To Strictly Maintain the Salomon Principle or Not: That is the question?
By Vivek Khanna LLB, LLM, Barrister at Law
Introduction
The purpose of this paper is to discuss the apparent failure by the courts to
maintain the principle that the company is a separate legal entity, which was
established in the case of Salomon v A Salomon & Co Ltd1. In the light of
the formalistic approach taken towards the Companies Act by the House of
Lords in Salomon, it would seem particularly difficult to pierce the strict
legal rule of the separate legal entity of the company. However, in the
absence of any statutory regulations it has been the role of the courts to
deviate from the legal fiction.
Firstly, this paper will examine the case of Salomon v Salomon to determine
the exact nature and importance of the Salomon principle of separateness
often referred to as the ‘veil of incorporation’. Secondly, this paper will
examine how when limited liability is coupled with the Salomon principle a
company may be used as a vehicle for fraud. Thereafter, this paper will
briefly introduce some of the mechanisms, which are in place to prevent an
abuse of the corporate form.
Third, this paper turns its focus on when the courts are prepared to disregard
the Salomon principle to combat fraud or abuse of the corporate form. This
paper differentiates between ‘lifting’ and ‘piercing’ the metaphoric veil of
incorporation. It is submitted that ‘lifting veil’ does not in any true sense
erode or derogate from the Salomon principle because the courts in ‘lifting
the veil’ are merely suspending the application of the rule in Salomon. On
the other hand, it is submitted that ‘piercing the veil’ is the offensive act
which unsettles the rule in Salomon.
Fourthly, this paper begins its discussion of piercing the corporate veil with
an insight into how contemporary authors have approached the subject.
Ottolenghi, in his article ‘From Peeping behind the corporate veil to
ignoring it completely’,2 has provided a refined analysis of the cases
concerning the corporate veil. In an attempt to unearth fresh ideas in the
discussion of the corporate veil, this paper has selected to adopt the headings
used by the Court of Appeal in Adams v Cape Industries Ltd, 3 i.e. ‘agency’,
‘single economic entity’, and the ‘corporate-veil’.
Penultimately, this paper shall consider to what extent the law has been
clarified. On this point the paper shall conclude that although it is impossible
to extract an all encompassing principle it is possible to distil three separate
occasions where the court may pierce the veil. However, without the guiding
hand of legislation it remains impossible to lay out the exact parameters of
the rules, and to that extent difficult to pre-empt exactly when the courts will
pierce the veil. Finally, this paper will conclude that it is undesirable to
allow companies to take the benefits of the corporate entity principle without
having to suffer the consequences and to that extent it is necessary to limit
judicial inroads to instances of bad faith.
1
[1897] AC 22
[1990] 53 MLR 338
3
[1990] Ch. 433
2
The Salomon Principle: The Veil of Incorporation
The doctrine of separate legal personality is the cornerstone of modern
company law.4 It established that an incorporated company is an entity
separate from its shareholders and directors but not entirely free from their
existence. The case of Salomon v. Salomon & Co Ltd.5 is universally
recognised as authority for the principle that a corporation is a separate legal
entity.6 It created the idea that companies operate behind a metaphoric ‘veil
of incorporation’ which separates members from the company and permits
the company to be completely independent, with rights and duties distinct
from those possessed by its shareholders, directors and employees. The
company is deemed an artificial legal person,7 with independent existence.8
As Lord Macnaghten put it:
‘The company is at law a different person altogether from the
subscribers…’ 9
The practical need for a separation between a company and its members has
never been doubted since the decision in Salomon's case.10 The need for the
separate corporate entity has been justified on different grounds. Concession
theorists, for example, regard corporate personality as a privilege granted by
the state ‘thereby underlining the state's claim to control over the process of
incorporation and its subsequent use’.11 Similarly, the contractarian school
argues that ‘[c]orporation law reduces transaction costs by implying in
every corporate charter the normal rights on which shareholders could be
expected to insist’, such as separate legal status.12
In theory, Salomon's case was a good decision. By establishing that
corporations are separate legal entities, Salomon's case blessed the company
with all the necessary attributes with which to become the motivating force
of capitalism. However in practice and reality the separation of a legal entity
from its members can be problematic. By extending the benefits of
incorporation to small private enterprises, Salomon's case has provided a
loophole through which subscribers of a company can evade their legal
obligations. Despite its problems, the Salomon principle has stood the test of
time and remained in tact to preserve various practical functions for the
commercial market. Some of these functions include: perpetual existence,
flexibility, financing methods, specialised management and majority rule of
the corporation.13
Also available to subscribers of an incorporated company is the option of
forming a company with ‘limited liability’.14 Limited liability allows the
members of a company to limit their responsibility for a company’s debts.
4
Williams, ‘Fraudulent Trading’ [1986] 1 Companies and Securities Journal 14 at p. 14
(1897) AC 22 HL
6
This principle was already discussed in the earlier case of R v. Arnaud (1846) 9 QB 806.
7
Lee v. Lee’s Air framing [1961] AC 12, demonstrates the artificiality of the concept of separate legal
personality.
8
Ireland, P., ‘The Triumph of the Company Legal Form, 1856-1914’, in Adams, J., (ed), Essays for
Clive Schmitthoff, (1983), p.30
9
[1897] AC22, HL, at p. 51
10
Gower, Gower's Principles of Modern Company Law, (5th ed), (London: Sweet & Maxwell, 1992),
p 88.
11
Bottomley, S., ‘The Birds, The Beasts, and The Bat: Developing a Constitutionalist Theory of
Corporate Regulation’ (1999) 27 F L Rev 243.
12
Posner, R., Economic Analysis of Law, (1977), (2nd ed.), Boston: Little, Brown & Co, Boston, p. 302.
13
Pettet, B., ‘Limited Liability- A Principle for the 21st Century?’ [1995] CLP 125, p.151
14
s. 2(3) Companies Act 1985
5
1
This means the members of an insolvent company do not have to contribute
their own personal assets in the liquidation to meet the debts of the
company. Liability may be limited to a predetermined sum, payable on
winding up,15 or to the nominal value of the shares held, unless this sum has
been paid by the current or a former shareholder.16 Since most shares are
issued fully paid, shareholders have, effectively, no liability for the
company’s debts. Limited liability stimulates the economy as a whole,
through investment and business activity. It reduces the cost of separation of
management and control and reduces the need to monitor control. Limited
liability encourages companies to take on the optimal investment and
diversification of holdings that may be deemed negative risk taking by an
unincorporated trader.17
The Difficultly with Limited Liability and the Salomon Principle
Limited liability was very controversial when it was introduced because of
its effect of shifting the hazard of business breakdown away from investor(s)
to creditor(s) who had to bare the consequences of liquidation. This was
perceived to be unfair.18 The idea behind the controversy is whether limited
liability should be available for what is effectively a ‘one-man company’
often used to ‘defraud creditors’.19 Khan-Freund criticised Salmon as a
‘calamitous decision’20 and adhered to the view it is unjust to attribute
limited liability to a small company, where there is no business risk or need
to encourage outside investment.21
The Salomon principle when coupled with the consequential attribute of
limited liability provides an ideal vehicle for fraud.22 It has been argued the
Salomon principle is malleable and provides a facility for protecting
directors and members against the claims of creditors. The corporate form
has been responsible for the development of many different forms of
fraudulent activity.
An example of corporate fraud is where subscribers set up a limited liability
company that is ‘wafer-thin’ and undercapitalised. The owners then cause
the corporation to incur large debts in it’s own name, with little or no
prospect of being able to meet these debts. When the creditors seek
repayment, the owners argue that they are not liable for the debt because the
company as a separate legal person is the debtor.
A second example of corporate fraud is where assets of a corporation are
transferred to a new corporation for the purposes of avoiding tax liability.23
This transfer is often framed in a confusing series of transactions to conceal
the real design of the scheme. When funds are traced back to the new
‘vehicle corporate shell’, investigators will find ‘straw men’ have been
15
s. 2(4) Companies Act 1985 - A company limited by guarantee
s. 2(5) Companies Act 1985 - A company limited by shares
17
Easterbrook, and Fischel, ‘Limited Liability and the Corporation’ (1985) 52 University of Chicago
Law Review 89, p. 94
18
Ireland, P., ‘The Triumph of the Company Legal Form’, 1856-1914’, in Adams, J., (ed), Essays for
Clive Schmitthoff, (1983), p. 32 – 33.
19
Khan-Freund, ‘Some Reflections on Company Law Reform’, (1944), 7 MLR 54 at p. 56
20
Ibid. p. 54.
21
Goulding, S., Principles of Company Law (1996), London: Cavendish Publishing Limited, p. 49
22
Tomasic and Bottomley, Corporations Law in Australia, (Sydney: The Federation Press, 1995), pp
42 and 46 cited in Puig, G., V., ‘A Two-Edged Sword: Salomon and the Separate Legal Entity
Doctrine’, E Law - Murdoch University Electronic Journal of Law at
www.murdoch.edu.au/elaw/issues/v7n3/puig73a.html
23
This is termed the ‘Phoenix Syndrome’.
16
2
appointed in the place of original directors. The new asset rich corporation
will attempt to dissipate the assets by granting unsecured, interest-free loans
by the corporation to the directors or to companies in which they have an
interest and the payment of astronomical fees to directors for management
services or living expenses.24
Today for a small business the Salomon principle coupled with limited
liability is an illusory advantage, to some extent because creditors have
developed different capacities to protect themselves.25 Moreover, s. 213, 214
and 215 of the Insolvency Act 1986 impose liability for the debts of a
company where its subscribers have been engaged in fraudulent or wrongful
trading. Furthermore, negative aspects of the decision in Salomon's case,
have (arguably) been neutralised, through the understanding ‘The courts can
and often do draw aside the [corporate] veil. They can, and often do, pull off
the mask. They look to see what really lies behind.’26 This is a difficult
decision to make, because the courts have to decide whether to obey the
principle of the separate legal entity or recognise the need for ‘lifting’ or
‘piercing’ the corporate veil.
Lifting and Piercing the Veil
It is important at this stage to draw a distinction between ‘lifting’ and
‘piercing’ the corporate veil. In the case of Atlas Maritime Co. SA v Avalon
Maritime Ltd (No. 1)27 Staughton LJ deemed ‘lifting’ or ‘peeping behind’28
the corporate veil to mean having ‘regard to the shareholding in a company
for some legal purpose’.29 An example of this can be seen in Daimler Co
Ltd v Continental Tyre and Rubber Co (GB) Ltd30 where the court (after
war broke out with Germany), was prepared to lift the corporate veil of a
tyre company, to determine who was in control of the company. If the
company was controlled by enemy aliens, the company could also be
regarded as an enemy alien. It is submitted that the court when ‘lifting the
veil’ is momentarily suspending the Salomon principle to determine who
controls the company. Lifting the veil has been described as an act which is
the ‘least offensive to separate entity theory’ and is merely an ‘act of
curiosity’.31 In no true sense can we say that lifting the veil constitutes a
decomposition of the rule in Salomon.32
On the other hand, ‘piercing’ the corporate veil is an expression, which
describes where the court ignores the separateness of the company and
regards the rights, liabilities or activities of a company as those of its
shareholders. 33 Therefore, this paper seeks to address when the courts are
prepared to ‘pierce’ the corporate veil and derogate from the Salomon
principle, their reasons for doing so and their current legal stance.
24
DTI, Modern Company Law For A Competitive Economy: Final Report, (The Company Law
Review Steering Group, July 2001), paragraph 15.55 at www.dti.gov.uk/cld/final_report/ch_15.pdf
25
For example, the requirement, for small-incorporated companies to give guarantees in respect of the
company’s indebtedness.
26
Littlewoods Mail Order Stores Ltd. v. Inland Revenue Commissioners [1969] 1 W.L.R. 1241 at
1254 per Lord Denning M.R.
27
[1991] 4 All ER 769
28
As referred to by Ottolenghi, S., ‘From Peeping behind the corporate veil to ignoring it completely’, [1990]
53 MLR 338
29
Ibid. at p. 779 per Staughton LJ
30
[1916] AC 307
31
Ottolenghi, op.cit. p. 340
32
This point is arguable, but for the benefit of this paper lifting the veil is not regarded as having a
significant effect on the Salomon principle.
33
Ibid. at p. 779 per Staughton LJ
3
Furthermore is it possible or desirable to reduce these inroads into some
consistent principle?
How do we go about answering this question and what principles can we
rely on to determine when the veil will be disregarded? Ottolenghi highlights
there can be no restriction on the number of cases where the court will lift
the corporate veil.34 He feels the problem lies in trying to explain the
judgments that deviate from the strict Salomon principle.35 He proposes a
re-categorisation of the common nomenclature and detects four different
‘attitudes’ the court will adopt when deciding whether to ‘lift’ or ‘pierce’ the
corporate veil.36 It is submitted the analysis he offers goes some way
towards reconciling the common law in this area.37
As this paper seeks to critically discuss caselaw where the courts have
apparently failed to maintain the Salomon principle, it is more appropriate to
adopt the three categories laid down by the Court of Appeal in Adams v
Cape Industries Ltd, i.e.:38 ‘agency’, ‘single economic entity’, and the
‘corporate-veil’. These headings represent the circumstances in which the
court may be prepared to pierce the veil and they are each discussed below:
Agency
The principle of agency provides the first way of circumventing the
corporate entity rule while acknowledging the separate legal personality of
the company. The principle of inferring an agency - principal relationship
between a sole owner and a company, was envisaged by Vaughan-Williams
at first instance39 but expelled later by the House of Lords in Salomon. Lord
Herschell said: ‘In a popular sense, a company may in every case be said to
carry on business for and on behalf of its share-holders; but this certainly
does not in point of law constitute the relation of principal and agent
between them…’.40
Thus it would seem bold for subsequent cases to infer such a relationship.
However, this was the exact approach adopted by the court in Smith, Stone
& Knight v Birmingham Corporation.41 The case concerned a local
government authority compulsorily acquiring a location inhabited by The
Birmingham Waste Co. Ltd., a wholly owned subsidiary of Smith, Stone and
Knight Ltd. In order to claim compensation for loss of business, the parent
company had to establish that the subsidiary was its agent in conducting
business on the premises. All but five shares of the subsidiary were owned
by the parent company, and the residuary were held on trust by the directors
for the parent company. Furthermore, the parent company was in effectual
and constant control of the subsidiary, and its profits were treated as those of
the parent company.
Akinson J considered that in certain circumstances agency relationship
might be inferred and proceeded to lay down a six point criteria which
would tend to establish agency; viz,42 1) Were the profits of the subsidiary
34
‘[T]here can be no numerus clauses’, Ottolenghi, op.cit. p. 354
Ibid. 338
36
‘Pepping Behind the veil’, ‘Penetrating the Veil’, ‘Extending the Veil’, and ‘Ignoring the Veil’.
37
This method of looking at the subject of lifting the veil is also adopted by Lowry & Watson,
Company Law, (London: Butterworths, 2001), Chapter 3.
38
[1990] Ch. 433
39
Broderip v. Salomon (1895) 2 Ch. 323 at 332
40
Salomon v Salomon & Co Ltd [1897] AC 22 at 43
41
[1939] 4 All ER 116
42
[1939] 4 All ER 116 at 121 B
35
4
treated as the profits of the parent? 2) Were the persons conducting the
subsidiary’s business appointed by the parent company? 3) Was the parent
company the head and brain of the venture? 4) Did the parent company
govern the venture, decide what should be done and invested, etc.? 5) Did
the parent company make the profits from the venture by its own skill and
direction? and 6) Was the parent company in effectual and constant control?
The creation of such a six-point criteria test would clearly enable the courts
to infer agency where justice demands it. However, as Sealey notes ‘ if a
judge were, free to infer agency from the mere facts of control, more or less
at will, then the result would be that the veil could be lifted as often as [the
court] chooses and the law would be unpredictable.’ 43 Indeed, to make such
an inference where one has not been expressly stated as between the parties
would greatly dilute the Salomon principle. Furthermore, it is submitted that
any attempt to define the conditions from which agency may be inferred, in
terms of a test, results in its application to the facts of Salomon.
The decision in Smith, Stone & Knight v Birmingham Corporation can be
differentiated and reconciled with Salomon in terms of ‘capitalist control’
and ‘functionalist control’ of a company.44 Farrar highlights that Salomon’s
case concerned the control of the company by ownership of share capital,
which did not therefore invoke an agency.45 Conversely, functional control
is concern with who is running the company (this is the focus of five of
Akinson J’s criteria), and thus relevant to the determination of agency. This
reconciliation can be criticized because the precise nature of ‘capitalistfunctional’ division of control and ownership is not apparent and it cannot
be established from other cases before or since Smith, Stone & Knight v
Birmingham Corporation. 46
An attempt to solve the problem of agency was considered in Adams v Cape
Industries Ltd 47 where Slade LJ considered that although the court is bound
to investigate the relationship between the subsidiary and the parent
company, there was no presumption that a subsidiary was the company's
alter ego.48 This would indicate that agency must be proved on the evidence
to exist and may not be inferred from the control of a company or ownership
of its shares.49 Gower recognises in the absence of express agreement it
would be difficult to prove an agency relationship.50 This suggests in certain
circumstances, albeit rarely, an agency relationship may be inferred.
However, the question, which remains to be answered, is the extent to which
Smith, Stone & Knight v Birmingham Corporation is still applicable? It is
perhaps therefore not helpful to regard agency as a method of piercing the
veil but rather a device the courts use to piece the veil when they deem it
expedient to do so.
43
Sealy, L. S., Cases and Materials in Company Law, (6th ed.), (London: Butterworths, 1996) at p. 62
A distinction drawn by Professor Otto Kahn Freund in [1940] 3 MLR 226 cited in Farrar, Furey &
Hannigan, Farrar's Company Law, 4th ed., (London: Butterworths, 1998), p 7, also Pickering, M., A.,
‘The Company as a Separate Legal Entity’, (1968) 31 MLR 483, at p 494.
45
Farrar, Furey & Hannigan, op.cit. p 71
46
Pickering, M., A., ‘The Company as a Separate Legal Entity’, (1968) 31 MLR 483, at p 494
47
[1990] Ch. 433
48
[1990] Ch. 433 at 537
49
J. H. Rayner (Mincing Lane) Ltd. v. DTI [1989] Ch 72.
50
Gower, L., C., B., Principles of Modern Company Law, (6th ed.), (London: Sweet & Maxwell, 1997),
p. 173.
44
5
Single Economic Entity
A fundamental principle of company law is that within a group of
companies, each member is a separate legal entity. However the court will
when deemed appropriate ignore the separateness of its members and treat
them as one entity. Slade LJ51 in Adams v Cape Industries Ltd held that
there was no general principle that a group of companies is regarded as one.
On the contrary he concluded that the fundamental principle provided that
each company within a group is a single entity.52 Furthermore he considered
that the contention that the distinction will be ignored is fallacious.53
Although it is clear from the decision that regard to the economic realities
will, in certain circumstances, permit the court to hold a group of companies
to be one, the exact parameters of this rule remain unclear. The ambiguity
arises under the courts’ analysis of DHN Food Distributors v Tower
Hamlets London Borough Council.54 The Court of Appeal in Adams 55
considered DHN to have been decided upon the relevant statutory
provisions: i.e. for the purpose of the statute the court, having regard to the
economic realities, concluded that parent and subsidiary were one unit.56
However, in DHN Goff L.J. clearly considered (relying ‘on the facts of this
particular case’) that the court was ‘entitled to look at the realities of the
situation and pierce the veil.’57 As Gower recognises this would fit more
appropriately under the corporate veil heading.58 The problem arises as the
court clearly in Adams59 accepted the House of Lords Judgement in the
Scottish case of Woolfson v Strathclyde Regional Council60 that held that
the corporate veil might only be pierced where the company is a façade.61
What then remains unclear is whether the court while examining the
document or statute, having regard to the economic realities, needs to apply
the façade test? In Adams the court recognised ‘the relevant parts of the
judgment in the D.H.N. case …must we think, likewise be regarded as
decisions on the relevant statutory provisions for compensation…’.62 Gower
concludes that a façade concealing the true facts is not an essential element
in interpretation cases. He submits an additional analysis of whether a
company is a façade, is what distinguishes interpretation cases from
‘corporate veil’ cases.63
Some indication of the narrowness of the courts’ application of the single
economic entity rule may be extracted from the courts decision in Re Polly
peck International Plc (in administration).64 In that case the court rejected
the claim that the subsidiary and parent company were a single entity,
notwithstanding the fact that this allowed the bondholders to circumvent the
purpose of the document and claim separately against each company.
51
[1990] Ch. 433 at 532
He cited the Roskill L.J. as authority of this in the case of The Albazero [1977] A.C. 774, 807.
53
[1990] Ch. 433 at 536
54
[1976] 1WLR 852
55
[1990] Ch. 433 at 536
56
DHN Food Distributors v Tower Hamlets London Borough Council [1976] 1WLR 852 per Lord
Denning MR at p. 860 and per Shaw LJ at p. 867
57
[1976] 1WLR 852 at p. 861
58
Gower, L., C., B., Principles of Modern Company Law, (6th ed.), (London: Sweet & Maxwell, 1997), p. 168
59
[1990] Ch. 433 at 539
60
[1978] SLT 159
61
[1978] SLT 159 per Lord Keith of Kinkel at p. 161
62
[1990] Ch. 433 at 536
63
Gower, L., C., B., op.cit. p. 169
64
[1996] 2 All ER 433
52
6
The Corporate Veil
The courts have come to accept a well-recognised exception to the rule, that
they are able to pierce the corporate veil where special circumstances
suggest that the corporate structure is a mere facade obscuring the true
facts.65 The term façade has been interchangeably used with numerous
descriptions, such as ‘device’, ‘sham’, ‘mask’, ‘cloak’, ‘stratagem’, and
‘puppet’ to highlight that the company has been controlled by a member
who has used the company for his own desired ends, which may well
involve the ‘abuse of the corporate form’. 66
The circumstances and the extent to which the court will pierce the corporate
veil and refuse to acknowledge the separate legal personality of the company
have long been unclear. Although some commentators might claim that the
mist has cleared in the light of the Court of Appeal’s ‘mammoth decision’ in
Adams v Cape Industries Ltd.67 It is submitted that this is not the case. The
ambiguity arises from the Court of Appeal's categorisation of previous
caselaw and its attempt to reduce the ambit of the rule to a single principle,
while failing to provide a comprehensive definition of it.
Firstly, prior to the decision of Adams v Cape Industries Ltd the courts were
confronted with two opposing decisions, that of the Court of Appeal in DHN
Food Distributors v Tower Hamlets London Borough Council and the
House of Lord’s decision in the Scottish case of Woolfson v Strathclyde
Regional Council. In the former case the premises from which the company
traded where compulsorily acquisitioned. However, as the premises were
owned by a wholly owned subsidiary of the company, the local authority
contended under the principle of Salomon that no business of the owner had
been disrupted. The Court of Appeal unanimously held that ‘it was entitled
to look at the realities of the situation and pierce the corporate veil’.68 Thus,
the company although not actually the owner, was able to recover for loss of
trade. Lord Denning MR69 quoting Gower considered that there was
‘evidence of a general tendency to ignore the separate legal entities of
various companies within a group, and to look instead at the economic
entity of the whole group'.70
The case of Woolfson similarly concerned the compulsory acquisition of
property by an authority and the claim for loss of business by the trading
company, notwithstanding the fact that the company itself did not own the
premises. The case of Woolfson was distinguished from DHN on the fact
that the company owning the property was partially, rather than wholly,
owned by the claimant company. Moreover, the House of Lords hinted that
the decision of DHN was incorrect. Lord Keith doubted ‘whether the Court
of Appeal [in DHN] properly applied the principle that it is appropriate to
pierce the corporate veil only where special circumstances exist indicating
that it is a mere façade concealing the true facts.’71 Despite the Woolfson
decision stemming from the House of Lords, it was questionable whether the
case laid down a binding precedent for English courts (because of its status
as a Scottish decision). Furthermore, the Court of Appeal failed to
65
Woolfson v. Strathclyde Regional Council [1978] S.L.T. 159 at 161 per Lord Keith of Kinkel
Schmitthoff, ‘Salomon in the shadow’ [1976] JBL 305
67
Griffiths, M., ‘Lifting the Corporate Veil’, ACCA: Corporate Sector Review, (2003) issue 44 at
www.acca.co.uk/publications/corpsecrev/44/895748
68
DHN Food Distributors v Tower Hamlets London Borough Council [1976] 1WLR 852 per Goff LJ
at p. 861
69
[1976] 1WLR 852 at p. 860
70
Gower, Principles of Modern Company Law, 3rd ed. (1969), p. 216
71
[1978] SLT 159 per Lord Keith of Kirkel at p. 161
66
7
acknowledge it in Re A Company72 where it was held, that the court should
pierce the corporate veil whenever justice so requires.73
Instead of confronting the conflicting approaches directly, the Court of
Appeal circumvented the problem, (while expressly approving the decision
of Woolfson), by claiming DHN to have been decided on the relevant
statutory provision. In the light of the ambiguity of previous caselaw the
courts’ failure to reject outright the principle that the court could examine
the reality of the situation and pierce the veil is unfortunate. Furthermore, (as
shall be examined later), it is questionable whether it is desirable to retain
the principle, however limited, that the court is able to consider economic
realities and conclude that a group of companies is one.
Secondly, Slade LJ, with whom the rest of the Court of Appeal agreed,
stated that there was ‘one well recognised exception to the rule prohibiting
the piercing of “the corporate veil”’.74 He was referring to the House of
Lords decision in Woolfson, which considered that the corporate veil could
only be pierced when the company was a `facade concealing the true
facts’.75 The approach taken by the court in Adams was confirmed by the
subsequent Court of Appeal decision of Ord v Bellhaven Pubs Plc.76 Clearly
the reduction of the principle to a single rule dispels a certain amount of
uncertainty. However, ambiguity remains as the court in Adams expressly
stated that it did not intend to provide a comprehensive definition of
‘façade’.77 Furthermore, it is equally unhelpful to return to the House of
Lords decision in Woolfson who were similarly vague in the discussion of
the term. What can be distilled from both cases is the approval of the Court
of Appeal’s decision in Guilford Motor Co Ltd v Horne,78 and Russell J's
decision in Jones v Lipman.79
In both cases companies were formed and used as a ‘cloak or sham’, a
‘device’ enabling the individual controlling the company to avoid binding
legal obligations. As Russell J colourfully put it in Jones v Lipman the
company was ‘the creature of the first defendant, a device, a sham, a mask
which [he] held before his face to avoid recognition by the eye of equity.’80
However, in the light of Creasey v Breachwood Motors Ltd81 it remains
questionable whether the corporate veil can be pierced on grounds of the
fraud exception, in a case where a company has already been incorporated
prior to a transfer, which had the effect of facilitating members from
escaping their current legal obligations.
Payne in her article ‘Lifting the corporate veil: a reassessment of the fraud
exception’ comments that a ‘fraud is no less of a fraud’, simply because a
pre-existing company was used. She further submits that Creasey should
72
[1985] BCLC 333
The suggestion that the Court will use its powers to pierce the corporate veil whenever it thinks
necessary to achieve justice was later disproved in Adams v Cape Industries Ltd, where it was held
that: ‘save in cases which turn on the wording of particular statutes or contracts, the Court is not free
to disregard the principle of Salomon… merely because it considers that justice so requires.’ [1990]
Ch 433 Per Slade LJ. This has been affirmed as the current position by Robert Walker J in Re Polly
Peck International plc (No. 3) [1996] 1BCLC 428 and by Morritt V-C in Trustor AB v Smallbone
(No. 2) [2001] 1 WLR 1177.
74
Adams v Cape Industries Ltd [1990] Ch. 433 at 539
75
Woolfson v. Strathclyde Regional Council [1978] SLT 159 per Lord Keith of Kinkel at p. 161
76
[1998] 2 BCLC 447
77
[1990] Ch. 433 at 543
78
[1933] Ch 935
79
[1962] 1 All ER 442
80
[1962] 1 All ER 442 at 445 c -d
81
[1993] BCLC 480
73
8
have been decided on the basis the ‘existence of a legal right must pre-date
the use of the corporate form and not the incorporation of that vehicle’.82
The judge in Creasey refused to apply the fraud exception, as he understood
it because he felt there was no intention to defraud; he held that ‘it would be
wrong to draw so strongly adverse an inference’.83 Commentators have
taken the view that making such a distinction is ‘arbitrary’, ‘irrelevant' and
nonsensical.84 To what extent this represents the law is unclear as the case
was disproved, albeit on a separate ground, by the Court of Appeal in Ord v
Bellhaven Pubs Plc. However, the Court of Appeal’s treatment of Creasey
raises further doubt as to the true extent of the 'facade' test.
In Ord the Court of Appeal considered Creasey to have been decided on the
basis that the court considered it possible to pierce the corporate veil
whenever justice required. This, if true is clearly contrary to the authority of
Adams v Cape Industries Ltd. However, it has been suggested by Broreilow
that although the court in Creasey stated this, read in its true context it was
‘not intended to be a statement of general principle’ rather it was an
‘observation that there is no general principle as to when this power should
be applied’. 85 The true basis of the decision in Creasey was that ‘the
transfer was a breach of the directors’ fiduciary duties to [the company]’.86
As the facts of Creasey were distinguished87 from Jones v Lipman and
Guilford Motor Co Ltd v Horne it would seem Creasey cannot therefore be
considered within the line of authority supporting the fraud exception (as
conventionally understood), as the case does not fall within the factual
boundaries of the exception. It would seem clear that Creasey has extended
the ‘façade principle’ (which if so extended, it would surely require a change
of name). Although the decision is unlikely to be resurrected after its
treatment by Ord it exemplifies the uncertainty resulting from the courts
failure to set out clearly the notion of ‘façade’.
Conclusion: Does the Current Legal Position Adopt an AllEncompassing Consistent Principle?
This paper has shown that caselaw has failed to produce an allencompassing principle as to when the court is able to lift the veil. Rather
the circumstances in which the courts will draw upon the three exceptions
remain unclear. The principles of agency and single economic entity, despite
being narrowly defined and limited in scope, permit the court to circumvent
the principle of separate corporate entity, notwithstanding the absence of bad
faith. Conversely the principle of piercing the corporate veil would seem to
have been limited to cases where there has been a deliberate concealment of
the identity of the incorporator in order to avoid incumbent and binding legal
obligations. Although the exact ambit of the principle remains unclear it
seems that the court will be unwilling to lift the corporate veil in the absence
of bad faith and not simply where justice demands it. It remains to be
considered whether it is desirable to reduce the courts power in such a way.
It is arguable that the development of the principle of piercing the corporate
veil where justice demands it is appropriate. Indeed, the notion of adopting
such a rule on a case-by-case basis allows justice to succeed in each
individual case. However, can justice be encompassed within an uncertain
82
Payne, J., ‘Lifting the corporate veil: a reassessment of the fraud exception’, [1997], Cambridge Law
Journal, 284, p.290
83
[1993] BCLC 480 at 492-493 per Mr Richard Southwell QC (deputy judge of the High Court)
84
Bromilow , D., ‘Creasey v Breachwood Motors: Mistaken Identity Leads To Untimely Death’ [1998]
Company Lawyer 198 at p. 198
85
Ibid. at p. 198
86
Ibid. at p. 199
87
[1993] BCLC 480 at 490
9
rule? It is submitted that justice can only be achieved when parties are able
to depend upon clear and certain principles. Caselaw has been able to
provide such a principle although its clarity remains questionable. But as
Lord Parker in Daimler Co Ltd v Continental Tyre and Rubber Co (GB)
Ltd88 stated, the ‘legislature might, but no court could possibly, lay down a
hard and fast rule’. Thus it is desirable for parliament to expressly set out
the conditions when the corporate veil may be pierced, as ‘the legislature
can forge a sledgehammer capable of cracking open the corporate shell.’89
Aside from this, there would seem a more important reason why the
development of judicial inroads should be halted.
The corporate entity rule as established in the case of Salomon v. Salomon
& Co Ltd. provides the fundamental principle of the separate legal entity of
the company. Although some commentators have pointed to the
‘jurisprudential ineptitude’ of the court in rejecting the clear intentions of the
parliament, it must now be recognised that parliament has had ample time to
reject it and thus it must be inferred that the rule is the intention of
parliament.90 In the case of companies which seek to benefit from a piercing
of the corporate veil such as Smith, Stone & Knight v Birmingham
Corporation, DHN, and Woolfson, the companies should not take the
benefit of the incorporation i.e.: limited liability, without the disadvantages:
in those cases separate legal personality.91 Following from this it would
seem unfortunate that the Court of Appeal in Adams v Cape Industries Ltd
rather than limit their ambit, did not expel completely the principles of
agency and single economic entity. If inroads into the principle are desirable
at all, they must be limited to circumstances of bad faith. As noted
previously it must be concluded that this may be best achieved through
legislation.
88
[1916] AC 307 at p. 346
Per Devlin LJ in Bank voor Handel en Scheepvaart NV v. Slatford [1953] 1 QB 248 at 278.
90
Hicks, A., ‘Limiting the rise of limited liability’, in Baldwin and Cane (eds), Law and Uncertainty:
Risks and Legal Processes, (Kluwer, 1997) in Hicks & Goo, Cases & Materials on Company Law, (3rd
ed.), (London: Blackstone, 2001), p. 100
91
Rixon, F., G., ‘Lifting the Veil Between Holding and Subsidiary Companies’ (1986) 102 LQR 415
89
10
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