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Company Law Essay

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It has been a long established principle of Company Law that the corporate personality is a separate legal entity distinct from its members. (Salomon v Salomon & Co. (1897) However, there are circumstances in which the courts might find it appropriate to dispense with this principle and ignore the principle of separate corporate personality by ‘lifting the corporate veil’ so to speak. Yet, the courts have not been as prepared to pierce the veil of the corporation as they have been to protect it.

Salomon v Salomon & Co. gave birth to the separate legal personality of the corporation.

In this case, Mr. Salomon, who was conducting business as a leather merchant formed a company which he called Salomon & Co. Ltd in 1892. His shares were distributed among his wife and children, each of whom held one share each, for Mr. Salomon. This was necessary at the time because the law requires that the company consist of at least seven shareholders. It is also important to note that Mr.

Salomon was the managing director of the company. (1897) Salomon & Co. Ltd. purchased the leather business which Mr. Salomon estimated to be worth 39,000 pounds. Mr.

Salomon based this valuation on his view that the business was bound to be a success rather than the actual value at the time of purchase. The funds were paid as follows: 1) 10,000 pounds worth of debenture stocks leaving a charge over all of the assets of the company and 2) 20,000 pounds in 1 pound shares and 9,000 pounds in cash. At this juncture, Mr. Salomon paid off all of the creditors of the business. As a result, Mr. Salomon held 20,001 shares in Salomon & Co. Ltd. and his wife and kids held the remaining 6 shares. Also, as a result of the debenture, Mr.

Salomon was a secured creditor of the company. (Salomon & Salomon Co. Ltd. 1897) The leather business floundered and within a year Mr. Salomon ended up selling all of his debentures so as to salvage the business. This did not work out the way Mr. Salomon planned and the company was unable to pay its debts and consequently went into insolvent liquidation. The company’s liquidator alleged that Salomon & Co. Ltd. was nothing but a sham serving as an agent for Mr. Salomon. Therefore Mr. Salomon should be held personally liable for the company’s debts.

The Court of Appeal agreed with this finding and held that a company’s shareholders were required to be a bona fide organization with the intention of going into business rather than just for the purpose of meeting the statutory provisions for the number of shareholders. (Salomon & Salomon Co. Ltd. 1897) The House of Lords reversed the decision of the Court of Appeal holding as follows:- 1) It was not relevant for the purposes of determining the genuineness of a company’s formation that some shareholders were holding shares for the purpose of forming the company pursuant to relevant statutory provisions.

In fact, it was perfectly legal for the procedure for registration to be used by a person for the purpose of conducting a one-man business enterprise. 2) Moreover, a company that was formed pursuant to the regulations provided in the Companies Acts is a separate legal person and was not therefore an agent or trustee for the controller. Therefore the company’s debts were its own and were not the debts of its members.

The liability of the members would be limited in proportion to the shares that they each held. (Salomon & Salomon Co. Ltd. 1897) Salomon v Salomon & Co. Ltd. has stood up well against the test of time. In Macaura v Northern Assurance Co. [1925] AC 619 the House of Lords held that in the same way that the company’s liabilities are the company’s and the shareholders, the assets are also the company’s rather than the shareholders. (Macaura v Northern Assurance Co. [1925]) In Barings Plc (In Liquidation v Coopers & Lybrand (No. 4) [2002] 2 BCLC 364 a parent company suffered a loss as a consequence of the loss incurred by one of its subsidiaries.

It was held that the subsidiary was the proper party to commence an action in respect of the loss. This rationale followed the rationale in Salomon v Salomon & Co. Vis-a-vis the loss was that of the subsidiary and was therefore that company’s liability rather than the parent company’s liability. The subsidiary was a separate legal entity from its parent company. (2002 p 364) This ruling was closely followed in both Gile v Rhind [2003] as well as Shaker v Al-Bedrawi {2003].

In Re Southard &Co Ltd Templeton [1979] 3 ALL ER 556 at 565 LJ said that A parent company may spawn a number of subsidiary companies, all controlled directly or indirectly by shareholders of the parent company. If one of the subsidiary companies, to change the metaphor, turns out to be the runt of the litter and declines into insolvency to the dismay of its creditors, the parent company and other subsidiary companies prosper to the joy of the shareholders without any liability for the debts of the insolvent subsidiary. ’(Re Southard &Co Ltd Templeton [1979] 3 ALL ER 556 at 565)

Lee v Lee’s Air Farming, a New Zealand case, is another good example of the court’s reluctance to pierce the corporate veil. In this case, in 1954 Lee started a company called Lee’s Air Farming Limited. Lee owned all of the shares of the company and was the company’s Governing Director. In addition, Lee worked for the company as its chief pilot. He died in a plane crash while flying the company plane and his wife tried to claim damages via the company’s insurance scheme under the Workers’ Compensation Act. (Lee v Lee’s Air Farming [1961])

The New Zealand Court of Appeal rejected the widow’s claim that Lee was a worker within the meaning of the Workers’ Compensation Act and the case went to the Privy Council. The Privy Council found that Lee’s Air Farming Limited was an entirely different legal entity from Lee and legal relationships between the two were perfectly permissible. Moreover, the Privy Council found that Lee, as Governing Director could indeed give order to himself in his capacity as chief pilot. Therefore a master/servant relationship did exist between the two and Lee was in that respect a ‘worker’ within the meaning of the Act.

Indeed, as seen in the cases discussed above the courts aggressively protect the separate legal identity of the corporate citizen. However, there have been legislative intervention whereby specific situations have been defined where it would be appropriate to pierce the corporate veil. For example Sections 213 and 214 of the Insolvency Acts make it possible for the lifting of the corporate veil in cases of fraud and wrongful dealing. (The Insolvency Act 1986 Sections 213 and 214) Section 213 is often referred to as the ‘fraudulent trading’ provision. (Dignam & Lowry 2006 Ch. )

This section arises if the court is satisfied that company carried on any of its business ventures with the intention of defrauding the company’s creditors or the creditors of anyone else. Section 213 will also arise if the court finds that the company acted for any other fraudulent reason and persons involved in those fraudulent ventures can be found liable for the company’s debts. In order to satisfy the court of the existence of fraud Section 213 requires proof of ‘actual dishonesty, involving, according to current notions of fair trading among commercial men, real moral blame’. The .

Section 214 does not impose as onerous a burden or standard as does Section 213. It is not necessary to prove an intention to defraud. Section 214 applies to the period just before a company begins winding up procedures. Section 214 arises when the court is satisfied that the directors either knew or ought to have known that the company was becoming insolvent and continued to trade anyway. The director can be liable for the company’s debts in these instances. (The Insolvency Act 1986 Section 214)

Section 227 of the Companies Act 1985 makes further provision for lifting the veil of the corporation. This section arises in instances where it is necessary to require the production of group members or group accounts to verify whether or not a subsidiary’s financial activity is that of the holding company. (Companies Act 1985 Section 227) The judiciary has also demonstrated a will to lift the corporate veil whenever the ends of justice desire it to be done. The circumstances in which the court will ignore the corporate veil are ill-defined and the impression is that these circumstances are developed on a case by case basis.

Professor Gower said that ‘challenges to the doctrines of separate legal personality and limited liability at common law tend to raise more fundamental challenges to these doctrines, because they are formulated on the basis of general reasons for not applying them, such as fraud, the company being a “sham” or “facade”, that the company is the agent of the shareholder, that the companies are part of a “single economic unit” or even that the “interests of justice” require this result. ’ (Davies 2003 p 184) Adams v Cape Industries Plc [1990] Ch 433 is viewed by Gower and Davies as the leading case on the exceptions to the corporate veil.

In the case the Court of Appeal said that it is not satisfied that the ‘court is entitled to lift the corporate veil as against a defendant company which is a member of a corporate group’ merely on the grounds that the company was used to shield a member of that group from future liabilities of the company. As a matter of fact, the Court of Appeal maintained that this was a legal right by adding ‘whether or not this is desirable, the right to use a corporate structure in this manner is inherent in our corporate law. ’(Adams v Cape Industries Plc [1990] Ch 433)

The courts tend to be rather inconsistent with its position on the grounds upon which it will displace the laws protecting the corporate veil. While Adams v Cape Industries Plc was very strict in its position in favor of safeguarding the corporate veil, the House of Lords was rather liberal in DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852. In the latter case Lord Denning speaking of a parent company and its subsidiary holdings said, ‘these subsidiaries are bound hand and foot to the parent company and must do just what the parent company says’.

He went on to say ‘this group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point’. (DHN Food Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852) It wasn’t long before the courts departed from the position taken by Lord Denning. Woolfson v Strathclyde R. C [1978] SLT 159 the House of Lords took issue with Denning’s view on the nature of holding companies and the groups under them.

The Lords maintained that the corporate veil would not be displaced unless it was shown that the company was a facade. (Woolfson v Strathclyde R. C [1978] SLT 159) In Trustor AB v Smallbone (No. 2) [2001] 1 WLR 1177 the court was adamant that the corporate veil would only be lifted in three circumstances. They were, 1) if the court was satisfied on the evidence that the company was a mere sham or facade, 2) the company itself was involved in some impropriety or 3) where the interest of justice required it. (Trustor AB v Smallbone (No. ) [2001] 1 WLR 1177)

Earlier cases identified appropriate circumstances where the court might find that a company was indeed a facade. In Gilford Motor Company Ltd. v Horne [1933] Ch 985 the court found that the company was a facade. In this case an employee bound by a covenant not to solicit the business of his employers, left his employment and set up a company which he used to breach the covenant. The employee argued that while he was bound by the covenant, the company was not. (Gilford Motor Company Ltd. v Horne [1933] Ch 985)

In another case the defendant signed an estate contract with the plaintiff for the sale of realty to him. The defendant changed his mind and formed a company, transferring the realty to the company. He claimed that he was no longer the owner of realty and therefore no bound to the terms of the estate contract. The court found that the company was a mere facade for the defendant and he was ordered to sell the realty as per the estate contract. (Jones v Lipman [1962] 1 WLR 832) The Court of Appeal identified three instances in which it would be appropriate for the corporate veil to be lifted.

The court said, ‘save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon v A. Salomon & Co Ltd [1897] AC 22 merely because it considers that justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies, which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities. (Adams v Cape Industries Plc [1990] Ch 433)

Adams has effectively narrowed the circumstances in which the courts will intervene and lift the corporate veil. This is unfortunate since changing times together with the complex development of both the corporate structure and company law, the Salomon v Salomon & Co. rule is in reality perhaps out of place today. (Gallagher & Zeigler 1990) Although there have been times when the courts have shifted away from this ruling it remains the poster child for the criteria to be met when determining whether or not to life the veil of the corporation.

The prevailing attitude is to safeguard against lifting the corporate veil. Question 2b) The doctrine of majority rule has been a long established principle of Company Law within the English Legal System and makes it difficult for minority shareholders to take legal action in respect of majority shareholder improprieties. That said, Rebecca as a minority shareholder is protected to a limited extent by the provisions of Section 459(1) of the Companies Act 1985. The development of the common law doctrine of majority rule was enunciated in Foss v Harbottle.

The rationale behind Foss was that any difficulties within the structure of the company ought to be dealt in the general meetings of the company by ratification by the majority shareholders. The prevailing attitude of the courts was one of nonintervention. It would only step in if it was for the purpose of dissolving the business. The facts of Foss v Harbottle reveal that in 1835 a company, Victoria Park Company purchased land in the Manchester primarily for residential purposes.

Thomas Harbottle, a director of Victoria Park Company had purchased the property and resold it to Victoria Park Company who eventually developed the property. Richard Foss and Edward Turton, shareholders of Victoria Park Company brought an action against Thomas Harbottle alleging breach of fiduciary duties in that he sold the property to the company at an inflated price. Turton and Foss also claimed that, acting outside of their powers as directors the directors had burrowed funds in the name of the company.

The court held that plaintiffs had no locus standi, and that they were required to have obtained the company’s approval to commence legal action. This approval is properly obtained by virtue of a general meeting. In Foss v Harbottle, Wigram VC explained that ‘the corporation should sue in its own name and in its corporate character, or in the name of someone whom the law has appointed to be its representative. ’ It would therefore only be permissible in exceptional cases of serious abuse that minority shareholders could sue the company as a defendant.

This explains the relatively strict approach adopted by the courts in deciding representative forms of actions in the guise of minority shareholder oppression. Jenkins LJ in Edwards v Halliwell explained the justification of the majority rule doctrine in Foss v Harbottle when he said ‘the rule in Foss v Harbottle, as I understand it, comes to no more than this. First, the proper plaintiff in an action in respect of a wrong alleged to be done to a company or association of persons is prima facie the company or the association of persons itself.

Secondly, where the alleged wrong is a transaction which might be made binding on the company or association and on all its members by a simple majority of the members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that, if a mere majority of the members of the company or association is in favour of what has been done, then cadit quaestio’.

This is where Section 459(1) of the Companies Act 1985 is important to Rebecca in respect of what appears to be ‘insider dealing’, mismanagement and perhaps even fraud. Section 459(1) of the Companies Act 1985 provides as follows:- Any member of a company may apply to the Court by petition for an order under this section on the grounds that the affairs of the company are being or have been conducted in a manner which is unfairly prejudicial to some part of the members (including at least himself) or that any actual or proposed act of omission of the company (including an act of omission on its behalf) is or would be so prejudicial. ’

David Partington, notes rather bluntly, that the discretion contained in Section 459 is very broad and perhaps infinite. ‘The breadth of s. 459 means that there must be an infinite range of situations in which it may be employed. Partington goes on to say that the courts have been extremely flexible in their application of the term ‘unfairly prejudicial. ’ The test for ascertaining whether or not conduct is ‘unfairly prejudicial’ is an objective test rather than a subjective one.

The defendant’s motives are often times not of paramount importance to the courts. In Re Bovey Hotel Ventures Ltd. it was held that ‘the test …. is whether a reasonable bystander observing the consequences of (the defendant’s) conduct would regard it as having unfairly prejudiced the petitioner’s interests. The remedies are no longer limited to ‘winding up’ procedures and this of course explains the wider discretion for commencing an action by minority shareholders. Among the remedies available are, rectification, injunctive or ‘buyout relief. ’ By virtue of ‘buyout’ relief, the court makes an order requiring the company to purchase the shares of the petitioning minority shareholders. This is perhaps the best course for Rebecca to follow.

She might not wish to remain a part of a company in which she has all but lost faith in. Re Sam Weller & Sons Ltd. rovides some useful guidance as to the kind of conduct that might amount to ‘unfairly prejudicial’ within the meaning of the 1985 Act as amended. For example, failing to pay a dividend in the absence of a sound commercial explanation for such a failure amounts to ‘unfairly prejudicial’ conduct’. In Sam Weller’s case the dividend had already been covered 14 times with the company declaring it for the past consecutive 37 years. In interlocutory proceedings, Gibson LJ denied the company’s application to strike out the petitioner’s claim noting that the company had a case to answer.

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