The case of Salomon v Salomon & Co Ltd 1897 AC 22 established a president in company law precluding companies from being represented by anyone other than a solicitor or counsel and this remains apparent in the commercial world. However while it may be prevalent; this has allowed for courts to often face the difficulty of having to deal with complex cases. The following will identify how the veil of corporation remains to be relevant in modern company law as well as a look into whether or not the principle encourages fraudulent activity and whether or not courts should consider morality to be a primary factor when deciding to lift the veil or not.
The highlights of the Salomon case were that Mr. Salomon ran a successful leather business as a sole trader. He then set up a company with his family and was the major shareholder, a director, an employee and a creditor of the company he created. He observed the tenets of company law at all times. He was also the main shareholder and further to that the main creditor due to the loan. Mr. Salomon debts should take precedence over the unsecured creditors when the company was wound up because he conducted his business lawfully for instance, he went into a partnership with his family, and S1 Partnership Act defines a partnership as a mutual relationship between parties, who aim to carry on business in a common view of profit. The formation of a partnership must contain either one or more of the following; a formal written agreement (one that specifies the terms and conditions of the contract), an oral agreement, or by the behaviour of the parties (inference by conduct). Mr Salomon not only followed the above but he also adhered to the minimum membership required for a partnership (which is two). The Partnership Act 1980 states that in order for a partnership to maintain validity there must be participation in management and equal share of profits.
Within the case itself the judges accepted that ‘The first condition of the statute was satisfied because there were seven living persons who held shares in the company.’ As the ‘The Act did not stipulate the extent or degree of interest which might be held by each shareholder, or the proportion of interest or influence which might be possessed by one or the majority of the shareholders’. The former demonstrates indomitability as the reasons behind Mr. Salomon’s family being shareholders did not matter to the court as long as it was established that a partnership was made in order to create a company with business on a common view of profit. Thus Mr Salomon conducted his business legally.
The case of Salomon v Salomon & Co Ltd 1897 explicitly demonstrates how the veil of incorporation is drawn between a company and its members. The application in this case enables for an understanding that there is a separation between both members and company for the purposes of liability and identification. The issue of ‘limited liability’ been restricted to the unpaid shares of a member only.
Salomon v Salomon & Co Ltd 1897 expressed key points, the first being company’s property is company’s property; company’s debt is company’s debt; companies can contract with their members, directors and outsiders and lastly Companies can commit torts and crimes.
Firstly, ‘company’s debt is company’s debt’ has been remitted through the above Salomon v Salomon & Co Ltd 1897 AC 22 CASE.
Secondly, “company’s property is company’s property” represents the case of Macaura v Northern Assurance Co. Given that Mr. Macura had insured the property in his name he could not claim insurance on the grounds that, he did not have insurable interest for the insurance was bought in his name rather than the company’s name.
It was held that ‘in order to have an insurable interest in property a person must have a legal or equitable interest in that property.’ The court upheld the insurer’s decision and concluded that “the corporator, even if he holds all the shares, is not the corporation, and that neither he nor any creditor of the company has any property, legal or equitable, in the assets of the corporation.” In comparison to Salomon v Salomon & Co Ltd 1897 AC 22, this decision was not in favour of the individual registering the company in addition to this, the above principles can be applied when further understanding how the veil of incorporation is drawn between a company and its members.
Additionally, “Companies can contract with their members, directors and outsiders” was evident in Lee v Lee’s Air Farming Ltd. Within this case due to the fact that Mr. Macura was director of the company the insurers denied his wife’s claim.
The court stated that a ‘governing director of a company is also its controlling shareholder he may also be employed as its servant and therefore a worker’. This further demonstrates the argument for the relevance of the veil of incorporation as Lee’s Air Farming Ltd is recognised as an independent entity under the eyes of the law. Lord Morris noted that ‘then the capacity of the respondent company to make a contract could not be impugned merely because the deceased was an agent of the respondent company in its negotiation of Mr Lee’s contract of service.” The case above aided in assuring that members (including principle shareholders) are able to be employed by their companies. There is further evidence in the case of Industry v Bottrill (1999) as court stated ‘There is no rule of law to suggest that a sole director and owner of majority of shareholding could not be an employee’ The decision in this case also highlights a key strength of the veil of incorporation as due to the existence of the veil, the owner of the company can work for the company as a contracted employee under the Employment Rights Act 1996.
In addition, the third point ‘companies can commit torts and crimes’ is often associated with the Lifting of the veil and this refers to the situation where the judiciary or legislature have decided that the separation of the personality of the company and its members is not to be maintained. Provisions were introduced directed at ignoring the separate entities in subsidiary through taxation legislation. For example: S.399 CA 2006 provides that parent companies have a duty to produce group accounts. S.409 CA 2006 also requires the parent to provide details of the shares it holds in the subsidiaries and the subsidiaries’ names and country of activity. S.993 CA 2006 which provides a not much used criminal offence of fraudulent trading,
Additionally, the most important statutes concerning veil lifting issues are contained in Insolvency Act 1986.Insolvency Act 1986 are a set of civil sanctions that operate to lift the veil. These provisions include ss.213—215.
Section 213 of the Insolvency Act 1986 is known as the ‘s213 (IA) Fraudulent Trading’ provision. It is designed to combat circumstances where the formation of the company was used to as a tool for fraud. If in the course of the winding up of a 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’, the following has effect. The court, ‘on the application of the liquidator may declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned’ are to be ‘liable to make such contributions (if any) to the company’s assets as the court thinks proper’.
In pursuant to this provision, in the course of the winding up, if it appears to the court 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 on the application of the liquidator the court may “declare that any persons who were knowingly parties to the carrying on of the business in the manner above-mentioned are to be liable to make such contributions (if any) to the company’s assets as the court thinks proper.”
Section 214 of Insolvency Act concerns “wrongful trading”. This was introduced to deal with situations where negligence rather than fraud is combined with misuse of corporate personality and limited liability. There is no need to prove dishonesty as wrongful trading does not require an intent to defraud.
The provision states that if in the course of the winding up of a company it ‘appears that subsection (2) of this section applies in relation to a person who is a director of the company’, the court ‘on the application of the liquidator, may declare that that person is to be liable to make such contribution (if any) to the company’s assets as the court thinks proper’.
This applies in relation to a person if the company has gone into liquidation or at some time before the ‘commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation’, and that person was a director of the company. The section operates on the basis that “at some time before the company entered insolvent liquidation there will have been a point where the directors knew it was hopeless and the company could not trade out of the situation.” The reasonable director would not at this point continue to trade. If he does continue to trade he risks having to contribute to the debts of the company.
In summary of the above, the legislature has always been ‘concerned to enhance the protection of the interests of outside creditors’ and to minimise the extent to which the ‘Separate Entity Principle could be used as an instrument of fraud’. The provisions set affect the separate entity act in a variety of ways and clearly these statutory exceptions promote the separate entity principle rather than negating by perfecting the principle.
The case of Adams V Cape Industries Plc the veil of incorporation was not lifted as the court maintained the separate entity principle. The issue in this case was whether Cape was present within the US jurisdiction through its subsidiaries or had somehow submitted to the US jurisdiction. The court concluded that in spite of the fact that Cape’s motive was to try to minimise its presence in the US which ‘might make the company morally culpable but there was nothing legally wrong with this”.
“Our law, for better or worse, recognizes the creation of subsidiary companies, which though in a 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.” However, the case was very useful, the courts decision indicates that there has been a shift from the “restrictive approach” to a common sense approach. Adams V Cape Industries Plc essentially showed that the veil of incorporation is in effect lifted to three main situations. (a) Reorganisation of a group of companies was legitimate and not merely a sham to conceal the true facts, (b) Where the court is interpreting a statute or document (these statute or document is lack of interpretation) in order to reject fairness. (c) Where the subsidiary is an agent of the company.
In Creasey V Breachwood in which directors of Breachwood Motors Ltd, It was held that two associated companies had deliberately ignored the separate legal personalities (albeit on legal advice) and the transfer of assets from one to the other was a blatant attempt to deprive an employee of a court order for wrongful dismissal. In Ord V Belhaven Pubs Ltd 1998 Hobhouse LJ held that the previous judgment in Creasey V Breachwood was wrong and so it was overruled arguing that the reorganisation of a group company and the ensuing transfer of assets was in the interest of the group and not a sham.
In the case of Gilford Motor Co V Horne there is a relation to the separate entities principle as Horne created his own company and argued that the stipulation was not made under the company, claiming that the company is its own person.
In the decision of this case, the court lifted the veil of the company which Horne created and stated that he was liable for breaching his contract with Gilford. The court expressed that Honre’s company was a sham and in addition to this was created in order for Horne to avoid the stipulation agreed upon with Gilford. In regards to lifting of the veil, courts will not allow for fraudulent activity to take place under the company name. This simply results in the lifting of the veil of incorporation.
However, there have proven to be inherent difficulties with the courts decisions on lifting the veil for example in Beckett Investment Management Group Ltd V Hall 2007 EWCA Civ 613 the judge had agreed with the employees however in the court of appeal it was said that the ‘purpose of the non-dealing clause was clearly to protect the employer from losing its clients to the employees’, and that the ‘parties were aware of this purpose when they made the contracts’. In the court’s view, the “only sensible construction” of the clause was that it also applied to BFS. It was also found that 12 months was too long to restrain the employees and so the judge considered three months to be more reasonable.
From the above we can conclude that courts will lift the Veil of incorporation where justice requires them to do. This maybe the case where for instance when a company wishes to commit an act of Fraud. Also, instances where an agent (who seen as an individual authorised to act on another’s behalf) relationship is taking place in which a subsidiary is considered as an agent for a holding company. The veil of incorporation will be lifted making the holding liable to the debts of the subsidiary. Other reasons may include circumstances such as Paramount Public Interest or Evasion of legal obligations
Moreover, the case of Salomon v Salomon & Co Ltd 1897 AC 22 demonstrates a certain relevance in a commercial world. For instance, there is a better understanding of a sole trader. Someone who is defined as an individual who operates on their own and proceed to go into business on their own with no legal filing required. In addition to this, they provide their own capital so rely on either personal savings or a bank loan. If Mr. Salomon had remained a sole trader he would have had been held for the personal liability for all the debts of the business as there are no distinction between the sole trader’s personal and business assets.
To add to the above, most people who start as sole traders often operate with low capital, and share a common feeling of determination of achieving a goal. In reference to Mr. Salomon when he started his leather business he was in fact a sole trader who had the freedom to be able to operate in an informal organisational structure. In contrary to the aforementioned, sole traders who often operate with low capital often struggle with raising capital to cover the initial expenses such as premises, staff, electricity etc. A greater disadvantage is the fact that sole traders are liable for the debts of the business.
In conclusion, the veil of incorporation is relevant in modern company law and this has been shown in cases such as Lee v Lee Farming Ltd however as demonstrated in Adams V Capes morality clearly is not an option to consider when deciding whether or not to lift the veil. The veil of incorporation is an teleological approach in which actions are morally neutral when deciding whether or not to lift the veil. Courts should rather focus on a more deontological perspective which demands for judgements to be based on duty or obligation. An example of this how the judge stated ”might make the company morally culpable but there was nothing legally wrong with this” and if this was not the case then within the Adams V Cape Industries Plc case the veil would have been lifted. The moralistic argument would cause much greater issues in the court room understandably so and morality should not always be considered a primary determinant however “the legislature can forge a sledgehammer capable of cracking open the corporate shell”. Adams V Cape Industries Plc is an example of where the veil could be lifted but due to the strict application and at times inflexibility when deciding judgements the veil was not lifted. This rigidness has enabled the veil of incorporation remain a strong fixture within company law and so its relevance is undeniable however the approach is still quite questionable.