “is characterised by incautious dicta and inadequate reasoning”. Many of these cases attribute the doctrine of piercing the veil to the fact that the company is a ‘sham’ or a ‘façade’ but these expressions beg more questions than they answer. In recent times, the law has crystallised around the six principles formulated by Munby J. in Ben Hashem v Shayif, of which the most important is that there must be ‘relevant impropriety’, that is, impropriety in the use of the corporate structure to avoid liability. The one modification made to this by the Court of Appeal in VTB (that the corporate veil can be pierced even if other remedies are available to the claimant) is wrong (para 25);
  5. Although the recognition of the veil was obiter in many of these cases, and those in which it was not can be explained by conventional legal principles, the existence of the doctrine is well-established in the authorities: “I would not for my part be willing to explain that consensus out of existence” (para 27);
  6. Much of the confusion in the case law has arisen from a failure to distinguish between “the concealment principle” and the “evasion principle” (para 28);
    1. The concealment principle is, in fact, not an instance of piercing the veil but is the principle that “the interposition of a company…so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming their identity is legally relevant”.
    2. The evasion principle is the only real instance of piercing the veil. This is done if “there is a legal right against the person in control of the company which exists independently of the company’s involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement”.
  7. Lord Sumption illustrates the difference between the concealment principle and the evasion principle by comparing, on the one hand, Gilford Motor Co v Horne [1933] Ch. 935 and Jones v Lipman [1962] 1 WLR 832 with, on the other, Genco ACP v Dalby [2000] 2 BCLC 734 and Trustor AB v Smallbone (No 2) [2001] 1 WLR 1177). In Trustor and Genco, at the risk of over-simplification, a claim was made that a former director of the claimant was liable in knowing receipt by reason of the receipt by a company under his control of funds belonging to the claimant which the controller had procured the company to receive. In both cases, the claimant succeeded apparently on the basis that the veil was pierced so that it could be said that the former director had received the money. Lord Sumption explains that this is a wrong analysis of the cases: correctly analysed, both cases are instances of the concealment principle, not the evasion principle. This is because there was no legal right or liability on the part of the director independently of the company’s interposition: by attributing his knowledge to the company, the company became directly liable to the claimant, but without losing its corporate personality. As Lord Sumption puts it, the result would have been the same if Mr Dalby had caused his uncle to receive the funds with prior knowledge, instead of the company, and there would have been no doubt about his uncle’s separate existence. On the other hand, the order of injunction made against JM Horne & Co can be explained only on the basis that the company was created by Mr Horne for the purpose of defeating the right that his former employers had against him. That liability existed independently of the company (paras 29-33).
  8. This distinction explains why the veil could not be pierced in VTB Capital and indeed in Prest: in VTB, there was no legal right against or liability of Mr Malofeev that existed independently of the role of Nutritek and the other companies. In Prest, there was certainly impropriety, but it had nothing to do with Mr Prest’s obligation to Mrs Prest. This suggests that the result might have been different if Mr Prest had transferred his assets to the companies (beneficially owned by the companies) after the order was made, in order to defeat it (paras 34-36).
  9. The principle is best stated in the words of Lord Sumption, at para 35:
35. I conclude that there is a limited principle of English law which applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. The court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller of the advantage that they would otherwise have obtained by the company’s separate legal personality. The principle is properly described as a limited one, because in almost every case where the test is satisfied, the facts will in practice disclose a legal relationship between the company and its controller which will make it unnecessary to pierce the corporate veil.
There are three important points that arise out of this judgment. First, the point left open by the Supreme Court in VTB—whether at all the court has the power to pierce the veil—has now been decided, although Lord Neuberger appears to have done so with some reluctance, considering (rightly) that the doctrine is anomalous. He demonstrates (para 74) that in some eighty years of its existence, the doctrine of piercing the veil has not been successfully and correctly invoked even once. Secondly, Lord Neuberger (para 62) and Lord Sumption (para 35) agree that there is a ‘necessity’ threshold to cross before the veil can be pierced: that is, contrary to what the Court of Appeal decided in VTB Capital, the veil should not be pierced even where the evasion principle applies, if other appropriate remedies are available to the claimant. Thirdly, Lord Neuberger and Lord Sumption differ in their treatment of the important cases of Gilford Motor Co v Horne and Jones v Lipman. To Lord Sumption, these cases illustrate the evasion principle insofar as an order was made against the company; to Lord Neuberger (para 70), these cases wrongly invoked the doctrine of piercing the veil and the order made against the company can be explained on the basis of agency.

It is evident, especially after Petrodel Resources, that the law in India could not be more different: the courts pierce the veil more readily, and do not insist that the fraud or impropriety must be concerned with the use of the corporate structure. However, since the Supreme Court is yet to closely examine this question in the light of recent developments, the scope of the corporate veil remains an open question in India.


Unknown said...

Reading paragraphs 28 and 35 together, it would appear that the evasion principle not only entails: i)the existence of a legal right and ii) the interposition of a company defeating such legal right, but also iii) an intention to defeat 'that' right. Therefore, even where the company was interposed to avoid another legal obligation (such as tax, in the instant case), the Court shall not pierce the veil. Is this not too narrow an interpretation?

vswami said...

To one's mind, rather it is one's longstanding conviction that,the controversies still being repeatedly raised, discussed and debated are,if were to go to the root of the matter,are unwarranted; would pale into insignificance. That could happen provided the fundamental fallacy in the thinking /belief that the so called,- 'avoidance' and
'evasion' are not two entirely different concepts but are one and the same. For an appreciation in proper light, suggest to read mindfully the very illuminating article of the renowned legal luminary of our times, N A Palkhivala, titled
"Tax Avidance Is Legal"
(Source: Book, We, the Nation THE LOST DECADES). Also,his other equally and forcefully enlightening articles/speeches on this or other related topics.

It is a national tragedy that, even after the SC and High Courts have shown as to what should be the right approach,attempt to keep the frivolous controversy alive; and do so by barging into and seizing every instance or occasion, with no rhyme or reason, much less 'logic',- being the only useful tool /touch stone for testing what is profoundly right or better view.

For more, the personal Blog @ may be looked up.

Likely to be contd.

vswami said...

To share more: What is imperative and needs to be realized, in the very interests of a proper administration, so also adjudication, are these:- “Avoidance” and “evasion”, in the context of fiscal laws, are two distinct rather distinguishable concepts. And that it is so, howsoever thin or thick the line of distinction is considered or imagined to be. Once that distinction is the premise to proceed with, then it becomes a matter for a final adjudication by quasi -and judicial authorities; that is, to decide , by taking an objective and balanced view, as to whether a given case is one of ‘avoidance’, hence is not caught within the mischief of ‘evasion’ or vice versa.

Anyone is sure to find and be satisfied that the clues and guidance eminently provided in decided cases, also by the apex court, that too in great/minute details, are quite illuminating; and must be regarded to be more than adequate for reducing the rigor of , even if not eliminating, the on-going controversy,of course to the best of human intellect or endeavors.

In short, otherwise, the inevitable consequence can only be what has been impliedly foreseen / prophesied by the learned writer in the concluding part of his write-up,

Renganath said...

So, Group Seven Ltd v Allied Investment Corpn Ltd [2013] EWHC 1509 (Ch) is no more good law?