Introduction
The main reason for forming a corporation is to protect owners from liabilities and debts of their ventures. This guarantees the continuity of the corporation. However, we have noted cases whereby courts have reached a point of considering a separate business enterprise as a way of gaining unfair advantages over creditors and other claimants.
Moreover, it is clear that courts apply various standards for various types of business entities. Therefore, such variations in decision-making can affect the future decisions of courts when piercing the veils of other entities, which can have significant ramifications for the owners.
This paper looks at circumstances under which courts can decide to pierce the corporate veil using cases from England and Wales. It also reviews both past and recent trends and how they may affect future decisions of courts.
Piercing the Corporate veil
Shareholders of business corporations and limited liability entities design their organisations to protect themselves from creditors. Individual investors take risks by making investments in new or existing businesses. The public favours creations of new entities because of job creation. In addition, they also act as sources of taxes for the government.
Corporations and limited liability companies are responsible for business developments as they protect their owners from failure resulting from business activities.
Thus, if the new corporation fails, it is responsible for all debts it incurred as a new venture. However, corporations protect shareholders from such claims. Thus, the business owner has no obligation to pay such debts unless there are personal guarantees of the owner against debts.
Therefore, in case of lawsuits, business entities face risks of losing their assets. However, the corporate veil protects assets of the owner. Thus, we can say that not many entrepreneurs would risk their personal wealth without a corporate shield.
We have to note that the lawsuit may only remain as a form of threat to the business only if the owner treats that business as a distinct and separate entity from himself. In most cases, the court may establish that the corporation has no real assets to pay for its debts. In this case, the creditor may seek to convince the court that a corporate shield should not apply in the case.
Instead, the creditor will strive to recover the debts from personal assets of the owner. This practice of collecting debt is piercing the corporate veil in order to get the court’s decision regarding the owner’s obligations for the creditor in debts incurred.
Shareholder Protection and Piercing the Corporate Veil
Courts have often delivered some controversial rulings about piercing the corporate veil. The landmark case of Salomon v A Salomon & Co Ltd of 1897 is one of such court rulings.
The recent case that has influenced the idea of piercing the corporate veil is the case of VTB Capital Plc v Nutritek International Corp (VTB Capital) of 2011. There is also the case of Antonio Gramsci Shipping Corp v Stepanovs (Gramsci) of 2011. These cases have created new interests regarding the scope of piercing the corporate veil (Pugh, 2012).
In the case of Gramsci, the Court ruled that it was appropriate to pierce the corporate veil of Stepanovs so that Gramsci could enforce terms of the agreement under the contract. The Court based its decision on the fact that the owners established the company to perpetuate fraud by abusing structure and personality of the company.
The UK has effective Corporate Governance Codes (the Code). It works based on “comply or explain” principle. This gives it flexibility of adoption among corporations of the UK. The Code has gained popularity due to its effectiveness in promoting corporate governance in the UK. According to the Code, “corporate governance is the system by which board of directors direct and control companies” (Financial Reporting Council, 2012).
The main reason for corporate governance is to promote effective growth of business through prudent management, which bring the long-term success of the corporation. As a result, the Code ensures that corporations exist to serve interests of shareholders and the public.
However, the Code can only controls regulatory practices of corporations, but it cannot control their internal affairs such as acquisitions of assets or credit facilities. Thus, corporations are liable for their own debts.
In some cases, there are exceptions regarding directors or shareholders obligations to creditors (Rogowski, 1999). Thus, creditors may seek personal assets of directors and shareholders. Given such conditions, courts may pierce the corporate veil of the corporation and hold shareholders liable for debts.
Shareholders have enjoyed limited personal liabilities. This implies that such directors and shareholders are not liable for creditors (Gower & Davies, 2003).
Occasionally, shareholders or directors may fail to uphold financial integrity and effective corporate governance requirements. In these cases, directors or shareholders risk becoming personally liable for corporation debts. This is because creditors or the court may establish that there is no difference between the shareholder and the corporation.
Theories of piercing the corporate veil
The principle of piercing the corporate veil differs from one country to another. It also creates confusion in the corporate law because of the idea of limited liability. The views among corporate law scholars point to interpretations of limited liability and corporation activities when handling the corporate veil issue.
Two theories exist to explain the idea of piercing the corporate veil. They also explain why courts can lift the corporate veil. First, there is the alter ego or self-theory. This theory looks at “if there is a distinctive nature of the boundaries between the corporation and its shareholders” (Forji, 2007).
Second, instrumentality theory focuses on the use of a company by “its owners in ways that benefit the owner and not the corporation” (Forji, 2007). Thus, on any given case, the court shall decide which theory applies in a particular case. However, courts have not been effective in piercing the corporate veil and may only do it to achieve equitable results for both parties.
Situations under which the court lift the veil of corporation
Occasionally, courts may ignore the provision of limited liability and pierce the corporate veil. This applies when the court perceives that shareholders may not be different from the company. In this case, the court disregards the provision of corporations as a separate entity. Instead, it treats the two as a single entity (Payne, 1997).
In English and Wales company laws, the courts insist on establishing a distinction between the business and its owners. Thus, Anglo-Saxon courts reflect on several issues before piercing the corporate veil. These may include some irregularities in the companies, in the partnership, groups, and subsidiaries.
The company may be a sham, facade, or a creation of another company with intentions of facilitating evasion of fiduciary requirements. In this case, they automatically disregard the separate personality of the company in question (Bainbridge, 2001).
Fraud
English and Wales courts have pierced the corporate veil in cases involving fraud. In this case, a shareholder of a corporation establishes the corporation for evasion legal or fiduciary obligations. This is when the intention to create a corporation is to deny the creditors’ pre-established legal rights and refute claims. The famous case is that of Re Edelsten ex parte Donnelly.
In this case, the court did not ascertain fraud of the owner of the company, who failed to take the responsibility regarding his creditors basing his decision on limited liability.
This means that the court could not rule out fraud as the establishment of the business was not out of sham (Farrar, 1990). Shareholder created the company in order to protect any property acquired after bankruptcy from ending with the one of bankrupt trustees.
Creditors incur unjust costs
Sometimes, creditors may incur unfair costs or losses and the court may decide to pierce the veil.
Unfairness may cause courts to pierce the corporate veil. The court may argue that it would result to justice and fairness for the creditor.
Lack of a clear separation between the entity and the owner
Some business owners have failed to establish a distinction between their personal lives and their entities. In this case, the plaintiff may request the court to declare the business as a sham entity, which does not exist. Therefore, owners take personal operation of the business and are liable for debts incurred.
Agency
Some companies operate as corporate groups. Thus, the parent company may not be clear. Scholars argue that the parent company may conceal its identity under the agency name. The courts have argued that companies do not exist to serve the purpose of being agents for their owners. Instead, they are separate entities. The case that explains the role of agency in piercing the corporate veil is Barrow v CSR Ltd (Forji, 2007).
However, it is difficult to establish that the company operates as agent to its shareholders. Thus, courts may refuse to pierce the veil in that case. This was the case of The Electric Light and Power Supply Corporation Limited v Cormack where the court did not pierce the veil (Forji, 2007).
Corporate groups
The courts also do not hesitate to pierce the veil in corporate partnerships. A good example to illustrate this instance is the case of Bluecorp Pty Ltd v ANZ Executors and Trustee Co Ltd (supra). The court declared, “Inter-relationship of the corporate structure and the degree of their participation in shared enterprise with benefits reaped from steps initiated and plans executed” (Forji, 2007).
Sham
The court may consider a sham or a facade when lifting the corporate veil. In this case, the real plans behind the establishment of the entity are vague and may not be real. Briefly, it is something that makes false appearance, disguise, and or serves to conceal the real purpose behind its existence. The case of Sharrment Pty Ltd v Official Trustee in Bankruptcy served to explain a sham (Forji, 2007).
Fraud and sham go together. Courts have maintained that an argument for a sham also depends on an argument for a fraud. This is because shareholders cannot perpetuate fraud using a legal and an existing entity.
Consequences of Piercing the Corporate Veil
If courts pierce the corporate veil, then the business owner become personally liable for the entity’s debts. Thus, the owner loses rights to limited liability. Instead, the creditors turn to the shareholders personal properties, homes, other investments, and bank accounts to clear their business debts.
The recent arguments in the case of Gramsci and VTB Capital highlight how the judges give diverse views about piercing the corporate veil of an entity.
Judges argues for or against their decisions regarding rulings of whether or not they ought to have pierced the corporate veil. Several corporate scholars review the case with increased interest to understand whether the courts have established cases of injustice and impropriety in the case.
A closer look at the VTB Capital Inc. v. Nutritek International Corp
The Court of England allowed for an appeal in the case of VTB, which has raised several questions regarding the legality of piercing or lifting the corporate veil. This case shall provide an opportunity for the Court to explain circumstances under which a Court can pierce the veil. It shall also demonstrate the Court’s position regarding the shareholders or directors of the company with reference to facility agreements.
We have to recognise that there is no definite rule on how the case can go as the decision entirely rests with the Court. In all, this case shall set a new precedent on the doctrine of piercing the corporate veil. The impact of VTB case shall extend beyond England and Wales to other countries under the Commonwealth influence.
Facts about VTB case
This case comes from the failure of Russagroprom LLC (RAP) of to repay its loan to Capital (VTB). RAP acquired a loan facility in order to facilitate an acquisition of some dairy companies for Nutritek International Corporation (Nutritek). Nutritek is the defendant in this case. VTB is an English company operating as a subsidiary of the Russian Bank, JSC VTB Bank of Moscow.
VTB granted a facility to RAP through a ‘Facility Agreement’ terms. They also executed many interest rate swaps (ISA). RAP is a Russian company. However, when RAP failed to service the facility, VTB saw it appropriate to sue the loan beneficiary, Nutritek. Nutritek is a Virgin Island company of England.
VTB also sued two foreign affiliates of Nutritek. In addition, the list also included a Russian (Malofeev) VTB claimed as the owner and controller of the companies. VTB argued that Malofeev was the main beneficiary of the facility, owner and controller of Nutritek, its foreign affiliates, and RAP (Kain, 2012).
The company first made its claims under tort. It claimed that Nutritek and other defendants were liable for deceit or fraud and conspiracy. VTB claimed that Nutritek and its associates engaged in two acts of fraudulent activities that facilitated its entry into the facility arrangement and ISA.
First, VTB claimed that Nutritek and its associates misrepresented that RAP was an independent entity with its own arm of control. Second, VTB also claimed that Nutritek and its associates misrepresented the actual value of the company to its auditors, Ernst & Young Valuation Company, which conducted valuation for VTB Moscow.
VTB acquired an ex parte order that allowed it serve Nutritek and its associate ex juris in 2011. Ex parte order also had a “worldwide freezing of Malofeev’s assets of US $200 million” (Kain, 2012). Nutritek’s reaction aimed at setting the orders aside.
As a result, VTB realised it was appropriate to amend its claims. In this new claim, VTB claimed that Nutritek and its associates acted jointly on several occasions with RAP to disregard the Facility Agreement and ISA arrangements. VTB argued that, under these new claims, the Court would pierce the corporate veil of RAP.
VTB based its main argument rested on the fact that the “Facility Agreement contained forum-selection and choice-of-law clauses in favour of England” (Kain, 2012).
VTB claimed that the Court could consider all defendants as responsible parties to the facility under the Facility Agreement. In this case, the Court could apply “the English forum-selection clause, or base the case on the English CPR Practice Direction, which permitted service ex juris in relation to contractual claims” (Kain, 2012).
Discussion of the case
Judge Arnold dismissed VTB’s claims in November 2011. On the other hand, he granted the Nutritek’s motion of the service ex juris order. This also extended to the worldwide freezing of Malofeev’s assets. The judge claimed that VTB had not established whether England was the appropriate location to try the case.
Judge Arnold maintained that even if the Court pierced the corporate veil of RAP, it could not guarantee that the legal consequences would mean that the Court could enforce the Facility Agreement and ISA against Nutritek and associates.
Further, the Court reaffirmed Arnold’s ruling on June 20, 2012 at the English Court of Appeal. Lloyd argued that there was no such principle as piercing the corporate veil.
However, the Judge had only one provision for VTB. It argued that the Court could look into the case based on the company’s corporate sham or facade. In this case, the Judge argued that the case of was only valid under “special circumstances, which indicate that it was a mere façade concealing the true facts” (Kain, 2012). The Judge asserted that:
“… In cases in which that is done, the authorities show that it will or may lead to the granting of remedies against the company which, veil piercing apart, might appear in principle to be available only against those controlling it; and, equally, against the controllers when they might appear in principle to be available only against the company”….. (VTB Capital plc v Nutritek International Corp and others [2012] EWCA Civ 808).
Lloyd also maintained that the Court had the competency and the capacity to pierce the corporate veil in case there was no other means to ensure that the company and its controllers take responsibility for their wrongdoing. Lloyd also established the following arguments from the case. First, Lloyd noted that ownership and controls of entities alone do not guarantee piercing the corporate veil.
Second, the court cannot simply pierce the veil in “the interest of justice even if there is no third party in the case” (Kain, 2012). Third, the Court can “only pierce the veil on grounds of impropriety” (Kain, 2012). Fourth, there must be a connection between the use of the company’s structures in order to evade or conceal liability and the impropriety.
He also notes that the company’s engagement in impropriety alone does guarantee piercing its corporate veil. Fifth, the Court argued that it was necessary to establish both an act of impropriety, control, and ownership of the entity by the offender.
In this case, the offender uses the corporate to conceal the real facts with the intention of concealing impropriety. Finally, the Court also recognised that an entity could also be a sham from its inception, even if the ownership did not intend to use it for deception.
Therefore, the Court agreed that it could pierce the corporate veil based on the relevant offense of fraudulent or dishonest activities involving misuse of the corporate identity in order to conceal the facts behind the corporation identity.
The failed VTB’s Claims
From these observations, the Court established that VTB had a case against Nutritek and its associates, and that it was proper to pierce the corporate veil of RAP. In this sense, the issue was whether it was possible for the Court to pierce the corporate veil of RAP in order to render the defendants (Nutritek and its associates) liable for the Facility Agreement and ISA.
However, VTB’s claims did not succeed on the following ground, at least, from Lloyd’s argument. According to Lloyd, after reviewing the English law, they established that they could not support the idea of granting equitable relief against the corporation or its owners beyond this. In other words, the Court could not hold the owner as an actual party to the contract.
Given this view, the Court rejected claims of undisclosed principals as agents of the contract. According to the Court, VTB assumed that, under the English law, the Court could hold a party responsible to a contract because of controls or ownership. However, the Court established that none of the parties had any idea about the contract.
The Court also noted that to accede to VTB’s claims would amount to making intrusions into the principle of law that respects contractual agreements between parties, and any other party interested in the contract. In this light, the Court noted that the case of VTB did not fall under this category and that a stranger to the contract was not liable to the contract.
The Court also did not recognise the puppet entity and the controlling puppeteer. However, it was important to identify the puppet company and its owners to justify the grant of a judicial remedy when it was convenient and necessary to do so.
Still, the Court could not go to the extent of treating the puppeteer and the puppet entity as the other parties because they were distinct entities. The Court noted that fulfilling this claim amounted to ignoring Salomon principles. In this context, the Court could not assume that the puppeteer and the puppet entity were party to the contract.
In short, Lloyd noted that it was not proper to use the common law as VTB had suggested. In other words, the court did not recognise VTB’s claims of piercing the corporate veil of RAP in this case. Any such decision would indicate that the Court surpassed the current principle of the common law.
Further, it would mean that the Court brought new parties to the contract. The Court expressed that such claims could not apply in this case because it was not the right one for such common laws.
The Court viewed this case as a commercial deceit that English law could handle under tort. This implied that VTB could only make claims against defendants under tort principles for deceits and wrongful acts.
Therefore, the Court claimed that there were “no policy reasons for giving the case an artificial remedy in a situation, which VTB did not need” (Kain, 2012). According to the Court, VBT merely invoked claims to support it cases because it “assumed that the English courts could assume jurisdiction in its claims” (Kain, 2012).
Possible contributions of the case with regard to piercing the corporate veil
This case has created debates regarding the legal principle of piercing the corporate veil. Consequently, it will have significant influence among the Commonwealth states. Courts and commercial lawyers must also review their approaches with reference to this case and principle of piercing the corporate veil. This case raises some issues of fundamental interests.
First, the Court established that VBT’s claims had no factual, legal, or principle basis under English common law in which the Court could lift the corporate shield of RAP. According to this ruling, the Court cannot make a controller of another entity a party to a contract of another company. In this sense, the Court observed “the principle of a separate legal entity and the law of privity of a contract” (Kain, 2012).
Scholars may argue that this decision can limit England’s attraction for foreign cases involving corporate disputes. However, the English Court has clarified significant matters about piercing the corporate veil.
This implies that the Court cannot just rule to satisfy the claims of another party. It must observe principles of common laws. Any ruling in favour of piercing the corporate veil of RAP could have created new controversies regarding the principle of corporate law.
Second, if the Court could have affirmed VBT’s claims, then it would have raised issues regarding the remedies available to VBT and the position of the company’s controller with reference to separate and distinct party to the contract.
Affirming these claims of VBT would mean disregarding the principle limited liability for corporation directors. Thus, the Court avoided contradict the principle of separate legal personality in the benchmark ruling of Saloman v A Saloman & Co Ltd [1897] AC 22.
Third, we must also note that VBT wanted the Court of England to pierce the corporate veil of a foreign company. The Court of Appeal did not refer to RAP as a foreign company.
The issue arises whether it is appropriate for the Court of England to a pierce a veil of a foreign company and the possible consequences of doing so. On the other hand, we must also note that VBT is a Virgin Island company. Thus, the Court acted under English law. However, it did not confirm the position of RAP as a foreign entity.
We must also recognise careful analysis of the English law by the Court. This analysis helps commercial entities and lawyers understand circumstances under which the Court can pierce the corporate veil. Thus, it helps clear discrepancies in past rulings.
For instance, in the case of Gramsci, the Court had to pierce the corporate veil. As a result, the puppeteer or the controlling mind had to bear responsibilities of the contract. In contrast to VTB case, questions arise whether the Court made a wrong judgment on the case of Gramsci. In other words, the Court did not obey the principle of separate legal entity of the owners.
In addition, the Court’s ruling highlighted that it could only pierce the corporate veil based on the principle of equitable remedies. In this manner, the puppeteer must not evade its contractual liabilities. However, the Court could not take such action on a non-contractual puppet or puppeteer.
However, this case is not over just yet. VTB applied for an appeal to the Supreme Court. This implies that new decisions on piercing the corporate veil of a corporation and its controlling minds shall emerge.
Conclusion
This matter raises some controversies regarding the relevancy, applicability, and effectiveness of the principle of piercing the corporate veil. In this case, the Courts should declare their positions regarding the principle of piercing the corporate veil. This is because Judge Arnold declared that there is no such principle as piercing the corporate veil.
From the above examples, it is clear that the act of piercing the corporate veil is not clear. It is also controversial and will persist to be so for many years coming. The case of VTB shows that piercing a corporate veil exists only in theories. For instance, the Court noted that it was only valid under a “special circumstance, which indicates that it was a mere façade concealing the true facts” (Kain, 2012).
With reference to the above terms, English law does not recognise the principle of piercing the corporate veil. In addition, the use of terms like “a mere façade concealing the true facts” makes VTB’s claims under piercing the corporate veil difficult.
Conversely, English Courts are willing to preserve well-established and long-standing principles of common laws like the rule of corporate personality. This is exactly how the Court ruled on the case of VTB. It recognised the claim that Nutritek and its associates were independent party to the contract. Thus, were not part of the agreement consequently, had no liability over the claims.
Nevertheless, we have to recognise that there are no provisions on how courts should rule on cases about piercing the corporate veil. Still, rulings may also vary from various jurisdictions.
For instance, the outcome of the case could have been different in Russia where RAP has its origin. Therefore, we have to look at how courts appreciate different cases involving piercing the corporate. We can see the contradicting decisions on Gramsci and VTB cases and the merits under each case.
The ruling could have different if there were direct issues like fraud, sham or facade, unfairness, corporate groups, and agency. Most courts pierce the veil based on these issues. However, the Court established that the case of VBT was a deceit with a perfect remedy under tort laws. Thus, it ignored the inappropriate conducts of the controlling mind behind the deceit.
These rulings make the concept of piercing the corporate veil uncertain and not reliable for creditors. The concept is also undergoing inevitable changes.
Thus, the issue persists whether Courts can go beyond injustice and impropriety. Still, we have also recognised that the English Court can only pierce the veil to grant equity to parties in dispute. This ruling also demonstrates that Courts still focus on fraud as the key requirement for piercing the veil.
Reference List
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Payne, J 1997, ‘Lifting the Corporate Veil: A Reassessment of the Fraud Exception’, Cambridge Law Journal, vol. 1997, p. 56.
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