Учебный год 22-23 / Critical Company Law

24 Critical company law

form, but the judicial inclination to uphold the doctrine of separate corporate personality overrode all other considerations.

The purpose of this chapter is twofold. The first section will assess the consequences of registration through the black letter law on the doctrine of separate corporate personality, including what the doctrine means in detail and the circumstances in which the courts may deviate from it. From this law it will be seen that the circumstances in which the courts will deviate from the doctrine are extremely limited, eschewing broad considerations such as justice and fairness as a basis on which to set aside the separateness of the company. Indeed, the courts in general have required evidence of fraud before allowing the corporate personality of a company to be dispensed with. The second section will look at explanations of why the company has separate corporate personality, or why incorporation has the consequences it does. In so doing it will assess evidence drawn from the nineteenth century (the century in which the doctrine emerged), in the form of cases and in the form of more contemporary scholarly work about this period. In this section I will assess the role of the economy, law and ideology in creating the doctrine which lies at the heart of modern company law.

THE DOCTRINE OF SEPARATE

CORPORATE PERSONALITY

An important consequence of incorporation is that the company may be registered as a limited liability company and the members may enjoy limited liability.2 This means that the company’s liabilities are the legal responsibility of the company and the members will not be liable for the company’s debts. No personal liability will arise for the members in addition to the full price of the shares already purchased (in the case of a company limited by shares) or the value of the guarantee pledged (in the case of a company limited by guarantee). Historically, the introduction of limited liability was highly controversial, but now, English company law, more than any other common-law system, is highly protective of the limited liability of company members. In protecting limited liability, company law protects investors and the role of investment in the economy more generally.

Limited liability can pose a problem for the creditors of an insolvent company without su cient assets to repay its debts. The distinct legal personality of the company means that creditors cannot (as a general rule) turn to the owners of the company for recompense. In this context it is easier to understand the strict rules in respect of the company’s name discussed in

2 It is important to note that a company may have a separate personality without limited liability and companies may register as with unlimited liability.

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it had been legally registered as a company and modern company law declared an incorporated company to be a legal being distinct and separate from its members regardless of its size. As we shall see in the latter part of this chapter, in so doing the House of Lords was espousing the normative values of company law resulting from the economic, ideological and legal developments of the nineteenth century.

This case began as an action by a secured creditor of a small limited company in the case of Broderip v Salomon in 1895 and ended with their Lordships setting out the most fundamental principles of a doctrine that underpins all aspects of modern company law.4 The facts of this case were this. Aron Salomon carried on a business as a boot manufacturer, government contractor and leather merchant. On the 28 July 1892, Mr. Salomon registered his business as a limited company under the 1862 Companies Act. The total purchase money of Salomon’s business was £38,782 19s. 7d. and his books were made up by an accountant hired by him. At the time of incorporation the business was solvent although the price that the company was to pay for the business far exceeded the amounts showing in the balance sheet. The nominal capital of the company was £40,000 divided in 40,000 shares of £1 each. The memorandum of association was subscribed to by Aron Salomon, his wife, his daughter and his four sons, who held one share each because this was the minimum requirement under the 1862 Act. After incorporation Aron Salomon afterwards had 20,000 shares allotted to him and no one else ever had a share in the company. The debenture holders (secured creditors) were Aron Salomon and Edward Broderip; the latter had debentures of £10,000 as security for a £5,000 loan. When the company defaulted on payment of interest due on these debentures, Mr Broderip initiated proceedings to enforce the debentures. An o cial receiver was appointed and an order to wind up the company was made on 25 October 1893.

The judge at first instance held that Salomon Co Ltd was not a legal entity distinct from Aron Salomon and although there was no evidence of fraud, the judge contended that Salomon Co Ltd could not be treated as an independent legal entity distinct from Mr Salomon. He opined that Mr Salomon ‘took the whole of the profits, and his intention was to take the whole of the profits without running the risk of the debts and expenses . . .

one must consider the position of the unsecured creditor’.5 Mr Salomon appealed against an order to indemnify the company, Salomon Co Ltd against the unsecured debts and liabilities incurred in the name of the company whilst it carried on business. The Court of Appeal, however, upheld most of the reasoning of the Chancery Division. Lindley LJ held:

4[1895] 2 Ch 323.

5Ibid.

Separate corporate personality 27

There can be no doubt that in this case an attempt had been made to use the machinery of the Companies Act 1862 for the purpose for which it never was intended. The legislature contemplated the encouragement of trade by enabling a comparatively small number of persons – namely, not less than seven – to carry on business with a limited joint stock or capital, and without the risk of liability beyond the loss of such joint stock or capital. But the legislature never contemplated an extension of limited liability to sole traders or to a fewer number than seven.6

The case was finally heard in the House of Lords in 1897, wherein the most oft-quoted judgments will be found.7 The House dismissed the rationale and decisions of the lower courts, finding no reason why Salomon Co Ltd should not be treated as a legal entity, distinct from Aron Salomon and therefore responsible for its own debts. In a direct response to Lindley LJ’s statement above, Lord Hershall stated:

How does it concern the creditor whether the capital of the company is owned by seven persons in equal shares, with the right to an equal share of the profit, or whether it is almost entirely owned by one person, who practically takes the whole of the profits? The creditor has notice that he is dealing with a company the liability of the members of which is limited, and the register of shareholders informs him how the shares are held, and that are in the hands of one person, if that be the fact.8

And in respect to the notion that the company was an agent of Mr Salomon he stated:

In a popular sense, a company in every case may be said to carry on business for and on behalf of its shareholders; but this certainly does not in point of law constitute the relation of principle and agent between them or render the shareholders liable to indemnify the company against debts it incurs.9

The House of Lords was unanimous in upholding Aron Salomon’s appeal. The debts of the company remained the responsibility of the company and not its shareholders. Accordingly Aron Salomon was not liable for the company’s debts, although he was made a pauper by the court action.

6Ibid.

7Salomon v A Salomon & Co Ltd (1897) AC 22.

8Ibid, p 45.

9Ibid, p 43.

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This decision clarified the e ect of registration for both large and small companies. A business registered as a company according to the formalities set out in the Companies Acts should be treated in law (in the absence of fraud) as a separate legal personality, notwithstanding that in economic terms it is e ectively a one-man company. Thus, henceforth, one-man companies would enjoy separate legal personality. For example, in Lee v Lee’s Air Farming Ltd 10 the widow of the sole director and shareholder of a limited company was able to claim compensation on the grounds that her husband had been an employee of his company. And, in Macaura v Northern Assurance Co Ltd 11 the sole director and shareholder of a limited company was unable to claim for fire damage to the company’s property on his own personal insurance. In this case the court held that a claim could only be made on the company’s own insurance as a shareholder had no ‘insurable interest’ in the company’s assets.

Macaura raises other related and interesting company law issues. When company law answers the question ‘who owns the company’ or ‘who are the owners of the company’, it replies, without exception, that it is the shareholders that own the company. It is not management, who owe a fiduciary duty to the company, or the creditors who have claims against the company, or any other persons with a contract with the company such as employees or contractors. And yet, in Macaura, the sole shareholder and therefore the sole owner of the company could not claim for the property he owned (the company) on his own personal insurance although he could claim for all the other things he owned on this insurance.

In deciding the case in this way the court was following the principles laid down in Salomon to the letter. The company was a separate legal being which required its own insurance, the company was not something that Macaura could own. This approach is, of course, consistent with Salomon, however it directly conflicts with company law’s additional insistence that shareholders are indeed the owners of the company. The conjunction of these two perspectives is to say that shareholders own something that cannot be owned because according to the separation doctrine it (the company) is independent and self owning.

Perhaps the simple if not perfect solution to this conundrum would be to say that shareholders are the owners but owners only of title to dividend and residual voting rights – which indeed company law does. However, company law does not stop at this level of ownership and instead promotes the interests of shareholders above all other parties connected with the company on the basis that they, and they alone, are the owners of the company per se. In so doing company law extends a shareholder’s rights of ownership far beyond

10[1961] AC 12.

11[1925] AC 619.

Separate corporate personality 29

that of a mere dividend owner – a position which may surely only be reached by adopting a layer of ideology which promotes the interests of the investors over and above the logic of black letter company law. Salomon states that the company is separate. It is a doctrine which is the fundamental principle of company law. And yet, company law also maintains that shareholders own the very thing which the doctrine states cannot be owned. Thus the ideology of shareholder ownership sits uncomfortably with logic of the doctrine of separate legal personality but it does allow company law to both promote investor interests and give them the protection of limited liability.

Exceptions to the doctrine of separate corporate personality

The legal separation between the company and its members and those with whom it deals is often described using the metaphor of a veil, or the veil of incorporation which is drawn between the company and all other legal entities. This separation, following Salomon, is recognised in almost all situations; however, a body of law has developed through the courts and through statute that creates exceptions to the doctrine of separate corporate personality. Put another way, in certain circumstances the veil of incorporation may be ‘lifted’ or ‘pierced’ in order to reconnect the company with other legal entities such as other companies or people or to impose liabilities which might ordinarily fall to the company upon individuals connected with the company. The cases and the judgments are rarely tidy as veil piercing is not an end in itself but a means to an end. The court is attempting to find a solution to an inequity which may involve entirely disregarding the veil but often involves making an individual other than the company liable for a varied number of reasons. A true veil piercing, that is when the separateness of the company is entirely disregarded, only really occurs when corporate personality is being used to perpetrate a fraud or to sidestep a pre-existing legal obligation. However, many other circumstances have been discussed by the courts under the heading of exceptions to Salomon, which do not truly veil pierce but engage some other operation of law. All of these are discussed first in common law and second in statute.

Common law exceptions

•Single economic unit

•Façade or sham companies

•Agency

•National identity

•Tax evasion

•Alter ego for criminal or tortious liability

•Contractual guarantees

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Single economic unit

Occasionally, the courts have pierced the veil between companies in a group on the basis that, while legally distinct, economically they exist as one single, interdependent unit. This view was taken in DHN Food Distributors Ltd v Tower Hamlets LBC 12 when the veil between the three companies in this group was pierced in order to achieve what the judges considered to be an equitable result. In DHN, a firm in the East End of London which imported groceries and provisions and had a cash and carry business had organised its business into three companies. The business was owned by the parent company, DHN Food Distributors Ltd, the land was owned by a subsidiary called Bronze Investment Ltd, and the vehicles were owned by another, DHN Transport Ltd. The parent company held all the shares in both subsidiaries and the directors were the same in all three companies, in other words ownership and control was consistent throughout all three companies. The dispute began when, in 1969, Tower Hamlets London Borough Council made a compulsory purchase order to acquire the company’s land. Under the Land Compensation Act 1961 compensation was payable for the cost of the land compulsorily purchased and for any other relevant losses contingent upon the owner’s loss of land. DHN Food Distributors Ltd had made business losses as a result of the land purchase, as the three companies were wound up having been unable to find alternative accommodation. However, it had no property interest in the land and so Tower Hamlets refused to pay compensation for its loss of business. Bronze Investment would be compensated for loss of land but not for business, as its only business was holding the title to the land. Compensation for disturbance of business could only be granted within the terms of the Act if the veil between each company was removed and the business was viewed as one single economic unit that possessed both land that was being compulsorily purchased and business that was being disturbed.

The Court of Appeal held that the veil would be pierced, stating: ‘This group is virtually the same as a partnership in which all three companies are partners. They should not be treated separately so as to be defeated on a technical point. They should not be deprived of the compensation which should be justly payable for disturbance.’13

According to Go LJ the veil could be pierced between companies in a group if the companies were wholly owned subsidiaries which had no separate business operations and when the owners of all the businesses in question had been disturbed in their possession and enjoyment of it. This case represents a fairly radical departure from the Salomon doctrine. Instead of the legal principles being applied to all companies per se, it suggests instead that the courts should assess the economic and factual reality of individual com-

12DHN Food Distributors v Tower Hamlets London Borough Council [1976] 1 WLR 852.

13Lord Denning, ibid, p 860.

Separate corporate personality 31

panies to decide whether or not they should be treated as companies, or, as in this case, partnerships. An application of such a perspective in the Salomon case might well have left Mr Salomon liable for all the businesses debts with costs. Unusually, DHN takes a micro-economic perspective, suggesting that a company’s separateness should be assessed on a case-by-case basis. As we shall see, it is a perspective that entirely disregards the macro-economic perspective generally adopted, where the domination of the large company over the economy largely determines the normative values of all companies regardless of size. To suggest that the corporate veil, which has important functions such as protecting investors (when accompanied by limited liability), could be set aside through judicial examination of the factual nature of individual companies, or as Lord Denning put it ‘whenever it was just and equitable to do so’, would be to undermine the very foundation of the economy. Therefore, it was not surprising that after a brief post-DHN flurry of speculation on the integrity of the corporate veil, the judiciary resumed its protection of the Salomon doctrine. This was first evidenced in a Scottish case, Woolfson v Strathclyde Regional Council,14 heard soon after the decision in DHN. This case involved a compulsory purchase order made in relation to shop premises in St George’s Street, Glasgow by Glasgow Corporation where although the facts of the case were very similar to those in DHN, the veil was not pierced. It was distinguished on the basis that the ownership of the companies was divided between Mr Woolfson and his wife and the court refused to see ownership as embodied in the one person of Mr Woolfson. The decision in DHN was to be confined to the exact facts of DHN and enjoy no general application.

An overview of judgments in respect to groups of companies was pro ered in the case of Adams v Cape Industries plc.15 Here, the plainti s were persons and the personal representatives of persons to whom an award was made in a Texan court in respect of claims for damages for personal injuries and consequential loss su ered as a result of exposure to asbestos fibres. These fibres were emitted from an asbestos insulation factory called Unarco Industries from 1954 to 1962, and then by Pittsburg Corning Corporation (PCC) until 1972.

The defendants were Cape Industries plc and Capasco Ltd, companies registered in England. Cape owned the shares in subsidiary companies in South Africa (which had mined the asbestos) and in its subsidiary Capasco, which organised the sale of the asbestos worldwide. Damages were awarded as it was successfully contended that the defendants had been responsible for the supply of asbestos to Unarco and PCC without giving proper warnings of the dangers. Default judgments were made against the defendants and this case related to the enforcement of these judgments in the UK. Cape argued

14[1979] JPL 169.

15[1990] Ch 433.

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that it should not be liable for the activities of its subsidiary companies in the mining and marketing of asbestos. The House of Lords held that there was no basis upon which the veil could be pierced in order to make Cape liable for the activities of its subsidiaries.

In examining the criteria upon which the veil could be pierced, Lord Keith stated that the economic unit argument was only applicable in cases ‘where legal technicalities would produce injustice in cases involving members of a group of companies’. That is, when the courts were attempting to give e ect to an outside legal document or statute and could only achieve this end by piercing the veil. He demonstrated this approach with reference to the case of Revlon Inc v Cripps and Lee,16 where the question arose as to whether the goods in question (a trade mark held by Revlon Suisse SA (a subsidiary of Revlon Inc)) were connected in the course of trade with Revlon Inc. In judgment Buckly LJ stated:

Revlon is neither the registered proprietor nor a registered user of the REVLON FLEX mark. Since, however, all the relevant companies are wholly owned subsidiaries of Revlon, it is undoubted that the mark is, albeit remotely, an asset of Revlon and its exploitation is for the ultimate benefit of no one but Revlon. It therefore seems to me to be realistic and wholly justifiable to regard Suisse as holding the mark at the disposal of Revlon and for Revlon’s benefit. The mark is an asset of the Revlon Group of companies regarded as a whole, which all belongs to Revlon. This view does not, in my opinion, constitute what is sometimes called ‘piercing the corporate veil’; it recognizes the legal and factual position resulting from the mutual relationship of the various companies.17

Although the Salomon principle should mean that a company’s assets belonged to the company alone, to apply that in this case would have undermined the purpose and raison d’être of a legal document such as a trade mark. The courts took the view that to give legal e ect to the trade mark, the veil between the companies should be pierced to the extent that all companies in the group could use the trade mark to identify their products and activities as part of the Revlon Group.

Lord Keith went on to state that the court could only lift the veil if a defendant was using the corporate structure in an attempt to evade limitations imposed on his conduct by law, or such rights or relief against him as third parties already possessed. Importantly, he held, the veil would not be pierced to set aside limited liability, if the rights or grievances of third parties were gained after the legitimate incorporation of a business. The veil would not

16[1980] FSR 85.

17Ibid, p 105.

Separate corporate personality 33

be pierced to impose liability for post-incorporation activities which would have the e ect of undermining limited liability as a principle. Lord Keith was in essence stating that the veil would only be pierced if the company was operating a fraud or acting as a façade, a principle established in the original

Salomon case.

Where company is a mere façade

This exception applies when the corporate form is utilised in order to avoid an existing legal obligation or to evade limitations imposed by the law and in that respect such usage may be fraudulent. There are a number of di erent factual circumstances which have caused the court to hold that the corporation is being used as a façade. For example in FG Films Ltd 18 under-capitalisation was the basis for holding that the company was a mere façade. An American corporation, Film Group Incorporated, invested £80,000 in the making of a film. The applicant company FG Films Ltd (an English company) claimed to be the maker of the film and wished to register it as a British film. FG Films Ltd had issued capital of £100, the majority of which were owned by the president of Film Group Inc. Furthermore it had no film-making facilities and hired no sta . The court held that the English company was a façade company.

The suggestion that this American company and that director were merely agents for the applicants is, to my mind, inconsistent with and contradicted by the evidence, and a mere travesty of the facts, as I understand and hold them to be. The applicants’ intervention in the matter was purely colourable. They were brought into existence for the sole purpose of being put forward as having undertaken the very elaborate arrangements necessary for the making of this film and of enabling it thereby to qualify as a British film. The attempt has failed, and the respondent’s decision not to register ‘Monsoon’ as a British film was, in my judgement, plainly right.19

Often the avoidance of an existing legal obligation will lead a court to pierce the veil of a company, often dubbed a ‘sham’ company. For example, in

Gilford Motor Company Ltd v Horne 20 the defendant, Mr Horne, had covenanted with his former company not to solicit its existing customers after he had left its employ. When he left his employment with this company, he began a similar business undercutting the prices of his former employer and in direct breach of the covenant. Following legal advice he set up a company,

18[1953] 1 WLR 483.

19Ibid, p 485.

20[1933] Ch 935.