INTRODUCTION
One of the obvious
attractions of the corporate form to those wishing to run a business is the
separate existence of company from its members and the limited liability of the
latter. Although some creditors, usually large ones, may seek to leap over the
barrier of limited liability by seeking personal guarantee of those involved in
the business, there is no doubt that this doctrine does restrict the extent of
the recovery which many creditors can achieve upon the company’ insolvency, at
least if they have not been able to obtain a position of priority in relation
to the company’s assets by taking an appropriate security
On the other hand
the doctrine of limited liability encourages public investment on companies by
those who do not have the time continuously thereafter to monitor the
activities of the company’s management.
The argument in
favour of Limited Liability Company was won decisively in nineteenth century.
However the law has been left with the question of whether limited liability,
although the normal situation, should also be incapable of exception, say, in
case of “abuse” or in relation to group of companies, where the question is
whether the single company or the group as a whole should be regarded as a legal
entity.
With or without
limited liability the existence of a company as a separate legal entity within
which a number, sometimes a large number, of people have come together to
effectuate a common purpose, raises question about how relations among this group
are to be most effectively arranged and about how they are to organize the
running of the business.
In addition, how is
the company, an artificial entity which can act only when the acts of human
being are attributed to it by law, to represent and bind itself against
outsiders?
Finally the
existence of this doctrine, by excluding creditor’s recourse to the assets of
individual members or directors, forces the law to create special rule to
protect the asset of the company for the benefit of the creditors.
LIFTING THE VEIL
What is generally
described as “lifting the veil” has until quite recently aroused little
attention and even less theoretical discussion in Nigeria. It is a favorite
topic in USA where the veil is lifted more readily.
Nevertheless it has
always been recognized that “ the legislature can forge a sledgehammer capable
of cracking open the corporate shell”
and even without the aid of a legislative sledgehammer the courts have
sometimes been prepared to have a crack. In cases where the veil is lifted, the
law either goes behind the corporate personality to the individual members or
directors, or ignores the separate personality of each company in favour of the
economic entity constituted by a group of associated companies. The latter
situation is often merely an example of the former, the individual members
being corporate, rather than human, beings but even when that is so the two
situations are worth distinguishing since there seems to be a greater readiness
to lift the veil in the latter.
Before dealing with
exceptional situations in which the veil is lifted, it should be emphasized
that the veil never means that the affairs of the company are completely
concealed from view. On the contrary, the legislature has always made an
essential condition of the recognition of corporate personality with limited
liability that it should be accompanied by wide publicity. Although third
parties dealing with the company will normally have no right to resort against
its members, they are nevertheless entitled to see who those members are, what
shares they hold and in the case of a listed company, the beneficial interest
in those shares if substantial. They are also entitled to see its official are(
so that they know with whom to deal), what its constitution is, etc.
Normally, however,
third parties are neither bound nor entitled to look behind such information as
the law provides shall be made public; in addition to the veil of
incorporation, there is something in the nature of a curtain formed by the
company’s public file, and what goes on behind it is concealed from the public
gaze. But sometimes this curtain may be raised. For example, an inspector may
be appointed to investigate the company’s affairs, in which case he will have
the widest inquisitorial powers; indeed he may even be appointed for the
purpose of going behind the company’s registers to ascertain who its true
owners are. It is not always so easy to decide whether one is faced with a true
example of lifting the veil or with a raising of the curtain and some of the
examples dealt with hereafter should perhaps be regarded as lifting the curtain
(rather than the veil)
SOME OF THE EXAMPLES ARISING UNDER THE EXPRESS WORDS OF A STATUTE ARE:
Reduction of number
of members:
Under section 24 of
the COMPANY’S ACT, if a public company carries on business for more than six
months with fewer than two members any person who is a member after that six
months may become liable, jointly and severally with the company, for the
payment of its debt. This rule is the final and probably now insupportable
remnant of a legislative policy which attached significance to the number of
members of a company as a protection for those who deal with it. The limited
liability Act of 1855 applies only to companies with 25 members and as late as
1980 public companies had to have at least seven members. But the requirement
was effectively undermined by the decision in Salomon’s case, and since
parliament chose not to reverse the decision, the requirement of members has
ever since be capable of being met through the use of bare nominees. The rule
was all but abolished by the twelfth company law directives on single-member
private limited liability companies which had the consequence that private
companies limited by shares or by guarantee were excluded from section 24.
This section does
not operate to destroy the separate personality of the company; it still
remains an existing entity even though there is one member only, or, indeed,
although there is none. And the rights which the section confers on creditors
are limited. It is only the member who remains after the six months that can be
sued. (not those whose withdrawal has led to the fall below the minimum) and
then only if he knows that it is carrying on business with only one member and
he is liable only in respect of debt contracted after the six months and while
he was a member. The crowning anomaly is that liability attaches only to a
member and not to a director unless he is as well a member.
Although the facts
giving rise to a possible application of the section are of not infrequent occurrence,
it seems rarely to be invoked, doubtless because of the limitations considered,
and with the exclusion of most private companies from the scope of the section
in 1992. It constitutes an exception to the general rule of theoretical
interest rather than practical importance.
FRAUDULENT OR WRONGFUL TRADING
An example of far
greater practical importance has long been afforded by provisions which, until
1986, were in section 332 of the companies Act 1948. This created a specific
but widely defined criminal offence of carrying on the business of the company
with intent to defraud. It further provided that, if the company was in the
case of winding up, the court will declare that the culprits were to be
personally liable, without limitation of liability, for all or any of the debt
or other liabilities of the company to the extent that the court might direct.
In the legislative reforms of 1985-1986 the criminal offence became section 458
of the Company’s Act but the civil sanction was moved to sections 213-215 of
the insolvency Act 1986 and following the recommendation of cork committee extended
to” wrongful trading” involving a lesser degree of moral culpability. It is
with the later section that we are concerned with and they constitute what is
probably the most extreme departure from the rule in Salomon’s case yet
achieved in the United Kingdom.
These provisions
recognize that the separate entity and limited liability doctrines are capable
of being abused and that the benefit of them should be removed from the
abusers. Abuse in the shape of hiding behind limited liability to effect fraud
is easy to identify, as the long standing provisions against fraudulent trading
indicate.
More significant are
the recently added provision on wrongful trading which, in effect, make access
to limited liability dependent upon objective standard of competence on the
part of controller of companies, at least during the period when insolvency
threatens and the controllers are under the greatest incentive to take
advantage of companies creditors. As we shall see below, this statutory
innovation has had a significant impact upon the court’s development of the
general common law duty of care to which directors are subjects.
Section 231 dealing
with fraudulent trading, is generally the same as the relevant provision of the
former section 332 and decision on the later remain relevant. It provides that:
(1) If in the curse of the winding up of the company it
appears that any business of the company has been carried on with intent to
defraud creditors of the company or creditors of any other person or for any
fraudulent purpose…”
Then;
(2) “The court on the application of the liquidator may
declare that any persons who were knowingly parties to the carrying on the
business in(that) manner are to be liable to make such contributions(if any) to
the companies asset as the court think proper.”
Hence, unlike the
criminal offence now in the companies Act, it applies only if the company is in liquidation
and, in contrast with the former section332, application for the declaration
can be made only by the liquidator. But the class of persons against whom the
declaration can be made is far wider than member or directors. Hence the
government when less reluctant than it now is to rescue “lame duck” and banks
and parent companies have at times felt inhibited from providing finance to
ailing companies, fearing that they may thereby fall foul of the provisions.
Their fears, however, seems unfounded so long as they play no active role in
running the company with fraudulent intent.
To establish that
intent, what has to be shown is “actual dishonesty involving, according to
current notions of fair trading among commercial men, real moral blame”. That
may be inferred if “a company continues to carry on business and to incur debts
at a time when there is, to the knowledge of the directors, no reasonable
prospect of the creditors ever receiving payment of those debt”, but cannot be
inferred merely because they ought to have realized it. It is this proves to prove
subjective moral blame that led the Jenkins committee in 1962 vainly to
recommend the introduction of a remedy for “reckless trading” and the cork
committee, 20 years later, successfully to promote it under the name of
“wrongful trading”.
Wrongful trading is
dealt with in section 214 of the insolvency Act. It empowers the court to make
a declaration similar to that under section 213 but only in one specific set of
circumstance. It operates only when the company has gone into insolvent
liquidation and the declaration can be
made only against the person who, at some time before the commencement of the
winding up, was a director of the company and knew, or ought to have concluded,
at that time, that there was no reasonable prospect that the company would
avoid going into insolvent liquidation.
But the declaration
is not to be made if the court is satisfied that the person concerned thereupon
took every step with a view to minimizing the potential loss to the company’s
prospect of avoiding insolvent liquidation, he ought to have taken. In judging
what fact he ought to have known or ascertained, what conclusion he should have
drawn and what step he should have taken, he is to be assumed to be a
reasonable diligent person having both the general knowledge, skill and
experience expected of a person carrying out his function in relation to the
company and the general knowledge, skill and experience that he generally has.
There are in fact
two questions that needs to be answered, both on an objective basis. Should the
director have realized there was no reasonable prospect of the company avoiding
insolvent liquidation and, once that stage has been reached, did the director
take all the steps he or she ought to have taken to minimize the loss to the
company’s creditors, especially, no doubt, by seeking to have the company cease
trading? Both these judgment will depend heavily on the fact of each case: what
sort of company was involved, what were the functions assigned to or discharged
by the director in question, what outside advice was taken and what was its
content?
Moreover, and this
is of considerable importance for a number of reasons, for the purpose of
section 214 “directors” includes “ shadow director”, i.e. a person, other than
a professional adviser, in accordance with whose direction or instructions the
directors of a company are accustomed to act. This considerably widens the
class of persons against whom a declaration could be made. The two potential
defendants of greates interest are, once again, banks and parent companies. Ass
far as the former are concerned, the courts have so far taken a cautious line, on
the ground that the definition of a shadow director required that the board
cede its management autonomy to the alleged shadow director and that the taking
of steps by the bank to protect itself does not include such a cession, if the
company retains the power to decide whether to accept the restrictions put
forward by the bank, even though the company may be thought to have no
practicable alternative.
In relation to parent
companies, such a degree of the cession of autonomy by the subsidiary may be
more easily found, but much will still depend upon how exactly intra group
relationships are established. The degree of control exercised by parent
company may vary from detailed day to day control to virtual independence, with
many variations in between. It would seem that the establishment of business guild
lines within which the subsidiary has to operate would not make the parent
inevitably a shadow director of the subsidiary.
Thus, whether the
court will take the opportunity afforded by the wrongful trading provisions to
rationalize the legal position of the group of companies remains to be seen.
Section 214 is
expressly stated to be “without prejudice” to section 213 and there may well be
cases where the circumstances will justify an application by the liquidator under
both.
Indeed, section 215
contains certain procedural provisions common to both fraudulent and wrongful
trading. Most of these repeat, in substance, provisions in the former section
332: for example, that on an application for a declaration, the liquidator may
give or call evidence and that the court may add further directions for giving
effect to any declaration it makes and in particular, may direct that the
liability of any person against whom the declaration is made shall be a charge
on any debt due from the company to him or on any mortgage or charge in his
favour on assets of the company.
And both sections
213 and 214 have effect not withstanding that the person concerned may be
criminally liable. What is new and valuable is that section 215 also provides
that the court may direct that the whole or any part of the debt and interest
thereon, owed by a company to a person against whom a declaration is made,
shall be postponed to all other debts, and interest thereon, owed by the
company.
It was accepted in
Re Produce marketing that the jurisdiction under section 214 was primarily
compensatory, in contrast to assessment under section 213 where a penal element
may be appropriate.
The outer boundaries
of the compensation are thus set by the amount by which the company’s assets
have been depleted by the director’s conduct. Within that the court has discretion
to fix the amount to be paid as it thinks proper. It seems that the
contribution from the director is to the assets generally and not to the
particular benefit of those who became creditors of the company during the
period of wrongful trading. What is less clear is whether the contribution can
be caught by a floating charge previously granted by the company. The better
view is that it cannot, certainly, the opposite view will defeat the policy
espoused by cork committee, which was to improve the position of the unsecured
creditor. On the other hand the liquidator may be unwilling to sue except in
the strongest cases, and if the contribution goes into the hands of the general
creditors, the bank will have no incentive to fund it either.
ABUSE OF COMPANY NAME OR EMPLOYMENT OF DISQUALIFIED DIRECTORS
The insolvency Act 1986 added further example
of cases where the manager of a company may become liable for its debt and
other liability. A common abuse has been for those responsible for the running
of a company which had gone into insolvent liquidation to from another company,
with an identical or very similar name, which bought the undertaken and other
asset from the original company’s liquidation and in which they continued to
trade.
At best this was
likely to mislead and confuse customers, at worst it was a deliberate fraud.
Section 216 of the insolvency Act now makes it an offence for anyone who was a director
or shadow director of the original company at any time during the 12 months
preceding its going into insolvent liquidation to be in any way concerned
(except with the leave of the court or in such circumstances as may be
prescribed) during the next five years in the formation and management of a
company, or business, with a name by which the original company was known or
one so similar as to suggest an association with that company, the first and
the most important of the prescribed cases is where the successor company
purchases the whole of the insolvent companies business from an insolvency
practitioner acting for the company and gives notice of the name the successive
company intends to use to all the creditors of the insolvent company. This
suggests that the aim of the section is the protection of the creditors of the
insolvent company rather than that of the new company. The insertion of the
insolvency practitioner is intended to ensure that the sale by the insolvent
company is not at an under value and the notice to the creditors ensures that
they are not mislead into thinking that they may assert their own claim against
the new company.
A person acting in
breach of section 216 is, under section 217 personally liable, jointly and
severally with that company and any other person so liable, for the debt and
other liabilities of that company incurred while he was concerned with its management
who acts or is willing to act on the instruction given by a person whom he
knows, at that time to be in breach of section 216
Similar consequence
applies to a person against whom a court order has been made under the company director’s
disqualification Act1986.
Section 15 of the
Act provides that if such a person acts in the management of the company in
contravention of the order, both he, and any other person concerned with the
management of that company who is willing to act on his instruction despite
knowing he is disqualified are jointly and severally liable with the company
for its debt contracted during that time.
It will be observed,
that these sanctions though similar in their consequences to sections 213 -215
of the insolvency Act, differ from them in that they apply without the need for application to, and
declaration by, the court though the person concerned may apply to the court to
be granted leave.
They differ also in
that in that the sanctions apply to conduct, not in relation with the company
that has gone into liquidation, but in relation to another company or business
whether that or not goes into liquidation.
MIS-DESCRIPTION OF
THE COMPANY
On ordinary agency
principle the officers of a company will, of course make themselves personally
liable, not withstanding that they are acting for the company, if they choose
to contract personally; for example by not disclosing that they are acting on
behalf of the company.
But the company’s
Act has gone further. What is now section 349(4) of the company’s Act 1985
provides that if any officer of the company or other persons acting on its behalf:
“Signs or authorizes
to be signed on behalf of the company any bill of exchange, promissory note, endorsement cheque or order for money
or goods in which the companies name is not mentioned (in legible
characters)…he is…liable to a fine and that he is further personally liable to
the holder of the bill of exchange, promissory note , cheque or order for money
or goods for the amount of it (unless it is duly paid by the company) “
The result of this
is that if the correct and full name of the company does not so appear, the
signatory will be personally liable to pay if the company does not. And it
seems clear that it makes no difference that the third party concerned has not
been misled by the description.
However, as a result
of what is now section 27 of companies Act, the use of the authorized
abbreviation “ltd” or “plc” instead of
the full prescribed suffix “limited” or “public limited company” (or the welsh
equivalent) is permissible. And the abbreviation of company to “co” has been
held to be acceptable.
Furthermore the
holders conduct may estop him from enforcing the liability of the signatory;
for example where he has written the document with the misdiscription and
submitted it for signature. In any event the liability of the signatory is very
important only if the company is insolvent.
If the signatory is
authorized to act on its behalf, it will not escape liability, although
misdescribed, so long as its identity can be established, and if the signatory
is successfully sued, he will be entitled to be indemnified by the company.
On the company’s
insolvency, however it affords the holder a remedy which may be wholly
unmeritorious. It might be a useful reform to amend the subsection by affording
a signatory a defense if he could establish that the holder had not been misled
by the misdescription; the recent decision display a marked disinclination to
apply the provision when that is so.
PREMATURE TRADING
Another example of
personal liability in the companies act is in section 117(8). Under the
section, a public limited company, newly incorporated as such, must not “do business or exercise any borrowing power”
until it has obtained from the registrar of companies, a certificate that it
has complied with the provisions of the Act relating to the raising of the
prescribed minimum share capital or until it has re-registered as a private
company.
If it enters into
any transaction in contravention of this provision, not only are the company as
it on officer in default, liable to fines but if the company fails to comply
with its obligation in that connection within 21days of being called upon to do
so, the directors of the company are jointly and severally liable to indemnify
the other party in respect of any loss or damage suffered by reason of the
company’s failure to comply.
Whether this is a
true example of lifting the veil is questionable; technically, it does not make
the directors liable for the company’s debt but rather penalizes the directors
for any loss the third party suffered as a result of the director’s default in
complying with the section.
But the effect is
likely the same. It is however unlikely to be invoked often since it is unusual
for companies to be formed initially as a public company.
COMPANY GROUPS
Reference has
already been made to the growth of groups of companies and to the failure of
English company legislation to adapt adequately to this phenomenon. Nevertheless
it has long been recognized that, in relation to financial disclosure, the
phenomenon cannot be ignored if a true and fair view of the overall position of
the group is to be presented and that accordingly when one company (the parent
or holding company) controls others (the subsidiary and the sub- subsidiary
companies) the parent company must present group financial statements as well
as its own individual statement, thus avoiding the misleading impression which
the letter alone might give.
Having taken this
step and prescribed criteria for determining when a parent subsidiary relation
was established, use of the concept was extended to other areas. A further
complication aroused when it was thought desirable to provide for financial
disclosure regarding some companies over which the degree of control was not
such as to make them subsidiary within the meaning of the statutory definition.
This is not the
place to describe in detail the highly technical statutory provisions. It
suffixes to summaries briefly and ignoring many refinement and qualification,
their general effect in the light of the changes resulting from the implication
of the servant company law directive by the companies Act 1989 which introduced
a distinction between parent and subsidiary undertaken (relevant in relation to
financial statements) and holding company and subsidiaries (relevant to other
statutory provisions)….
MISCELLANEOUS STATUTORY EXAMPLE
In addition to the
forgoing examples culled from the companies and other related legislation,
scattered throughout the statute book are to be found many examples of
modification of the corporate entity principle. This is particularly the case
under taxation; the Revenue, not surprisingly has been astute to secure the
passage of legislation “capable of cracking open the corporate shell”. When
this is being used for purposes of tax avoidance and has occasionally done so
to mitigate the burden of taxation if a strict application of the corporate
entity principle would be unduly harsh and inhibiting. Mostly, statutory inroad
has been in relation to groups (using the companies act definition of holding
and subsidiary companies or some lesser degree of common control) or to
situation arising on a change of control. Illustrations of both occur in
the employment legislation relating to
redundancy and unfair dismissal, under which changes of employment within the group from one company
to the other or as a result of mergers are not treated as breaking the period
of continuous employment. Another illustration occurs in relation to rights
under business tenancies. Under the landlord and tenant Act of 1954, as amended
by the law of property Act1969, when either the landlord or the tenant is a
company its right under the act may enure for the benefit of other companies in
the group and reversing a decision in which the court has refused to lift the
veil, an individual landlord may be able to recover possession if he requires
it for the purpose of the business carried on, not by him, but by a company
which he controls.
Nevertheless the
court have generally been reluctant to construe a statute as lifting the veil
unless compelled to do so by the clearest words of the statute. The classic
illustration is the refusal of the house of lords in Nukes v. don caster
amalgamated collieries to construe what is now section 427 of the companies Act
1985 as meaning that an order made there under transferring the property and
liabilities of one company to another on a reconstruction could operate to
transfer a contract of personal service; and this not withstanding that the
section specifically provides that “property” includes property, rights and
power of every description.
To lord Akin the
contrary interpretation would have been “tainted with oppression and confusion”
and would have subverted “the principle
that a man is not to be compelled to serve a master against his will…[which] is
deep seated in the common law of this country”.
Yet, had the whole
share capital of the transferor company being transferred instead of the under taken, the man would have been compelled
to serve what in reality, was a new master.
The employee is
better protected by recognizing the continuation of the enterprise but
providing him with right to payment for redundancy or unfair dismissal if he is
not kept on. And this is now recognized in respect of transfer of the
undertaken ( where the effect of the Nokes decision has been reversed) under
the influence of EC social law.
UNDER CASE LAW
Efforts by the
judges to lift the veil have in general been hamstrung by the Salomon’s case
which finally destroyed the possibility of regarding a one man company as a
mere alias of, or agent for, the principal shareholder. Perhaps, the most
extreme illustration of a refusal to lift the veil is afforded by Lee v. Lee
Air Farming Limited. There Lee for the purpose of carrying on his business of
aerial top dressing had formed a company of which he beneficially owned all the
shares and was sole governing director.
He was also
appointed chief pilot pursuant to the company’s statutory obligation he caused
the company to insure against liability to pay compensation under the work men’s
compensation Act. He was killed in a flying accident.
The court of appeal
of new Zealand held that his widow was not entitled to compensation from the
company ( that is from the insurer s) since Lee could not be regarded as a
worker ( i.e. servant) within the meaning of the Act.
But the Privy
Council reversed that decision holding that Lee and his company were distinct
personalities which had entered into contractual relationship under which he
became, qua chief pilot, a servant of the company.
In his capacity of
governing director he could on behalf of the company give himself order in his
order capacity of pilot, and hence the relationship between himself, as pilot,
and the company was that of servant and master. In effect, the magic of
corporate personality enabled him to be master and servant at the same time and
to get all the advantages of both (and of limited liability).
Nevertheless there
have been exceptional cases in which the court have been able to lift the veil and until
recently there were perhaps signs of a greater willingness to do so. Indeed as
recently as 1985 a judgement of the court of appeal declared that:
In our view the
cases… shows that the court will use its power to pierce the corporate veil if
it is necessary to achieve justice irrespective of the legal efficacy of
the corporate structure…
A view emphatically
rejected by the court of appeal in the case of Adams v. Cape Industries Plc. In
that important case the court in a mammoth judgment involving a number of
issues, subjected lifting the veil to the most exhaustive treatment that it has
yet received in the English (or Scottish) courts.
The fact of the case
were somehow complicated but for present purposes it suffices to say that what
the court had ultimately to determine was whether judgment obtained in the
united state against Cape, an English registered company whose business was
mining asbestos in s. Africa and marketing it worldwide would be recognized and
enforced by the English court.
In the absence of
submission to the foreign jurisdiction this depended on whether Cape could be
said to have been “present” in the United States. On the facts the answer to
that question depended upon whether Cape could be said to be present in the
united states through its wholly owned subsidiary or through a company (C.P.C)
with which it has close business links.
In contending that
Cape had been present in the United States the plaintiff raised three arguments
which are
1. The “single
economic unit” argument
2. “The corporate
veil” point
3. The agency argument
CONCLUSION
Where then does this
leave “lifting of the veil’’? Well”, considerably more attenuated than some of
us would wish. There seems to be three circumstances only which the court can
do so. These are:
1.
When the court is
construing a statute, contract or other document;
2.
When the court is
satisfied that a company is a “merely facade’ concealing the true facts;
3.
When it can be
established that the company is the authorized agent of its controller or its
members, corporate or human.
And
number 2 only is a true example of lifting the veil; in number one and three
the separate personality of the company is not denied but the practical effect
on the parties’ rights and liability is the same as if it had been. The court
cannot lift the veil merely because it considers that justice so requires.