Lifting/piercing the cooperate Veil.

 

Lifting/Piercing the Cooperate Veil

From juristic point of view a company is a legal person different from its members Salomon v Salomon & Co Ltd. (1897) A.C. 22.The principle may be referred to as the ‘Veil of incorporation”. The courts in general consider themselves bound by this principle. The effect of this principle is that there is a fictional veil (and not a wall) between the company and its members. That is, the company has a corporate personality which is distinct from its members.

The human ingenuity however, started using this veil of corporate personality blatantly as a crack for fraud or improper conduct, thus it became necessary for the courts to break through or lift the corporate veil or crack the shell of corporate personality and look at the persons behind the company who are the real beneficiaries of the corporate fiction. In United States v. Milwaukee Refrigerator Co. , the court observed

“A corporation will be looked upon as a legal entity as a general rule… but when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud or defend crime, the law will regard the corporation as an association of persons”.

In Littlewoods Mail Order Stores Ltd. V. Inland Revenue , Denning MR. Observed:

“The doctrine laid down in Solomon v. Solomon & Co. Ltd. has to be watched very carefully.  It has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see.  But that is not true.  The courts can and often do draw aside the veil.  They can, and often do, pull off the mask.  They look to see what really lies behind”.

The power to pierce the corporate veil, though, is to be exercised “reluctantly” and “cautiously” and the burden of establishing a basis for disregard of corporate fiction rests on the party asserting such claim.

The circumstances which have been considered significant by the courts in actions to disregard the corporate fiction have been “rarely articulated with any clarity”. This is true because the circumstances necessary vary according to the circumstances of each case and every case where the issue is raised is to be regarded as sui generic (to be decided in accordance with its own underlying facts.)

Various Cases in which corporate veil can be lifted.

Protection of Revenue

The court may ignore the corporate entity where company is used for tax evasion.  Tax planning may be legitimate as it is within the framework of the law.  Where it is desired to determine for tax purposes the residence of a company the court will lift the veil and find out where its central management is, and that place will determine the residence of the company.

Prevention of fraud or improper conducts

The legal personality of a company may also be disregarded in the interest of justice where the machinery of incorporation has been used for some fraudulent purpose. In Jones v Lipman (1962) All ER 442. L agreed to sell certain land to J.  He subsequently changed is mind and to avoid the specific performance of the contract, he sold it to a company which was formed specifically for that purpose.  L and a clerk of his solicitors were the only members. J brought action for specific performance against L & and the company.  The court looked at the   reality of the situation, ignored transfer and ordered that the company should convey the land to J. 

Determination of character of a company whether it is enemy.

A company may assume an enemy character where persons in de facto control of its affairs are residents in an enemy country. In Daimler Co. v Continental Tyre & Rubber Co. Ltd (1916) a company was incorporated in England for the purpose of selling in England tires made in Germany by a German Company which held bulk of shares in the English company.   The holders of remaining shares except one, and all the directors were Germans, resident in German. During the First World War, the English company commenced an action for recovery of a trade debt. Held:  The Company was an alien company and the payment of the debt to it would amount to trading with enemy, and therefore the company was not allowed to proceed with the action.

Where the Company is a sham or is formed to avoid legal obligations

Where the use of an incorporated company is being made to avoid legal obligations the court may disregard the legal personality. Nicole & Sandra partners, sell their business to Benja and undertake not to start a similar business and not to compete with Charles for certain number of years.  After some time they form a private company, become the principal shareholders and directors and start a similar business.  The court may restrain the company from carrying business.

In the case of Gilford Co. Ltd v Horne (1933) Ch. 935 C.A. Horne a former employee of a company was subject to a covenant not to solicit its customers.  He formed a company to carry on a business which, if he had done so personally, would have been a breach of the covenant.  An injunction was granted against him and the company to restrain from carrying business.  The company was described in a judgment as “a device, a stratagem” and a as a mere crack or sham for the purpose of enabling the defendant to commit a breach of his covenant against solicitation.”

Protecting public policy

The courts invariably lift the corporate veil to protect public policy and prevent transactions contrary to public policy. In the case of Connors v. Connors Ltd (1940) 4 All ER 174 it was held that where there is a conflict with public policy, the court will lift the veil of incorporation.

Statutory lifting

Apart from judicial considerations, the exercise may also be carried out statutorily under the provisions of Companies Act e.g. where the number of members is reduced bellow the statutory minimum

Enlightenment to Business associations 

One must also not confuse a business with a company.  For that purpose it is important to appreciate distinction between Sole Proprietorship, a Partnership & a Company:

Sole Proprietorship: This is an individual carrying on business either in his own name or in an assumed name which is usually referred to as the Trade Name. For example:  Mr.Kagya buys diamonds from Kenya and sells it to Malawi.  He does so in his own name.  The law permits Mr. Kagya to make his purchases of diamonds and to sell it to any person whether in Tanzania or elsewhere. As with any business he will have a capital, some assets, liabilities from time to time and profits or losses. As with all business, if need be, he is required to register his business under the Business Names Registration Ordinance and any other relevant law.  He is required to file tax returns and he is taxed on his profits. He merely has to satisfy the Tanzania Revenue Authority of the extent of his profit or loss from his own balance sheet which need not be audited.  The TRA may require him to audit his balance sheet if there is suspicion as to his income or expenses. As the business grows Mr. Kagya may hire employees, consultants, and establish branch offices. In all respects Mr.Kagya is running a business but is not a company. Mr. Kagya may at the beginning adopt a trading name or register a trading name later.  For example he may call is business “Nshomi Trading Company”.  As far as the General Public is concerned they will be dealing with a business called Nshomi Trading Company.  However the legal position is that it is Mr. Kagya trading as Nshomi Trading Company. If a supplier or buyer of diamonds wishes to institute proceedings against the business he would do so against “Mr. Kagya trading as Nshomi Trading Company.  The liability of Mr. Kagya is personal.  If there is a judgment against Mr. Kagya he is personally responsible to satisfy the judgment.  In the event of a judgment being entered against him he will have to pay up the damages that are assessed against him personally.  If he cannot satisfy the judgment he runs the risk of being declared bankrupt by the judgment creditor. 

It is important to remember that a sole proprietor is personally responsible for his liabilities.  So too, he is the only person entitled to profits.  He need not share his profits.

When two or more people join together for a common purpose, usually the purpose of doing business for profit, such an association is called a Partnership.  Partners do business under a trade name for instance Mr. Kagya of the Sole Proprietorship can bring in his friend Mr. Lau as a partner and can trade under the name of Nshomi Trading Company.  For purposes of the law it really means Kagya and Lau trading in partnership under the name and style of Nshomi Trading Company. The Partnership has an existence of its own to the extent that it can sue and be sued in its own name.  However, the consequences of a liability against the partnership are that each of the partners is fully liable to the entire extent of the debt. In law, each partner is the agent for the other.  The act of one partner binds the firm and the other partners.