Legal Briefing

Behind the corporate veil: is that all there is?

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Corporate and commercial | 01 December 2013

That companies have an existence entirely separate to that of their shareholders and directors is a foundational principle of English law and commerce.

But, however much historians and economists (and economic historians) may enjoy surveying the grand historical sweep of the development of trade and increasing prosperity, and the role of the company in that story, the practical effect of the company’s separate legal personality can cause difficult questions to arise in the day-to-day practice of law. 


Of course, for most corporate organisations and entrepreneurs, being able to limit liability in relation to a particular business venture to a particular subsidiary is so commonplace, and such a significant part of managing risk, that without it a great deal of commercial activity would simply become impossible or uneconomic. However, the corollary is that the ability of those who own and run companies to limit their liability and disguise the true decision-makers behind any number of activities can result in perceived unfairness when things go wrong.

For the commercial lawyer, this is particularly the case where fraud is suspected. The desire to cut away structures and focus on the wrongdoing of particular individuals, and to seize assets which have been hidden in corporate entities as a result of those individuals’ wrongdoing, causes victims of fraud and other wrongdoing to try to chip away at the very principles which they otherwise rely on without question.

For the courts, likewise, the desire to do justice has to be set against the need to preserve the company as a functioning unit of so much business activity.

The question arises, therefore, in what circumstances will the court go behind the company’s separate legal personality in order either (i) to make the company liable for the acts of its shareholders; (ii) to make shareholders liable for the acts of the company; or (iii) to enforce rights against the company which a claimant has against its shareholders? In other words, when will the court pierce the corporate veil, and have the courts found any other ways to do justice when circumstances require it?

In answering these questions, this article first considers piercing the corporate veil in light of the recent case of Petrodel v Prest [2013], before considering other ways in which the courts have sought to avoid the consequences of the separate legal personality of a company.

PIERCING THE CORPORATE VEIL: THE POSITION FOLLOWING PETRODEL V PREST

As well as cases of fraud and other wrongdoing in the course of business, the other area in which the courts have most frequently been asked to be creative in their approach to companies has been in the family division of the High Court in divorce cases.

The Matrimonial Causes Act 1974 (s24(1)(a)) permits a judge to order that property of one spouse (A) be transferred to another (B) where A is ‘entitled’ to that property, ‘either in possession or reversion’. This language was clearly intended to capture both equitable and legal interests. However, the family division has, over the last few decades, gone further and interpreted this provision as giving them the power to transfer assets held by companies in which (for example) spouse A has shares and which he or she controls. This is despite the fact that being an owner of shares does not, by itself, give rise to either legal or beneficial ownership of the company’s assets. What the family division had been doing, in effect, was to look through the separate legal personality of a company and attribute the company’s assets directly to a shareholder.

When considering what assets should be transferred between spouses, the Matrimonial Causes Act requires (in s25 (2)(a)) the court to have regard to the financial resources which each spouse has or is likely in future to have. There is no dispute that money from companies or the benefit of assets held by companies which a spouse owns or controls can fall within the scope of this provision. The controversial issue is the court, having carried out this exercise, deciding that assets held by companies are assets to which one spouse is ‘entitled’, and requiring their transfer to the other spouse on that basis.

This practice was brought into sharp focus in Petrodel v Prest. This was a particularly bitterly contested divorce case in which the court at first instance found that a number of properties held by offshore companies (of which Petrodel was one) were ones to which the husband, Michael Prest, was ‘entitled’, and accordingly ordered their transfer to his former wife, Yasmin. The companies appealed the decision and succeeded in the Court of Appeal. The Court of Appeal was extremely firm in its rejection of the family division’s approach and overturned the order requiring transfer of the properties.

Mrs Prest then appealed to the Supreme Court. The reason that the case became of wider significance is that Mrs Prest’s appeal provided an opportunity for the Supreme Court to clarify the general law in relation to piercing the corporate veil. This is of immense interest, because there had previously been some doubt about whether it was even possible ever to go behind the corporate veil, and whether, even if it were possible, this could ever be of use to potential claimants.

The Supreme Court’s judgment (led by Lord Sumption QC) confirmed that there were, indeed, limited circumstances in which the corporate veil could be pierced, but gave the strong impression that this may ultimately be of limited value to claimants seeking redress for wrongdoing.

In this regard, the Supreme Court held the following:

  • It is a central tenet of English law that the person who owns a company is separate and distinct from the company itself. This doctrine goes back to the 1897 case of Salomon v A Salomon & Co Ltd, and any exceptions to this rule are limited.
  • The phrase ‘piercing the corporate veil’ has been much misused. There are two principles which it has been used in connection with. The first is the ‘evasion principle’; the second is the ‘concealment principle’.
  • The ‘evasion principle’ involves making a company liable where its separate legal personality has been used to frustrate legal rights which third parties may have against its owner. This is what is properly described as ‘piercing the corporate veil’: the company’s separate legal personality is discarded and its owner’s actions, and liabilities, are treated as being those of the company itself.
  • As an example of the evasion principle, Lord Sumption cited Gilford Motor Co Ltd v Horne [1933]. Mr Horne was bound by restrictive covenants in relation to his conduct following departure as managing director of Gilford. In order to avoid those restrictions, he set up a company which (he said) was able to trade in breach of the restrictions because it had never been a party to Mr Horne’s original covenants. However, the Court rejected Mr Horne’s attempts to evade his covenants and made an order restraining the company from carrying on business where such business would (if it had been conducted by Mr Horne) have been in breach of the restrictive covenants. On Lord Sumption’s analysis, it did so because the company had been used to enable Mr Horne to evade his legal obligations, and so the company should (despite its separate legal personality and the fact it had not been a party to the restrictive covenants) be bound by those obligations.
  • The ‘concealment principle’, on the other hand, is ‘legally banal’: it means that the court will not allow a wrongdoer to use corporate vehicles to conceal their true identity and responsibility for wrongs committed. This is not disregarding a company’s separate legal personality and so is not piercing the corporate veil in the strict sense; the court is simply uncovering the true facts which the use of companies is attempting to conceal.
  • The concealment principle involves establishing that (for example) a company is acting as agent of its shareholder(s), or a nominee, thus permitting the Court to look behind the company and make orders against the principals. So, for example, despite the fact it was Mr Horne’s company in whose name business activities were being carried out, Mr Horne himself was liable for its actions because in practice he was the one carrying out those activities and the company’s actions were, in effect, his actions because he controlled it. The company was simply a ‘mere cloak or sham’. There was no need to pierce the corporate veil to justify an order against Mr Horne; the question for Court was simply to establish what was really going on.

Lord Sumption considered that the more limited evasion principle had been properly applied by the courts in only a small number of cases. As well as Gilford v Horne, Lord Sumption referred toJones v Lipman [1962], in which, in an attempt to evade an order for specific performance of a sale of a property which he regretted, Mr Lipman sold the property to a company wholly owned and controlled by himself. Despite the company not being party to the original sale contract, and despite a third party, a bank who was the company’s main creditor, suffering as a result, the company was ordered to transfer the property to the original purchaser. As with Gilford v Horne, the company was being made liable because its separate legal personality was being disregarded.

However, Lord Sumption also pointed out that:

‘… 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’.

Indeed, Lord Sumption’s fellow judges were even less sure about the scope of the doctrine. Lord Neuberger thought that there is (despite Lord Sumption’s efforts) a ‘lack of any coherent principle in the application of the doctrine of “piercing the corporate veil”’ and the other judges doubted whether the neat distinction between Lord Sumption’s concealment and evasion principles could be maintained. Therefore, although the principle of piercing the corporate veil exists, its value is relatively limited. What had occasionally been thought of as a wide doctrine enabling creative remedies against those who (for example) commit fraud, has in fact been confirmed as a very narrow principle whose application is likely to be very rare.

OTHER RECENT CASES WHICH HAVE CONSIDERED WHEN THE CORPORATE VEIL MIGHT BE PIERCED

The relatively restrictive nature of the principle of piercing the corporate veil which Lord Sumption outlined was demonstrated by the 2012 case (prior to the judgment of the Supreme Court inPrest) of Alliance Bank JSC v Aquanta Corp & ors [2012]. The judgment was concerned with the question of whether the English court had jurisdiction over proceedings (so it did not make any factual findings or ultimately decide whether claims could be proved). Alliance was a bank which alleged it was the victim of a $1.1bn fraud. It was alleged that the defendants (among whom were a number of companies) had procured loans from Cypriot banks, which were supported by US Treasury notes owned by Alliance but held in custody accounts as security for the loans. The defendant companies defaulted on the loans and Alliance had to surrender the US Treasury notes. Alliance claimed that (through subrogation of the banks’ interest in the loans) it had a contractual claim under the loan agreements against the companies which borrowed the money; and, significantly, it also had a contractual claim against the owners and controllers of the companies, again under the loan agreements. The owners, Alliance claimed, were to be held directly contractually liable under the loan agreements entered into by the companies and the separate legal personality of the companies should therefore be cast aside.

The defendants challenged jurisdiction on a number of grounds, including that the contractual claim against the individual defendants was ill-founded, but at first instance it was held that it was possible (following Antonio Gramsci Shipping Corp v Stepanovs, again a decision on jurisdiction) to pierce the corporate veil in this way.

However, what appeared to be a novel extension of the doctrine was rapidly halted by the judgment of the Supreme Court in VTB Capital v Nutritek International Corporation & ors [2013] deciding, again, a jurisdiction issue on similar facts. It found there was no justification for piercing the corporate veil by making shareholders liable for contracts entered into by a company and no proper basis for it under English law. As a result, not only did VTB’s claim fail, but Alliance was then forced to withdraw its claim against the individual defendants; the claims in Gramsci, which by that point had gone to trial pending judgment, ultimately failed as well. It was noted in a further judgment in the Gramsci litigation that the Supreme Court’s decision in Prest was the final nail in the coffin of the argument which the claimants in the Gramsci, Alliance and VTB cases had sought to make.

WHAT ARE THE OTHER OPTIONS FOR POTENTIAL CLAIMANTS?

In light of the above, the question arises as to how the problems created by the separate legal personality of a company can be avoided by those seeking redress for wrongdoing.

There remain a number of possible avenues, some of which have been considered in recent cases.

Prest itself is an example where the Court found an alternative remedy. The Court found that, rather than there being a need to pierce the corporate veil, it was in fact the case that the companies held the properties on trust for the husband, who was thus beneficially entitled to them (which brought them within the reach of s24(1)(a) of the Matrimonial Causes Act). Adopting a trust analysis when a claimant is seeking to bring into play assets held by companies can be an effective means of stopping wrongdoers from using companies to evade their obligations. Of course, such an analysis will always be highly fact specific, but it is a helpful remedy, and one which is unique to common law jurisdictions.

In R v Peter Sale [2013], the Court considered the application of asset seizure provisions under the Proceeds of Crime Act 2002. The Crown was seeking to seize from a man convicted of corruption, Mr Sale, a figure equal to the profits of a company owned and controlled by him which were referable to his corrupt activities, on the basis that those profits should be treated as his benefit from criminal conduct. It was argued by Mr Sale that doing so would be an illegitimate piercing of the corporate veil; but the Court held that, instead, the concealment principle in Prest was engaged and that the Court accordingly was entitled to make an order against Mr Sale for seizure of an amount equal to his company’s profits on the basis that the activities of the company merely concealed the fact that the corrupt activities which the company had undertaken were for Mr Sale’s benefit and at his instigation. A remedy was therefore found without needing to pierce the corporate veil in the narrow sense of Lord Sumption’s evasion principle.

Sometimes, it may be possible and appropriate to bring a company into proceedings on the basis that the knowledge of one of its owners or directors may be attributed to the company itself, thereby making it an author of wrongdoing and thus liable to third parties who were the victims of the fraud perpetrated by the person controlling the company. In this way, a company’s assets may be opened up to the victims. This approach was adopted, for example, in El Ajou v Dollar Land Holdings plc [1994]. Likewise, when a company is used as a vehicle to perpetrate a fraud by its owner, the owner’s knowledge can be attributed to the company (see for example Moore Stephens (a firm) v Stone & Rolls Ltd (in liquidation) [2008]). The law in this area is extremely complex but can yield helpful results for claimants.

Finally, in Chandler v Cape Plc [2012], a holding company was found liable for the negligent activities of its subsidiary without the need to pierce the corporate veil. This decision arose in the context of asbestos-related claims. The defendant company owned a subsidiary which had employed Mr Chandler to load bricks. He contracted asbestosis from dust from an asbestos factory on the site on which he worked. The subsidiary which operated the site no longer existed, but the holding company did. It was found that, on the facts, the holding company had assumed responsibility for health and safety at the subsidiary (for example, by employing a group medical adviser and scientific officer) and so had assumed responsibility for breaches of duty in relation to asbestos dust by the subsidiary. This meant that a liability which it was thought was located only in the subsidiary was in fact that of the holding company as well. The Court achieved this result without piercing the corporate veil and instead focused on the specific relationship between the company and its subsidiaries. In reality, this was a highly fact-specific case and the Court’s mind was clearly influenced by the holding company’s group-wide medical supervision arrangements. But the case does show that holding companies may not be immune from the liability of their subsidiaries.

In short, then, potential claimants are likely to find in future that going behind a company’s separate legal personality is both difficult and unlikely to assist them in finding remedies against potential defendants.

However, the English Courts have developed a range of alternative legal avenues for claimants to use in order to obtain redress, particularly in cases of especially egregious wrongdoing. Those avenues are not always easily navigated, but the courts will be sympathetic to claimants with merit on their side. As Denning LJ put it in Lazarus Estates Ltd v Beasley [1956]:

‘No court in this land will allow a person to keep an advantage which he has obtained by fraud… fraud unravels everything.’

By Charles Lloyd, partner, and Jonathan Arr, senior solicitor, Macfarlanes LLP.

E-mail: charles.lloyd@macfarlanes.com; jonathan.arr@macfarlanes.com.