Introduction
Separate Legal Personality (SLP) and limited liability concepts are the foundation of company law in the modern corporation used in many jurisdictions globally. Defining how a firm is formed and works, separate legal personality is alleged as one of the most thoughtful and consistent codes of corporate legal systems. Interestingly, this doctrine in reality has been an element of intense negotiations and is one of the most contested theories of law across the world. Although the legal narrative of the separate legal personality and limited liability has been widely embraced by different corporate entities as the base jurisprudence, there are, however, exceptions. That is, situations that require the corporate veil to be pierced, which have been determined by Courts to enforce the law. While the judicial remedy of piercing the veil of incorporation is a method to deal with possible fraud within private companies, this critical writing on comparative company law explores how Courts approach a public company when dealing with the same issue. It looks at the realities of ‘piercing the veil’ and other possible remedies based on the UK approach and the US jurisdiction for comparison. The analysis starts with the definition of key terms and then moves to theories for piercing the veil of the corporation, Separate Legal Personality (SLP), how Courts face a publicly-traded company, highlights the UK and the US approaches and then ends with a conclusion.
A corporation or Limited Liability Company
The word corporation emanates from the Latin word corpus, meaning a collection of body or persons, and within the business context, a corporation is a for-profit entity registered or incorporated under company law of a given jurisdiction. A corporation is an entity that legally acquires an independent status to act on behalf of shareholders. It is seen as an artificial being or a legal entity created under certain legal requirements by a person or a group of persons to drive business agendas and to ensure continued growth through succession for a limited period or in perpetuity. Overall, a corporation is an invisible, intangible being that only exists within the contemplation of laws.
Separate Legal Entity
One major character of a corporation is that it is considered a separate entity from its owners under law. A legally registered firm has its own rights and obligations, which are completely different from its owners’ responsibilities and duties. Assets and liabilities acquired by a firm belong to it and not its owners, as illustrated in the case of Salomon v. Salomon & Co. Ltd. In this case, the corporation was seen as a body or an independent legal personality created by members, and it had the capacity to act on behalf of its founders under the English company law. Additionally, the company possesses its own distinct personality from its membership. Merely by incorporating a firm, individuals acquire some legal privileges that would be otherwise impossible to realize without a corporation. They also can evade some statutory requirements that otherwise would be expected of them, but this is not an absolute reason for establishing a legal corporation.
Veil of Incorporation
Legally, the veil of a corporation or corporate veil is assumed to offer protection to persons behind the corporation. In this case, the actions of managers, directors, and shareholders are relieved from possible liabilities. However, a corporation assumes any liabilities arising from such actions.
Piercing the Corporate Veil
Lifting the veil of the corporation is the judicial decision to enforce personal liability on otherwise excepted corporate employees and shareholders from a firm’s unlawful activities. In this regard, courts ignore the veil of the corporation and pursue individuals behind the company.
Theories for Piercing of Corporate Veil
The alter ego theory is based on the wrong extent of control and authority by the parent of a corporation. In such instances, Courts fail to respect the distinctness between a subsidiary and its parent because the subsidiary is seen as a mere alter ego or shell for shareholders. It is, however, not sufficient that the parent company or shareholders utterly dominate the subsidiary company. Courts specifically strive to establish the presence of inappropriate or undue levels of influence and dominance. In reality, under the alter ego theory, Courts tend to demonstrate major unfairness or fraud to pierce the corporate veil. The alter ego theory, therefore, has developed to center more on the idea of unlawful activity and less on the concept of domination from where it was derived.
The agency theory appears to differ from the alter ego theory because Courts do not need to determine fraud or inappropriateness. This theory emanates from the common code of agency in which a principal, such as a shareholder, can be held legally liable for actions of agents (employees) since they act or are allowed to conduct business on behalf of a corporation. For a company employee to be held liable for acts of shareholders, the activity ought to be within the limit of the power granted by the owner to the agent – this power can be apparent or real. The real power is observed when a shareholder communicates the entrustment of power to the agent who subsequently acknowledges, while apparent power is noted on some acts of the owners that make it rational for a third party to assume that such authority exists. Courts often determine the extent of control exercised by shareholders to pierce the corporate veil. The dominance of shareholders is mandatory, but mere ownership of some stakes or overlap in a corporate structure is not a sufficient ground to break the shield.
The single economic unit theory is based on the argument that a firm is a distinct entity and separate from its owners, who are considered responsible only to the extent of their equity in a firm as determined in the case of Salomon v. Salomon 1897. According to this rule, each subsidiary of a conglomerate is viewed as a separate corporation and the parent company cannot, therefore, be made responsible for their obligations on insolvency. Parent companies are allowed to form subsidiaries even with insufficient capitalization and source loans for them but with fixed charges on their assets – this may be considered a deceitful approach in trading, Prest v Petrodel.
Separate Legal Personality (SLP) and Piercing of Corporate Veil
Laws to guide corporations were developed due to increased intricate aspects of the commercial arena to limit risks, to enhance efficiency, investment, competition, diversification, and liquidity, and to promote corporate activities. In fact, it is observed that all systems of the law that have acquired some given levels of maturity appear driven by the ever-increasing complicated affairs of humans to develop entities that can act on behalf of persons and to control their responsibilities and rights. Consequently, businesses can now restrict the personal liabilities of their owners in the complex field of commerce, and various business structures have led to the development of the principle of separate legal personality, which is seen as the major law behind corporate survival.
Separate legal personality offers a firm a distinct legal identity different and detached from that of its shareholders. This implies that a company bears its own liabilities and has its own rights, which are independent of its owners. To this end, the role of shareholders is restricted only to the number of their equity contributions. This legal principle allows a group of persons to pursue a commercial activity as a single body without necessarily exposing individuals to personal risks. As a corollary, a business, separate from its owners, can among other things, acquire property, enter into business deals, incur costs and debts, pay out cash, invest, sue, be sued, and even continue after the demise of its founding members.
Past cases reveal that English law was traditionally not applying the principle of separate legal personality and limited liability. This is illustrated in the case of Dr. Salmon v.Hamborough Company (1691) and in a 1673 case. The judge stated:
“If losses must fall upon the creditors, such losses should be borne by those who were members of the company, who best knew their estates and credit, and not by strangers who were drawn in to trust the company upon the credit and countenance it had from such particular members”.
It was, however, the case of Salomon v. Salomon, which changed the doctrine. Salmon was the majority owner of the company and was alleged to be personally responsible for the firm’s debts at the period of liquidation. The liquidator, acting on behalf of other creditors, claimed that the business was a pretense. The Court of Appeal viewed the corporation as a sham, but the House of the Lords maintained that the company was appropriately registered under the Companies Act at the time of incorporation. As such, it was a distinct entity with its own rights and liabilities, and individuals involved in the operations of the firm were completely immaterial with regard to rights and liabilities before the eyes of the law.
The concept of the corporate veil, therefore, was established through the case of Salomon. It was later adopted as the basic principle of corporate jurisprudence to separate a company from its owners. After the adoption of the ruling, the separate legal personality and limited liability concept have been widely applied as a categorical precedent in many other cases of similar nature. Some earlier cases were the Kandoli Tea Company Case 1886, Macaura v. Northern Assurance Co. 1925, Lee v Lee’s Air Farming Co. Ltd 1960, and the Farrar case among others. This fundamental principle of the company law is not restricted to the English law only, and in fact, Article 529 of the French Commercial Code of 1807 acknowledged that a company (société) owned its assets in its own right.
Having established the veil of the corporation, this predominant rule has some exceptions. In some contexts, the legal basis of separate legal personality and limited liability can cause unfairness and harm to creditors. To some extent, the separate legal entity allows a company’s managers, directors, and shareholders to evade obligations. Courts offer remedies. This implies that Courts may be compelled to go beyond the veil to target managers, directors, and shareholders in a practice referred to as lifting or piercing of the corporate veil in certain cases. District Judge Sanborn captured the classic explanation of piercing the corporate veil, which continues to be used today. In the case of the United States v. Milwaukee Refrigerator Transit Co., the judge argued, “when the notion of the legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law should regard the corporation as an association of persons and pierce the corporate veil”. Therefore, veil piercing” is regarded as an impartial cure to the otherwise imposing separate legal personality and limited liability principle, which allows other parties and Courts to go beyond the company to trace the owners or management team who have evaded legitimate corporate obligations. It is imperative here to mention the case of Adams v. Cape Industries 1991. The Court used this case to determine different reasons to pierce the veil, which included the agency, fraud, sham or façade, group enterprises, and unreasonableness or unfairness.
Piercing of the Corporate Veil for a Publicly Traded Corporation
So far, Court cases reveal that piercing the corporate veil generally is mostly applicable and effective for limited liability companies or corporations – usually smaller privately held entities where the company has a limited number of shareholders, assets, and the recognition of distinctness between shareholders and the firm is usually difficult. Courts are more concerned with the autonomy of managers, directors, and owners. Company rules and formalities should always be protected to check on the autonomy of owners to restrict their personal liability. Issuance of stock, although often disregarded, is an important element of corporate requirements and protection of shareholders. Courts often look at the failure of corporations to issue stocks as a possible ground for piercing the corporate veil.
Although the issuance of stock could be an insufficient ground to pierce the corporate shield, when Courts consider other factors, such as inadequate capitalization, absence of paid-in-capital, personal dominance, and/or piecemeal organization, then the failure to issue stock could be a reason to pierce the corporate veil. It is, however, imperative to recognize that the US states may apply different laws with regard to stock issuance before a firm can start operations. Another reason why publicly traded firms are not necessarily subjected to the principle of separate legal personality and limited liability is monitoring. Monitoring restricts or controls how management transfers assets. Notably, conventional modes of monitoring management are not always applied in closely held companies. For instance, corporations (closely held) do not have to audit their financial statements, and they rarely rely on bond financing, meaning that bond trading firms do not pay attention to their activities. Additionally, relative to closely held limited liability firms, publicly traded companies’ stocks are traded, and they are required to file disclosure to securities, and exchange authorities.
The inability of courts to pierce the veil of a publicly traded corporation is a practical matter. It is observed that Florida Courts, for instance, are not likely to pierce the veil of a publicly-traded firm or a company with many shareholders (ten or more). The rationale is simple – in publicly traded corporations with many shareholders, ownership is too broadly distributed for an individual shareholder to assume absolute control. To date, no evidence suggests a fruitful piercing of the corporate veil for any publicly-traded company due to many shareholders and the thorough compulsory filings required to meet the requirements for listing on a stock exchange market. In practice, it is improbable that owners or shareholders of a publicly-traded company would accept personal liabilities for their company obligations. As Court evidence shows in most instances, the principle of piercing the veil of the corporation would only touch shareholders of small, closely-held private businesses. Nonetheless, it is imperative to recognize that outside parties may still aim to pierce the corporate shield of a large publicly traded corporation in attempts to hold shareholders personally responsible for damages. Clients, workers, and even estates of owners could be claimants in efforts to pierce the veil of a corporation with mammoth shareholding. Publicly traded firms have successfully avoided breaking the corporate shield because of their corporate identity evident inappropriate representation, financing, reporting, and sufficient asset management.
The UK and the US Approaches
There appear to be some fundamental differences between the corporate veil doctrines of the US and the UK. Notably, all cases on abuse of corporate entity and separate legal personality are usually based on the case of Salomon v. Salomon in both jurisdictions. English Courts are seen as more conservative in their approaches, while the US Courts shows increased enthusiasm to explore new aspects when a case so warrants. The variations in the US and UK Courts demonstrate important dissimilarities in methods of decision-making, legal choices to develop new judicial doctrines, approaches to policy issues, and judicial focus on doctrinal rules.
The legal transformation of the US corporate veil doctrine shows differences with its UK counterpart and demonstrates the variation in judicial viewpoints in the two jurisdictions. It is observed that the US first applied the traditional common law principle but later shifted because of its deficiency. The US system went ahead to create new approaches like the alter ego and instrumentality, which were important to ensure that Courts identified only issues relevant to the veil of the corporation.
Further, the agency argument presents how the US Courts deals with cases of the corporate shield. Although both the US and the UK apply the principle of agency, the US Courts have long acknowledged shortcomings of this concept. For instance, in the case of Kingston Dry Dock v. Lake Champlain Transportation, the judge observed that while the agency theory could be applied in consensual agency engagements particularly contracted by the shareholder and agent, Courts might not focus on concerns like the parent’s direct involvement in operations, overlooking the subsidiary’s details of incorporation and management. These elements are fundamental in decisions for the veil of corporation to be pierced. This observation pointed out the insufficiency of the agency theory to resolve cases of corporate veil.
The US Courts have shown a greater tendency to promote justice and prevent fraud when they pierce the veil of corporation. More importantly, fraud is given a relatively wider meaning within the context of the corporate veil cases than in other cases. Courts focus on fraud as based on conducts that normally fall short of the general fraud law, and this is more convincingly seen as a misrepresentation. Thus, fraud and misrepresentation are often classified as similar conducts in the US Courts. In fact, the US Courts have often pierced the veil in most cases where misrepresentation was determined. On the other, under the English company law, fraud appears as the only determining element for corporate veil cases. The UK Courts have mostly pierced the veil when the suspect is found to have committed a fraud. Relative to the US cases, the UK cases classified under fraud have commonly referred to misappropriation of company assets and other clear fraudulent practices. Moving forward, the UK Courts have also sometimes extended the scope of fraud to include misrepresentation. For example, the cases of re Darby, Brougham demonstrates how the UK Court rightly expanded the scope. The case involved two notorious fraudsters, and the judge argued that Darby and Gyde were at the center of the fraud and not the corporation.
Majority commentators have often supported the view that veil piercing ought to be more freely presented to tort plaintiffs than to contractual appellants due to the former’s incapability to negotiate prior for compensation or to look for extra protection from a company. Nonetheless, US Courts appear considerate toward contractual plaintiffs than tort claimants. A careful analysis reveals that the English Courts seem to have a different approach to tort claims (such claims are not common under veil piercing). These divergent views could have originated from the case of Adams decision in which the English judiciary saw tort claims aiming to pierce the veil as generally irrelevant. The Court maintained the right to rely on a corporate structure as contained in the English company law, implying that it was legitimate to use a corporation to limit future liabilities. It is imperative to note that, to some extent, the US Courts may also share this view – Craig v. Lake Asbestos of Quebec but with different outcomes on cases of a similar nature.
There are also cases of voluntary piercing in both jurisdictions. Voluntary piercing or reverse piercing is noted with preponderance in the UK. The reverse piercing is often seen as a misnomer. It is the imposition of obligations on the company for the owners’ debts, which is opposed to the normal piercing or forward piercing where owners are held legally answerable for a company’s debts. It is the invocation of piercing the veil doctrine by shareholders themselves (not creditors or outsiders) to ‘spare’ the corporate entity, making it voluntary. Shareholders invoke this doctrine because they expect some forms of benefits or compensations, for instance, from a subsidiary. However, the English and the US Courts do not entertain voluntary piercing in most cases – Tunstall v. Steigman, Tate Access Floors Inc. v. Boswell and Macaura v. Northern Assurance Co Ltd.
Conclusion
This essay looked at the realities of ‘piercing the veil’ through a comparative law analysis of the English and the US approaches. The impartial law of piercing the veil of corporation ensures that creditors and other outsiders can hold corporation’s shareholders personally responsible for obligations of the company. In the two jurisdictions, the practice is deeply entrenched in Salomon v. Salomon. English Courts may be more conservative in their practices, while the US Courts have advanced various approaches to respond to different cases. Nonetheless, the two jurisdictions have never pierced the veil of a publicly traded corporation, but continue to deliver justice where corporations are involved when a case so warrants it. However, disregarding the corporate limited liability veil is an extraordinary remedy. Accordingly, a judgment creditor must be well versed with this doctrine if they wish to pursue a corporation’s owner in an individual capacity.
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