Corporate Veil Essay
In the main, traders and business people are risk averse; as a result, in whatever they do they always fight for risk minimization. The aforementioned factor –i.e. of minimizing risk- contributes, to a significant extent, for the decisions by traders and businessmen to forming companies. Consequently, traders and businessmen will see as the main attraction of forming a company the advantage of avoiding liability for business debts. This advantage arises from the concepts of separate legal person and limited liability which are embodied in the doctrine of corporate veil under company law. However, some businessmen, law scholars and the public at large argue that corporate veil is nothing but a fallacy meant to dupe business people into a false sense of security. The following presentation seeks to discuss this assertion, bringing out the significance and exceptions of the concept of corporate veil. The doctrine of corporate veil emanate from the ruling of the case of Salomon vs Salomon 1897, whose facts are as follows: Aron Salomon was a successful leather merchant who specialized in manufacturing leather boots.
For many years he ran his business as a sole proprietor. Salomon decided to incorporate his business as a Limited company, Salomon & Co. Ltd. Mr. Salomon himself was a managing director who owned 20,001 of the company’s 20,007 shares – the remaining six were shared individually between the other six shareholders (wife, daughter and four sons). Mr. Salomon sold his business to the new corporation for almost £39,000, of which £10,000 was a debt to him. He was thus simultaneously the company’s principal shareholder and its principal creditor. The company almost immediately ran into difficulties and only a year later the then holder of debentures appointed a receiver and company went into liquidation. Its assets were sufficient to discharge the debentures but nothing was left for the unsecured creditors. The liquidator argued that the debentures used by Mr. Salomon as a security for debt were invalid on the grounds of fraud; hence Salomon was not a genuine incorporator. The foundation of company law came by the ruling made by the House of Lords in the Salomon case.
It was held that Salomon’s company was a legal person separate from Salomon and since Salomon had become a secured creditor of the company, he had to be paid first before all other creditors. Once legal personality was established, the issue of shareholding could not be necessary. In concurrence with the Houses‟ (court) finding Lord McNaughten at P 51 said; “The company is at law is a different person altogether from the subscribers…..and though it may be that after incorporation, the business is precisely the same as it was before and the same persons are managers and the same hands receive profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent that in the manner provided by the Act”. It is always hard to exaggerate the significance of the case of Salomon Vs Salomon and Co Ltd in terms of its contribution to company law globally. By recognizing an incorporated firm as a corporate legal persona, it led to the creation of the corporate veil which brought a hatful of benefits to the business people.
A corporate veil is defined as a legal concept that separates the personality of a corporation from the personalities of its shareholders, and protects them from being personally liable for company’s debts and other obligations (m.businessdictionary.com). In other words, the corporate veil can be described as being the separation between a company and its members. Due to the separate legal status of a company from its members this is usually very strictly maintained. This will, on the other hand, provide a true sense of security to business people. As a separate legal persona, a company has; a limited liability, perpetual succession, ownership of property, rights and obligations in its own name and easy borrowing means as its features which are of great importance to investors and other stakeholders.
These features make a company enticing to business people. The corporate veil plays a pivotal role in maintaining the corporate legal persona status of a company, hence providing entrepreneurs with a less risky means of pursuing ideas and projects in the business world as they enjoy the benefits arising from the characteristics of the concept of separate corporate persona.
One of the benefit arising from an incorporated company that of limited liability. According to Anton Behr, “Stand behind the veil of incorporation is the principle of limited liability that the court will use to prescribe that a company will be responsible for all the debts that have been incurred instead of its shareholders or members. In the case of Tatro v. Citigroup, Inc. D.R.I. March 15, 2010 where the courts recognized limited liability of manager under Georgia law and dismissed claims against manager because complaint did not allege facts plausibly suggesting direct knowledge or personal involvement by manager in alleged fair credit reporting violations by the limited company. This gives the shareholders a great level of security. They are able to profit from the successes of the company whilst being safe in the knowledge that their personal liability is limited to the value of the shares they have purchased. Limited liability is even enforced in S7 of company act. However, it may not be attractive to potential creditors who may require additional security for their loan. Furthermore; a company, through the effect of the corporate veil, holds property in its own name as illustrated in the case of Macaura v Northern Assurance Co ltd (1925) wherein Mr Macaura had insured timber under his own name and this was then destroyed by a fire.
When Mr Macaura claimed for compensation, his claim was rejected on grounds that he did not have insurable interest since a company is a separate legal persona distinct from Macaura. As a result, by owning its own property, a company gives more security to its members than if when a leaving director was able to enforce a sale and division of any company property he owned. Pursuantly, the shareholders’ investments are made more attractive and secure. However, this may be to the detriment of a trader as in Macaura case. Another benefit flowing from the concept of corporate veil is of efficiency. As soon as it is recognised that a company is a distinct, legal person in itself then the company can create contracts in its own name. As a result, trade is made simpler when it involves complex commercial organisations. Members of different races and background can also benefit in trading in some areas where they are not personally allowed under the shield of the corporate veil.
For example in the case of Dadoo Limited V Krugersdorp Municipality where there existed during the apartheid regime legislation which prohibited non-whites from owning land in a certain area which was reserve for whites only. Mr Dadoo was an Asian and he formed a company called Dadoo Limited and it bought land in the white area and set up business there. The municipality sought to enforce the legislation and remove Dadoo from the place. It was that Dadoo Limited was a company and enjoyed legal personality separate from its members. A company could not be said to be white or Asiatic as race/ colour did not have any effect on the legal personality of the company. Equally important, the company can sue or be sued on its name as illustrated in the case of in the case of Foss v. Harbottle (1843). Held: The action could not proceed as the individual shareholders were not considered as proper plaintiff. He held that a wrong was committed against the company, and only the company could take the legal action. The members did not have legal standing to sue the wrongdoers because the members and the company were separate legal entities. By shielding the company from its members, the corporate veil enables perpetual succession of an incorporated company.
It can only be subsequently terminated by the law the conditions for which are specified in S206 of CA 24-03. Unlike people, companies are immortal and will continue to exist after the exit or death of its members by the process of perpetual succession. Even if all the members die, it will not influence the privileges, immunities, estates and possessions of a company. The principle of perpetual succession is clearly illustrated in the case of Re Noel Tedman Holdings Pty Ltd (1967).The company had a husband and a wife as its only shareholders. They were also the company’s directors. They died in an accident, leaving behind an infant child. After their death the company was still in existence. The problem that arose was, as the shareholders and directors had died, the shares could not be transferred according to the will of the deceased to the infant child. The court thus allowed the personal representative of the deceased to appoint directors of the company, so that these directors could allow the transfer of the shares to the child.
Therefore, the company may even continue to exist despite the death of all its shareholders and directors. It will last until it is deregistered or ‘wound up’ On the contrary; even though the corporate veil is one of the main advantages of establishing a company as it will provide a liability protection against lawsuits and creditors, it also crucial to note that there are times where there are some exceptional circumstances where the court would ignore it and strip the company members’ and shareholders’ limited liability that they enjoy. This is called the “lifting of the corporate veil,” which is defined as a legal decision which will treat the rights and obligations of a corporation as the rights or liabilities of its owner. In this case, the members will be responsible in carrying out their fiduciary duties towards the company. If they act in bad faith, the court will lift the company veil and they shall have a personal liability (ammangomolly.blogspot.com) Lifting the corporate veil writes off the sense of security once instilled in business people. Generally, the corporate veil is lifted through two ways namely by judiciary evasion and statutory evasion.
The former involves the use of common law to lift the veil. The courts have the following exceptions to peep behind the corporate veil: Firstly, where there is fraud and improper conduct. The Courts will not allow the corporate veil to be used as an engine of fraud. The Courts have been more that prepared to pierce the corporate veil when it fells that fraud is or could be perpetrated behind the veil. This is shown in the case of Gilford Motor Company Ltd v. Horne. Mr. Horne was an ex-employee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company. In order to defeat this, he incorporated a limited company in his wife’s name and solicited the customers of the company. The company brought an action against him. The Court of appeal was of the view that “the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne”. The Court of appeal regarded it as a mere sham to cloak his wrongdoings since it was clear that the main purpose of incorporating the company was to perpetrate fraud.
Secondly, courts also lift the corporate veil where the principle of corporate personality runs contrary to state interests. This exception supports the concession theory which holds that legal personality is just a concession by the state or a privilege granted by the state which the state may withdraw at any time. For example, as was held in case of Daimler Company V Continental Tyre Company. Daimler was a German company and during the course of the business, it came to be owed money by continental Tyre Company. World War 1 broke out and Daimler Company claimed the money owed to it by Continental Tyre Company which refused to pay arguing that since Daimler was a German Company and German was at war with England, paying Daimler Company the money would be tantamount to trading with an enemy. The court upheld the argument. The courts may also apply the agency construction to lift the corporate veil by holding that a wholly owned subsidiary would be acting as an agent of the holding company. This was clarified in the case of DHN Food V London Borough Of Tower Hamlet.
There were two companies, one holding the other a subsidiary. The subsidiary was wholly-owned but using land which belonged to the holding company. The municipality wanted to compulsorily acquire land but it was supposed to compensate the owner of the land if he disturbed him in business. The question was whether the holding company was disturbed in business. It was held that the holding company was entitled to compensation since the subsidiary company was acting as its agent. The corporate veil can also be lifted by the use of the Companies Act; this is known as statutory evasion. The following sections of the Zimbabwe Companies Act explain the situations on which the corporate veil can be lifted leaving the members of the company liable: Section 32 – imposes personal liability on a member who knowingly allows a company to carry on business for a period of more than 6 months without members.
Section 58 and 59 – imposes civil and criminal liability for misstatements contained in the prospectus. Section 124 – imposes liability on directors who fail to properly hold statutory meetings. Section 126 – directors are liable for failing to hold an extra-ordinary general meeting. Section 186 – directors are liable for failing to disclose interests which they have in company contracts. Section 318 – directors are liable for fraudulent conduct of the company business. Consequently, lifting the corporate veil leaves the members of the company without security which is the reason why some people say the corporate veil is a fallacy.
In the eyes of the law removing the shield of incorporation discourage business people from using a company as a vehicle of fraud hence serving justice. To sum up, it is certainly true that some of the implications of the corporate veil have proved damaging some of the time. However, it is submitted that the benefits generated as a consequence of the corporate veil hugely outweigh the negative effects that it has had.
GOULDING SIMON, COMPANY LAW SECOND EDITION 1999
MAVHUNGA. M. (UZ) CORPORATE LAW AND BUSINESS ADMINISTRATION STUDY PACK NCUBE LISON (NUST), COMMERCIAL LAW 1204 MODULE, 2014
COMPANIES ACT CHAPTER 24:03