Does Salomon still reign

Solution

Does Salomon still reign

1. Introduction

Following the aftermath of incorporating a company it ipso facto acquires a distinct legal personality which is distinct from its directors, promoters, employees or members. It is through this distinction that the concept of the corporate veil is formulated. Manifestly, the issue of piercing the corporate veil has fascinated legal practitioners and scholars alike with each endeavouring to weigh in on the justifications of lifting the corporate veil. Despite the extensive deliberation over the issue there seem to be no clear prescribed principles of where the threshold of piercing the veil should be slated.

A superficial view of the English legal framework has only yielded metaphorical terms masquerading as justifications for piecing the corporate veil. Failure to have a standardised and universal threshold and reliance on metaphorical terms has elicited uncertainty and confusion over the issue. Remarkably, there is a feeling from some quarters that the corporate veil established through the dictum of Salomon v. Salomon & Co. Ltd^[1] has been watered down to legal oblivion. In the same breath, arguments can be pieced together to make sense of the justifications put forth for piecing the corporate veil. Ideally, the purpose of this paper is to critically analyse the legal reasoning of Salomon and its efficacy in contemporary legal ecosystem.     

2. Concept of company as a separate entity

As mentioned above, the reasoning that a company can subsist distinctly from its directors, promoters, employees or members was derived from Salomon v. Salomon & Co. Ltd. Markedly; Salomon was a boot maker and trader who sold his manufacturing undertaking to Salomon & Co. Ltd a company he had incorporated in deliberation for all excluding six shares in the company, and received debentures amounting to 10 thousand pounds. According to the memorandum the other subscribers were his wife and five children who cumulatively owned one share of Salomon & Co. Ltd. Later on the undertaking collapsed prompting Salomon to make a claim grounding it on the debentures he was holding as a secured creditor. The appointed liquidator argued against Salomon’s point of view stating that Salomon’s claim could not be should not supersede of other creditors since Mr Salomon and the incorporated company could not be separated since the later furthered the interests of the former. Initially, the court concurred with the liquidator a situation that prompted Salomon to tender his appeal.

According to the appellate decision rendered by the House of Lords which discerned that Salomon & Co. Ltd could not be considered to be a charade. For this very same reason it was inappropriate to extend the liabilities incurred by Salomon & Co. Ltd to Mr Salomon since these were two separate legal entities. Significantly, as stated by Lord Macnaghten that once two separate legal entities had already been created it would not appropriate combine them with the purpose of apportioning liability from one entity to the other. Significantly, Lord Macnaghten elaborated that:

“The company is at law a different person altogether from the subscribers to the memorandum, 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 the profits, the company is not in law the agent of the subscribers or trustee for them.” ^[2]

Further, this position was galvanised in Macaura v. Northern Assurance Co. Ltd.^[3] another House of Lords decision which deliberated that insurers could not be held culpable under a contract of insurance on property that was previously insured by the claimant but was now under the ownership of the company. Accordingly, the House of Lords reasoned that the incorporated company was the only entity entitled to beneficial interest and not the claimant in this context. Thereupon, the claimant role as a shareholder was deemed legally insufficient to entitle one to a beneficial interest.

The separate legal entity was followed up in the case of Lee v. Lee’s Air Farming^[4]  in which the Privy Council discerned that the plaintiff Mr Lee was a separate entity from that of his company of which he had full control. Consequently, Mr Lee was regarded as an employee of that company and in that respect his wife was entitled to claim workers compensation after his passing on. Similar decisions were also rendered in other common law jurisdictions like Australia. Illustratively, Justice Kitto in Hobart Bridge Co. Ltd. v. FCT^[5] citing Lord Sumner in Gas Lighting Improvement Co. Ltd. v. IRC^[6] explained that:

“Between the investor, who participates as a shareholder, and the undertaking carried on, the law imposes another person, real though artificial, the company itself, and the business carried on is the business of that company, and the capital employed is its capital and not in either case the business or the capital of the shareholders. Assuming, of course, that the company is duly formed and is not a sham …”^[7]  

The common denominator in these cases is the fact that the court did not conduct a cost benefit analysis of the consequences of firmly sticking to the doctrine of distinct entity. Although this is an accepted legal doctrine most contemporary courts tend to conduct some sort of balancing act before determining either to keep entities separate or lift the corporate veil.^[8]                

Legal position on piercing the veil

Even as Salomon was assuming its reign as the guiding principle in corporation law , cracks had started forming making it impossible and irrational to grant absolute authority. As recognised by Lord Halsbury in Industrial Equity v. Blackburn^[9] as long as fraud or agency cannot be construed the relevant company is considered to be legally constituted. This position was seconded by Lord Denning in his reasoning in Littlewoods Mail Order Stores Ltd. v. IRC^[10] in which he posited that the corporate veil that has been cast on a particular company which acknowledges its distinction as a separate entity can be exposed if it turns out to be the subject of the issue before the court.^[11] Ultimately, the rationale of creating the exceptions by both Lord Halsbury and Lord Denning was founded on the premise that a corporation was in fact a separate legal entity it would not be proper to impose liability especially if imposition of such liability is dependent upon proving the intention or mens rea. Since a corporation is an artificial persona such an endeavour may not be possible prompting the court to pull down the veil and go after the directors or shareholders in its quest to apportion liability.^[12]           

Remarkably, the single most litigated issue in corporate law is the doctrine of lifting the corporate veil. Ideally, the presiding courts have to grapple with the fact that there are no established thresholds when the veil should actually be lifted. Legal practitioners and scholars are unanimous that the contemporary applied rules are inefficient in adducing proper results at the litigation level. Fundamentally, the doctrine of lifting the corporate veil exists as a check on the conduct of shareholders. This has been articulated in the logical reasoning based on three contemporary transaction costs conducted by investing shareholders. These three transactions can be summarised as; cost of shareholders keeping tabs with the wealth of other shareholders, risk surveillance on management decisions and reduction of costs in investment diversification. The theoretical understanding of these positions is grounded on social interests of providing checks and balances on investors in this instance shareholders and creditors.     

One of the reasons that have increased the justifications for the current increase of veil lifting is the proliferation of companies being shareholders of other companies. Commercially, these are referred to as parent companies hereby ipso facto acting as investors. Unlike natural persons investor shareholders, company based shareholding is unique in the sense that it wields enormous power to its subsidiary. Illustratively, the subsidiary exists as part of business of the parent company creating some sort of principal-agency relationship. The theoretical applied standard in current cases stipulate that if shareholders engage in day to day running of the company that in itself would be a sufficient justification to lift the veil. Unfortunately, the parent-subsidiary company relationship is grounded on this fact as the latter cannot exist without direct and consistent interference from the latter. When Salomon was being decided it was not rational that the bench would have contemplated that an artificial person can actually be a shareholder a position that would obviously necessitate a relook into the policy of lifting the corporate veil.  

3. Common law grounds of lifting the veil

Practically, the doctrine of lifting the corporate veil involves the presiding court ignoring the legal fact that shareholders or directors and the company in question are distinct entities.  In a pragmatic sense the application of this doctrine was to be exclusively determined through discretionary authority given to courts. However, as the case laws have pointed out the application of the doctrine is less of discretion but more of a reaction to the prevailing socio-economic and moral factors. In fact it is arguable that the Salomon principle will be superseded if there is an honest belief that its application would generate an unjust result.^[13] Markedly and as previously mentioned, there is no universal standard of determining as to where and when the corporate veil should be lifted a situation that burdens the court in making such determinations. Idyllically, the period from the1980s herald the era of intervention in which the western governments took a leading role in intervening in the markets. The objective of these governments was to ensure that the general public were insulated from adverse effects of private business decisions. With this in mind the courts responded accordingly by lifting the veil to ascertain that the company was not engaging in any form of transgression. ^[14]      

One of the common transgressions that have been used as a justification to lift the corporate veil is fraud. In one accord the courts have ensured that the Salomon principle shall not be used as a conduit to promote fraudulent activities. A case that comes to mind when this is mentioned is Gilford Motor Co Ltd v Horne^[15] in which the respondent, a former employee of the petitioner was contractually bound not to engage in any activity that would amount to soliciting of customers of his former employer. To circumvent this provision the respondent incorporated a company using his spouse name and proceeded to solicit customers a situation that prompted Gilford to institute legal proceedings against him. The Court of appeal concurred with Gilford that Horne primary objective of incorporating the company was to perpetrate fraud by circumventing the contractual obligations he owed to his former employer.

Another instance where fraudulent conduct was perpetrated through incorporating a company was in Jones v. Lipman .^[16] Just like in Gilford v. Horne the intention of the respondent was to circumvent a contractual obligation. Patently, Lipman had entered into a contract to sell land to Jones but changed his mind. To defeat the specific performance action against him, Lipman incorporated a company and transferred the land to the company in question. Russel J in citing Gilford v. Horne stated that Mr Lipman’s action amounted to fraud and the courts were not going to be used as facilitators of such fraudulent activities. Although these two cases look straightforward in so far as fraudulent activities are concerned in lifting the corporate veil, most cases are not since fraud is a conspiratorial crime. In response to this the courts have devised three benchmarks to ascertain fraudulent activities in the context of lifting the corporate veil. Firstly, the court would look at the motives of the fraudulent individual.^[17] Secondly, the courts would focus on the nature of the legal obligation being circumvented.^[18] Thirdly, the court will look at the timing of the incorporation in relation to the prevailing facts.^[19]

Another instance in which the court would be obligated to lift the corporate veil is whereby the directors or members conduct themselves as principals and the company in question as an agent. Ideally, this was the earliest form of exception to the Salomon’s principle that was raised by Justice Vaughan Williams but ignored in the House of Lords. This doctrine is still applicable especially for companies where its shareholders are involved in direct and daily running of the undertaking. This is the primary reason as to why corporate veil will be pieced in parent-subsidiary company relationship.

Similarly, the court would find it convenient to pierce the corporate veil if there are reasons to believe that the shareholding of the company is in form of trusteeship. Supremely, the rationale of this is a pre-emptive endeavour to deter potential transgressions. Companies by their very nature are considered to be commercial undertakings with profitability as its primary interests. In the same breath companies have legal obligations like filing of taxes which may be inconsistent with trusteeship provisions.                          

4. Recent trends

From the illustrations and explanations provided up to this point is the fact that all judicial cases involving lifting the corporate veil have no template. For this very reason most cases will be decided primarily based on the prevailing facts to determine if there is fraud, principal-agency relationship or trusteeship. These principles are still in application today as there has not been statutory certainty in setting standards to when the veil should be lifted. Markedly, contemporary courts have added three more considerations in determining if the corporate veil should be lifted. Firstly, the court will endeavour to look into shareholder s control and domination over the company. Secondly, the court will have to ascertain if there is a possibility of improper objective or use of the Salomon’s principle. Thirdly, the court will have to assess the resulting harm or damage occasioned by the application of the Salomon’s principle.

Ownership and control of any corporate entity is determined by the quantity of shareholding as it is the basis to which decisions are made. However, in the context of deciding to lift the corporate veil on the basis of control and domination, the shareholding amount in itself does not ipso facto connote domination. On this issue, the courts would try as much as possible to rely on the prevailing circumstances to determine if there is indeed complete control and domination to warrant the piercing of the corporate veil. Broadly, the following set of circumstances could elicit such considerations. To begin with, instances where there is undercapitalization based on the nature of the business could invoke control or domination. Likewise, if the company in question fails to adhere to the corporate formalities it would be construed to have attained the threshold of veil lifting. Equally, commingling of funds, roles and capital could indicate significant control or domination. In instances where there is parent-subsidiary relationship domination can be invoked if the directors or officers of the subsidiary entity act dependently to the parent entity or the parent treats the subsidiary as the part of its own. Equally, if the subsidiary is unable to exist commercially without the support of the parent company it would be construed as domination. Notably, the above named circumstances are in no way exhaustive and the presiding court will have to determine if indeed there is domination of any sort.

Another consideration the courts would have to grapple with is to determine if the company in question has been instituted to achieve or perpetrate an impropriety. This is a more straightforward consideration as the court would have to look into the suspected transgression and see if failing to lift the corporate veil would in fact promote the indiscretion. This provision covers the common law fraud that would automatically lead to the corporate veil being lifted. Uniquely, this provision is elaborate in the sense that violations including statutory contraventions that are not necessarily fraudulent in nature will be included.^[20]           

Uniquely, in an adversarial legal ecosystem the claimant would have to demonstrate that if the veil is not lifted it would occasion or perpetuate a legal damage. In other words, the claimant ought to show that if the veil is not lifted it would result in unjustly outcome. Contextually, this can only be invoked if the legal obligation has been ascertained and application of the Salomon’s principle would directly or constructively deny, threaten or jeopardize the fulfilment of that obligation.      

5. Conclusion

Following the impression created by this paper it would be untrue to think that the subsequent case laws have seriously undermined the Salomon’s principle. Ideally, the courts have to be credited with maintaining this principle in our legal discourse. The reasoning behind this is the fact that most judgments rendered on the subject greatly revolve around the prevailing circumstances and the application of judicial discretion. From its birth in1897 the Salomon’s principle is still alive and well amid several restrictions. Although these restrictions have created justifications for lifting the corporate veil, considerable number of legal practitioners and scholars would argue that the principle has been refined. 

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[1] [1897] A.C. 22.

[2] Salomon v. Salomon & Co. Ltd. [1897] A.C. 22 at p. 51

[3] [1925] A.C. 619.

[4] [1961] A.C. 12.

[5] (1951) 82 C.L.R. 372, 385

[6] [1923] A.C. 723,

[7] Ibid at para 741

[8] Contra Industrial Equity v. Blackburn (1977) 52 A.L.J.R. 89.

[9] (1977) 52 A.L.J.R. 89.

[10] [1969] 1 W.L.R. 1241

[11] Ibid at 1254

[12] Whitford Beach Pty. Ltd. v. FCT (1982) 150 C.L.R. 355; Daimler Company Ltd. v. Continental Rubber and Tyre Co. (Great Britain) Ltd. [1916] 2 A.C. 307; H.L. Bolton (Engineering) v. T.J. Graham & Sons Ltd. [1956] 3 All E.R. 624; Daimler Company Ltd. v. Continental Rubber and Tyre Co. (Great Britain) Ltd. [1916] 2 A.C. 307  

[13] Odyssey (London) Ltd. v. OIC Run Off Ltd. (2000) TLR 201 CA 

[14] Ibid   

[15][1933] Ch. 935 (CA)

[16] [1962] l WLR 832

[17] Adams v Cape Industries Plc [1990] Ch. 433 (CA (Civ Div) 

[18] Ibid

[19]Creasey v Breachwood Motors Ltd [1992] B.C.C. 638 (QBD) 

[20] See section 213and 214 of Insolvency Act; Section 349(4) Company Act