Corporate personality: Justice v Doctrine

It has been argued that the UK’s Companies Acts have never been complete, comprehensive codes,(1) as many uncertainties have always existed in this area of law. Although it has been depicted that “the legislature can forge a sledgehammer capable of cracking open the corporate shell”,(2) in order to deal with the unjust reality that surfaces as a result of the corporate form, it was in fact the courts that developed the doctrine of “piercing the corporate veil”.(3) This doctrine has accurately been described as a “rich but confused body of case law”,(4) as the decisions as to whether or not the veil should be pierced lack consistency.(5)

Piercing the veil holds shareholders personally liable, allowing creditors to collect a company’s debts from the shareholders' personal assets.(6) It can also disregard the separate entity of individual companies within a group, allowing either for parent corporations to be held liable for their subsidiaries, or for groups of companies to be treated as a single economic unit.(7) Although the courts recognise that the separate entity doctrine often causes injustice, their formulations for setting aside the doctrine fail to go far in dealing with the issues that the doctrine has created in regard to groups of companies and conflicts with delict law, and thus have rightly been criticised for being “timid” and not forcing or even encouraging parent corporations to answer for the debts and losses caused by their subsidiaries.(8)

As appears from the case law, situations in which the courts may pierce the veil can be broadly categorised into circumstances regarding when a company trades with an enemy during war,(9) when the company is a “mere façade concealing the true facts”,(10) or when the company is a “cloak or sham”, facilitating fraud or evasion of legal obligations.(11) A further two possible arguments that may sometimes be put forward, and are more applicable to cases regarding delictual claims, are that a company is acting as an agent,(12) or that a group of corporations are a single economic unit.(13) There are also limited statutory provisions that hold members liable for certain company debts and liabilities;(14) however these do little to assist in holding members personally liable to victims of delict.

Despite having formulated such exceptions, the courts have been described as remaining “far from enthusiastic” about piercing the corporate veil,(15) and shareholders of American corporations as being “virtually immune from the claims of tort victims so long as they treat their corporate entity with proper respect”.(16) This is also evidently true for shareholders of corporations in the UK, as there is no clear-cut category specifically for the situations where involuntary creditors suffer loss as a result of the undercapitalisation or insolvency of a genuinely incorporated company, whether that is a parent or a subsidiary. Blumberg therefore, perhaps accurately, describes limited liability as having been carried “unthinkingly beyond the original objective”.(17)

The agency argument

Lord Macnaughten had made it extremely clear in Salomon v Salomon [1897] AC 22 that the relationship formed between a company and its shareholders on incorporation is not one of agency (at 51). However, this ought to be distinguished from the fact that a shareholder may create a contractual relationship with the company by instructing it to act as the shareholder's agent.(18) In many circumstances this may raise no issues.(19) An agency relationship may be established between shareholders and a company or a company and a subsidiary, with the agent acting on behalf of the principal. When loss occurs, whether such a relationship exists may be considered alongside the categories for piercing the veil. The two, however, are distinctly separate,(20) although if such a relationship is found then the outcome will be the same as if the veil were being pierced.(21)

Although the courts continue to affirm the application of the entity doctrine to groups of companies,(22) they are not blindfolded from the disappointing degree to which the doctrine has been developed: it has been acknowledged that “it is perhaps permissible under modern conditions to regret the existence” of the principles of separate entity and limited liability.(23) In being unable to ignore the unsatisfactory nature of the consequential reality of the application of the doctrine, courts have not been strictly against piercing the veil in order to hold that a subsidiary is an agent of its parent, an example of this being Firestone Tyre and Rubber Co v Llewellin [1957] 1 WLR 352 (HL). In this case it was found that, although a subsidiary was a separate legal entity carrying on its own business, its American parent was using it as a means to carry out business in Europe and hence was trading through the agency of the UK company (at 358). However it has been rightly observed that it is difficult to predict what approach the courts will take, as for each case when a subsidiary is found to be an agent there is a matching case where the courts have not found so.(24) Therefore this category provides no guaranteed relief even where an agency relationship is apparent.

It has also been argued however that, due to the Salomon judgment, the courts will be reluctant to draw an inference of agency unless it is necessary to preclude a “grave impropriety” from taking place.(25) Therefore this exception is once again of limited relief, as it was observed in Adams v Cape Industries [1990] Ch 433 that the subsidiary would have to be in a position where it is able to bind its parent to contractual obligations (per Slade J). Yet in Smith, Stone and Knight Ltd v City of Birmingham [1939] 4 All ER 116, Judge Atkinson, taking a broader approach, emphasised that the central focus was in determining whether the subsidiary was undertaking its own business or the business of its parent (at [212]). The extent of this case as authority is however debatable, due to the inconsistent application of its principle in subsequent cases.(26)

Importantly however, the agency exception does not apply automatically in regard to wholly owned subsidiaries,(27) though in such cases the agency argument will have a greater chance of success.(28) Furthermore, although the Salomon principle ought to be disregarded in order to deal with injustice, injustice alone will not necessarily oblige the court to find a relationship of agency.(29) Although “doing justice to the facts” had been stated to be a relevant consideration in previous cases,(30) this was held to be incorrect in Adams v Cape Industries. This demonstrates that this exception is weak in protecting victims, as the situations when a company may be acting as an agent may be few. Even if companies were acting in such a manner, it still appears unlikely that courts will be willing explicitly to declare the existence of an agency relationship, so as to disregard the veil.

The single economic unit argument

It has rightly been described that large corporations “have ceased to owe allegiance to one country only” and it has been predicted that if no action is taken, “National Governments will be reduced to the status of parish councils in dealing with the large corporations which will span the world”.(31) Maintaining the strict application of limited liability to separate entities within group companies is limiting the UK’s own ability to deal with subsidiary and sub-subsidiary corporations that cause loss, as the corporate form is being used tactically to avoid such liability.(32) Also, shareholders of corporations that operate in the UK from abroad are freely enabled to create loss for the UK’s society to bear.(33)

This category has received no firm backing, and is thus not considered to be an independent category for when the veil may be pierced.(34) Slade LJ in Adams v Cape Industries had explained that the cases in which the veil was disregarded in order to hold that groups of companies were single economic units, on the justification that “justice so requires” or it is required by “the business realities”, fell “on the wording of particular statutes and contracts”. This explanation, although it may be true in regard to some cases, cannot be used as a generalisation for all cases.

For example, in DHN Ltd v Tower Hamlets LBC [1976] 1 WLR 852, Lord Denning had concentrated on the fact that the subsidiaries were “bound hand and foot” to the parent company (at 860). He therefore took the approach that the three corporations should be treated as one, single economic unit, consequently disregarding the veil of two wholly owned subsidiaries. However this approach was subsequently criticised in Woolfson v Strathclyde Regional Council [1978] SC (HL) 90, making the point that the Court of Appeal in DHN had made no mention of the principle that the veil would only be pierced “where special circumstances exist indicating that [the company] is a mere façade concealing the true facts” (at 96). The Lords therefore emphasised this principle but regrettably did not clarify the meaning of “special circumstances”, leaving room for subsequent cases to deviate once again.

The doctrine of separate legal entity was applied “automatically” to subsidiaries of parent corporations, creating “multiple layers of liability for the parent corporation”.(35)

The leading case in the UK on the issue of corporate personality and limited liability relating to corporate groups is Adams v Cape Industries plc. The English Cape Industries was involved in asbestos mining and marketing through a subsidiary in the USA, and as a result, employees of the Texas subsidiary suffered injury. This resulted in 668 personal injury claims. The court rejected the single economic unit argument made in DHN, and also the approach that the court will pierce the corporate veil “if it is necessary to achieve justice”.(36) By refusing to apply the Texas judgment for 206 claimants against the British parent corporation, the court powerfully reasserted the application of limited liability and the separate legal entity doctrine in regard to corporate groups. By disregarding the arguments that were made for imposing liability and by refusing to pierce the veil, the victims were left uncompensated.

The disregard for these victims demonstrates that a thorough re-examination of the law is strongly required. It is one thing to advocate for the protection of individual shareholders as natural persons; however the concept has been taken too far by not compelling entirely solvent parent companies to provide compensation to victims that have suffered loss at the hands of their subsidiaries.

The argument that a veil could not be pierced on the basis that companies were a single economic unit was subsequently certified in Ord v Belhaven Pubs Ltd [1988] BCC 607. In this case it was also held, perhaps unsurprisingly, that the decision to pierce the veil in a prior case,(37) where following the filing of a claim, a company was dissolved and its assets relocated tactically to another company which the same persons owned, was an incorrect application of the principle.(38) This was stated despite the fact that what took place would at first sight appear to be an avoidance of legal obligations, further emphasising the courts' lack of willingness to disregard the entity doctrine in order to provide a just outcome regardless of the facts.

In Adams v Cape Industries the Court of Appeal also acknowledged the fact that the rigid doctrine differs radically from the European Court of Justice’s approach. Advocate General Warner in Istituto Chemioterapico Italiano SpA and Commercial Solvents Corporation v EC Commission (Joined Cases 6/73 and 7/73) [1974] ECR I-0223, in considering whether a parent and subsidiary were separate “undertakings” within the definitions of articles 85 and 86 of the Treaty of Rome, found that “it would be inappropriate to apply rigidly in the sphere of competition law the doctrine referred to by English lawyers as that of Salomon v Salomon & Co Ltd – i.e. the doctrine that every company is a separate legal person that cannot be identified with its members”, and also that “to export it blindly into branches of the law where it has little relevance, could, in my opinion, serve only to divorce the law from reality” (at para 263).

Therefore, the approach taken by the Advocate General supports the proposition that the separate entity doctrine has been stretched too far by having been rigidly applied to groups of companies. He also stated that “there is a presumption that a subsidiary will act in accordance with the wishes of its parent – because according to common experience subsidiaries generally do so act”, and that, “unless that presumption is rebutted, it is proper for the parent and the subsidiary to be treated as a single undertaking for the purposes of Article 85 and 86 of the EEC Treaty”.(39)

It is clear that the European Court of Justice’s approach differs drastically from the UK’s approach, as the principles of Salomon require that each subsidiary be viewed and treated as a separate legal entity unless reasons can be shown as to why this should be ignored, whereas the ECJ’s approach is to presume the opposite, that a subsidiary and parent are one until it is proved otherwise.(40) Although the Advocate General’s reasoning regarding subsidiaries acting in accordance with the wishes of their parent corporations is credible, convincing and successful in holding parent companies to account, it regrettably did not influence the UK’s approach. Any dissatisfaction with the UK maintaining a different approach from that of the ECJ will however soon be eradicated following the UK’s exit from the EU, further diminishing the likelihood of influence.

Interaction with the law of delict

Delictual liability attaches to companies when a wrongful act is carried out by a managing director, whether that act was authorised by shareholders or not and even if the act was unrelated to the achievement of his duties.(41) A company will also be liable for delictual losses caused by employees,(42) unless the employee engages in acts which are ultra vires the company and he/she has no authority to do. However if management pursues an ultra vires goal, in the course of which a delict is authorised, the company will be held liable;(43) however, where such liability attaches, shareholders remain shielded.

There was an advance regarding groups of companies under tort law, where parent companies may be subject to a duty of care, allowing the involuntary creditors to bring an action against the parent company, as evidenced in Chandler v Cape plc [2012] 1 WLR 3111 (CA). This will be possible when the threefold test stipulated by Lord Bridge in Caparo Industries plc v Dickman [1990] 2 AC 605 (HL) at 618 is satisfied. This is namely that, the damage should be foreseeable, there should exist a relationship of proximity or neighbourhood and it should be fair, just and reasonable to impose a duty of care. Both agency and duty of care, however, provide a very limited amount of liberation and relief to tort victims, as they are of minor assistance regarding enormous multinational corporations which have a vast number of subsidiaries operating in hundreds of countries worldwide.

This issue was evidenced in His Royal Highness Okpabi v Royal Dutch Shell plc [2017] EWHC 89 (QB), as there were 1,366 companies within the Shell Group, operating in 101 countries. When leaks from oil from pipelines in the Niger delta, caused by the operations of a subsidiary, produced environmental damage, claimants argued that Shell owed a duty of care to one of its subsidiaries. However the court found that the Caparo tripartite test was not satisfied (at para 1381). This decision was subsequently upheld: Ogale Community v Royal Dutch Shell plc [2018] EWCA Civ 191. It will be unlikely that parent companies of such large corporate groups will satisfy the proximity and foreseeability tests in relation to a vast number of subsidiaries, as they will unlikely be aware of the foreseeable damage in relation to each company's undertakings. Therefore, the option for corporations to undercapitalise subsidiaries that engage in risky activities remains, at the expense of the victims of those activities.

Overall, two of the most evident and fundamental objectives of delict law are to compensate victims and discourage engagement in activities that are negligent or harmful,(44) each of which is obstructed by the application of limited liability. It has been demonstrated that if a company becomes insolvent and cannot compensate its involuntary creditors, the scope for shareholder liability is extremely narrow. The rationalisation that limited liability supports risk taking contradicts the social need to deter negligent or harmful activities. It has rightly been argued that, “even advocates of shareholder primacy accept that the principle of profit maximisation can only be achieved within the framework of external laws”,(45) emphasising that the law of delict should not be compromised at the expense of promoting economic activity. This is particularly evident in the group context, where a subsidiary may be incorporated exclusively to partake in highly risky activities. Thus, as Stone illustrates, limited liability makes a “mockery of deterrence”.(46)

References

(1) L S Sealy, Company Law and Commercial Reality (Sweet & Maxwell, 1984), 35.
(2) Bank Voor Haandel en Scheepvaart NV v Slatford [1953] 1 QB 248 at 278 (Devlin J).
(3) David Kershaw, Company Law in Context (2nd ed, Oxford University Press, 2012), 46.
(4) Ibid.
(5) John Birds, A J Boyle, Boyle and Birds’ Company Law (8th ed, Jordan Publishing, 2011), 62.
(6) Wouter H F M Cortenraad, The Corporate Paradox: Economic Realities of the Corporate Form of Organization (Springer Science and Business Media, 2012), 336.
(7) L C B Gower, Gower’s Principles of Modern Company Law (4th ed, Stevens & Sons, 1979), 112.
(8) Ibid, 133.
(9) Daimler Co Ltd v Continental Tyre & Rubber Co (GB) Ltd [1916] 2 AC 307.
(10) Tunstall v Steigmann [1962] 2 QB 593.
(11) Gilford Motor Company v Horne [1933] Ch 935.
(12) The Gramophone & Typewriter Ltd v Stanley [1908] 2 KB 89.
(13) DHN Food Distributors v Tower Hamlets LBC [1976] 1 WLR 852.
(14) See for example, Companies Act 2006, s 767, s 563(2); Insolvency Act 1986, s 213(2), s 76(3).
(15) Gillian Black, Business Law in Scotland (3rd ed, W Green, 2015), 554.
(16) Note, “Should Shareholders Be Personally Liable for the Torts of Their Corporations?” (1967) 76 Yale Law Journal 1190, 1195.
(17) Phillip Blumberg, “Limited Liability and Corporate Groups” (1986) 11 J Corp L 573, 575; Salomon v Salomon [1897] AC 22; Prest v Petrodel Resources Ltd [2013] UKSC 34.
(18) The Gramophone & Typewriter Ltd v Stanley [1908] 2 KB 89, 96 (Cozens-Hardy MR).
(19) L C B Gower, Gower’s Principles of Modern Company Law (4th ed, Stevens & Sons, 1979), 122.
(20) David Kershaw, Company Law in Context (2nd ed, Oxford University Press, 2012), 57.
(21) Ibid.
(22) For a further example see The Albazero [1975] 3 WLR 491 at 521 (Roskill LJ).
(23) Owners of Cargo Laden on Board the Albacruz v Owners of the Albazero [1977] AC 774, 807 (Roskill LJ).
(24) L C B Gower, Gower’s Principles of Modern Company Law (4th ed, Stevens & Sons, 1979), 129.
(25) Ibid, 124.
(26) David Kershaw, Company Law in Context (2nd ed, Oxford University Press, 2012), 60; JH Rayner (Mincing Lane) Ltd v DTI [1989] Ch 72; Munton Brothers [1983] NI 369.
(27) Kodak Ltd v Clark [1902] 2 KB 450 (Phillimore J).
(28) Mark J Loewenstein, “Veil Piercing to Non-Owners: A Practical and Theoretical Inquiry” (2011) 41(3) Seton Hall Law Review 839, 849 (access at this link).
(29) R R Pennington, Pennington’s Company Law (7th ed, Butterworths, 1995), 59.
(30) DHN Food Distributors v Tower Hamlets LBC [1976] 1 WLR 852; Re a Company [1985] BCLC 333.
(31) L C B Gower, Gower’s Principles of Modern Company Law (4th ed, Stevens & Sons, 1979), 61-62.
(32) Jodie A Kirshner, “Why is the US Abdicating the Policing of Multinational Corporations to Europe?: Extraterritoriality, Sovereignty, and the Alien Tort Statute” (2012) 30 Berkeley Journal of International Law 259, 264.
(33) L C B Gower, Gower’s Principles of Modern Company Law (4th ed, Stevens & Sons, 1979), 62.
(34) John Birds, A J Boyle, Boyle and Birds' Company Law (8th ed, Jordan Publishing, 2011), 75.
(35) Phillip Blumberg, “Limited Liability and Corporate Groups” (1986) 11 J Corp Law 573, 609.
(36) Re A Company [1985] 1 BCC 99 at [421] (Cumming-Bruce LJ).
(37) Creasey v Breachwood Motors Ltd [1992] BCC 638.
(38) Ord v Belhaven Pubs Ltd [1988] BCC 607, 608.
(39) Para 264; see also Cynthia Day Wallace, The Multinational Enterprise and Legal Control: Host State Sovereignty in an Era of Economic Globalization (Kluwer Law International, 2002), 639.
(40) For a further discussion of the case see: Valentine Korah, “Istituto Chemioterapico Italiano SpA and Commercial Solvents Corporation v Commission of the European Communities” (1974) 11(3) Common Market Law Review 248, 272.
(41) R v IRC Haulage Ltd [1944] KB 551, 559.
(42) Citizens Life Assurance Co v Brown [1904] AC 423, 427.
(43) R R Pennington, Pennington’s Company Law (7th ed, Butterworths, 1995), 134.
(44) Mark Geistfeld, “Negligence, Compensation, and the Coherence of Tort Law” (2002-03) 91 Geo LJ 585.
(45) Stefan H C Lo, In search of Corporate Accountability: Liabilities of Corporate Participants (Cambridge Scholars Publishing, 2015), 2.
(46) Christopher D Stone, “The Place of Enterprise Liability in the Control of Corporate Conduct” (1980) 90(1) Yale LJ 68.