Implications of limited liability

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This article mainly deals with situation where the corporate veil may be lifted. Whilst there is no unifying principle (:Briggs v James Hardie & Co Pty Ltd), Australian courts have agreed to lift the veil in the following instances:

  • Fraud/improper purpose: where a company is used as a fraud or a sham by the shareholders to escape liability, the court will lift the corporate veil to make the shareholders liable: Gilford Motor Co Ltd v Horne.
  • Agency: where a company is carrying on behalf of a principal and not its own, the corporate veil will be lifted and the principal will be liable: Smith, Stone and Knight Ltd v Birmingham Corporation.
    • Agency is a question of fact. Relevant considerations include:
      1. Were the profits treated as the profits of the principal?
      2. Were the persons conducting the business appointed by the principal?
      3. Was the principal the head and the brain of the trading venture?
      4. Did the principal govern the adventure, decide what should be done and what capital should be embarked on the venture?
      5. Did the principal make the profits by its skill/direction?
      6. Was the principal in effectual and constant control of the agent?
    • Merely holding all of the shares is not relevantenough: Smith, Stone and Knight Ltd v Birmingham Corporation.
  • Directors' duties - directors who breach their duties can be held accountable for their breaches. This is discussed elsewhere.
  • Insolvent trading - directors and parent companies can be held liable for the debts of its company/subsidiary under the Act. This is discussed elsewhere.

This topic is within Business Associations.

Contents

Required Reading

Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC, pp. .

Introduction

The ‘corporate veil’ is the ‘separateness’ between the shareholders/directors and the company itself – it refers to the limited liability of shareholders for the debts of the company. ‘Piercing the corporate veil’ is when a creditor manages to get something from the shareholder.

  • The veil is only ‘pierced’ in special situations, such as where there was fraud, improper conduct, agency etc.
  • There Corporations Act also specifies that the corporate veil may be pierced in the instance where the duty to duty prevent insolvent trading was breached (588G for directors and s 588V for holding companies.

Fraud or improper conduct

Shareholders using the corporation for the purpose of fraud or an improper purpose will not not protected by the corporate veil and limited liability. This was discussed in a number of cases, for example Gilford Motor Co Ltd v Horne:[1]

  • Facts: Gilford was a car manufacture business and Horne worked for it. He had a restraint of trade clause in his employment contract, but he ignored it after he left Gilford and started a competitor business. He then set up a company in his wife’s name and tried to rely on the corporate veil to protect himself personally.
  • Held: the second company was ultimately held to be a fraud used by Horne to conduct his business in violation of the restraint of trade clause. An equitable injunction was granted against Horne. 

And also in Jones v Lipman:[2]

  • Facts: Lipman was selling land to Jones. Before completion, Lipman changed his mind instead sold the land to a company owned by him for a significantly lower sum (so as to retain the land). Jones sought to enforce the contract.
  • Held: “The defendant company is the creature of the first defendant, a device and a sham, a mask which he holds...in an attempt to avoid recognition by the eye of equity...an equitable remedy is rightly to be granted directly against the creature in such circumstances”.
    • “Specific performance cannot be avoided by a vendor who, by his absolute ownership and control of a limited company in which the property is vested, is in a position to cause the (original) contract to be completed”

And also in Re Darby; Ex parte Borugham:[3]

  • Facts: Darby and another controlled Newco, which controlled Welsh Slate. Newco sold a license to Walsh Slate for a manipulated lower price, which then led to others investing in Welsh Slate. Welsh Slate later went bust, still owing money to Newco for the license, and the liquidator tried to recover money from Darby personally.
  • Held: the whole scheme was for fraudulent purposes, thus it is permitted in this circumstance to lift the corporate veil. The fraud was in sale price of license from Newco to Welsh, but also interference with contractual relations/improper conduct.

Agency

It has also been accepted that the corporate veil may be lifted in instances where a company was carrying business on behalf of a principal and not its own. This was discussed in Smith, Stone and Knight Ltd v Birmingham Corporation:[4]

  • Facts: SSK was a paper manufacturer who also owned a factory which was being rented out to a subsidiary, Birmingham Waste. The Council decided to compulsorily acquire the land and SSK lodged a claim for compensation (initially on behalf of BW, but then on their own claiming that BW were agents for SSK and that the loss will fall on SSK). The issue was whether SSK could claim compensation in this way (since a statutory ruled meant that BW couldn't claim since they were in the factory for less than a year).
  • Held: merely holding all of the shares in a company does not result in lifting the corporate veil. Rather, the test for agency is whether the relevant company (here, the subsidiary) was carrying on the business as the shareholder's (here, the holding company) business, or its own? There are six relevant consideration to determine this question of fact:
    1. Were the profits treated as the profits of the principal?
    2. Were the persons conducting the business appointed by the principal?
    3. Was the principal the head and the brain of the trading venture?
    4. Did the principal govern the adventure, decide what should be done and what capital should be embarked on the venture?
    5. Did the principal make the profits by its skill/direction?
    6. Was the principal in effectual and constant control of the agent?
    • In this case, the court found that all these questions were answered to the favour of SSK, so BW were deemed an agent and SSK were able to have the veil lifted and claim compensation.

And also in Re FG (Films) Ltd:[5]

  • Facts: An american film company called FGI had the rights to produce a movie. They wanted to receive a subsidy offered in England for local filmmakers, so its president incorporated a British company called FG (owned 90% of shares), which would technically produce the movie, although all funding and other aspects were done by FGI and the movie was to be produced in India. The licensing authority refused on ground that it was not made by FG.
  • Held: the question was whether FG were the sole statutory ‘makers’ of the film or whether they did so in cooperation with another? (ie, as their agent) - ‘maker’ being defined as the person by whom the arrangement necessary for making of film are undertaken/responsible for.
    • FG’s participation in the undertaking of the film was so small as to be practically negligible and they acted merely as the agent for the American company who financed their film under direction of the American director who happened to be its president. The sole purpose of making the entity was to satisfy the requirement of the statute.
    • Thus, the corporate veil was lifted because court looked into actual shareholders and not just the company as registered in England.

And in Spraeg v Paeson Pty Ltd:[6]

  • Facts: Spraeg succeeded in claim against Paeson. Spraeg wanted to also claim off C, Paeson's supposed parent company and alleged principal. Paeson had no bank account or other assets, premises of its own, didn't keep any accounts nor prepare balance sheet of profit and loss accounts - C had accounts suggesting payments made by it on Paeson’s behalf and loans to Paeson. Paeson's employees were employed by Paeson, but paid by C. Monies received by Paeson were paid to C (said paying back indebtedness but no book entry stating this). Paeson's employee's business card showed him as representative of C and on brochures brick maker called “C’s Brick maker”
  • Held: the considerations stated in SSK were all satisfied here - Paeson was clearly an agent of C, carrying its business for C.

Corporate personality within corporate groups

“The fundamental principles that each [company within a group] is a separate and independent legal entity, and that it was the duty of the directors of [each company] top consult its interests and its interests alone in dealing whether payments should be made to other companies”: Walker v Wimborne (1976).

  • “In the absence of contract creating some additional right, the creditors of company A, a subsidiary company within a group, can look only to that company for payment of their debt”: Industrial Equities v Blackburn (1977)
  • “Save in cases which turn on wording of particular statutes/contracts, the court is not free to disregard the principle of Salomon merely because it considers that justice so requires. Our law recognises the creation of subsidiary companies which though in one sense are creatures of their parent companies, will nevertheless under general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities”: Adams v Cape (1990).

In reality, a lot of companies are organised within corporate groups. The current law in Australia, which focuses on each company being a separate legal entity, doesn't really allow the veil to be lifted so as to make related companies within a corporate structure liable for related companies' debts (bar a few exceptions). The idea that related companies should be liable for each other's debts is called 'enterprise liability'.

This was discussed in Briggs v James Hardie & Co Pty Ltd:[7]

  • Facts: Briggs was poisoned with asbestos and sued his former employers’ holding company, James Hardie
  • Held: the problem arises from the fact there is no common, unifying principle, which underlies the occasional decision from courts to pierce the veil of incorporation. “The law pays scant regard to the commercial reality that every holding company has the potential and, more often than not, in fact, does, exercise complete control over a subsidiary."
    • The court discussed the merits and problems with enterprise liability.
    • Ultimately, this case did not settle anything in regards to lifting the veil, because it was rejected because of the statute of limitations. The court did not note that this area needs to be addressed.

And in Walkovsky v Cartlon:[8]

  • Facts: action against a cab driver, the corporation owning cab and Carlton who owned stock of 10 taxi corporations each owning 2 cabs carrying minimum insurance. The complaint alleged that corporations were operated as a single entity and that structure constituted attempt to ‘defraud’ members of the public. Carlton moved to dismiss for failure to state cause of action - this was granted, and this is the appeal.
  • Held: the courts will disregard the corporate form whenever necessary “to prevent fraud or to achieve equity” and in deciding whether liability should be extended beyond the assets of the corporation we are guided “by general rules of agency” (ie, when using control of corporation to further own interests rather than corporations’ business (improper purpose/agency), he will be liable for corporation’s acts - this principle extends not only to its commercial dealings).
    • Claimant relied on fraud not agency - if it is not fraudulent for the owner-operator of single cab corporation to take out only minimum insurance required, enterprise does not become fraudulent just because it consists of many such corporations.
    • Injuries are the same regardless, whatever claim he could make would have to come under agency principle. No cause of action established by the claimant.
    • The outcome of this case was to establish that if you organise your affairs to attempt to use the Salomon principle, then you have these consequences when dealing with tort victims.

Corporate crime

[9] The harms or cost of corporate crime significantly outweighs that of street crime yet it is much less the focus of ‘law and order’ officials. Various costs include:

  • Monetary: costs of economic-based street crimes e.g. burglary etc are “insignificant when compared to the costs imposed by corporate monopolistic and standard-breaching manufacturing”
  • Human cost: people die in workplaces as a result of corporate wrong-doing from things such as exploding products, toxic chemicals etc - less violent consequences include tax evasion, bribery etc
  • Global cost: corporations act across borders to injure foreigners

Recidivism is rife in the area of corporate crime - corporations are “habitual criminals” (p. 139) Nearly impossible that a corporation will not re-offend, examples include Hoffman-La Roche, Exxon, General Motors, Ford.

Corporate crime is fundamentally different from street crime, as is why they commit crimes - the same explanations (biological, sociological and psychological factors) cannot be used:

  • “Corporations engage in deviant, harmful behavior because it suits their agenda. They set out to maximize profits. They are legally created for that purpose”
  • “Corporate law… has emptied the corporation of moral and ethical constraints that might otherwise inhibit profiteering at any cost”
  • Accountability is significantly diminished in corporate crimes than it is in street crimes due to the organizational structure of a corporation - makes it difficult to pinpoint who might have actually committed the wrongful act
  • “Diffusion and delegation serve both the goals of efficiency and the not-so-worthy abdication of responsibility”
  • Corporate culture intensifies the prevalence of corporate crime - “profit-maximisation at virtually any cost becomes an incontestably good thing”
  • Investors are irresponsible (shareholders) and amoral
  • Everyday corporations are involved in illegal behavior - 6 out of 10 had been involved in illegal behavior in the past year

End

This is the end of this topic. Click here to go back to the main subject page for Business Associations.

References

Textbook refers to Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC.

  1. [1933] 1 Ch 935.
  2. [1962] 1 WLR 832.
  3. [1911] 1 KB 95.
  4. (1939) 161 LT 371.
  5. [1953] 1 WLR 483.
  6. (1990) 94 ALR 679.
  7. (1989) 7 ACLC .
  8. (1966) 223 NE 2d 6.
  9. Glasbeek, Wealth by Stealth: Corporate Crime, Corporate Law and the Perversion of Democracy (2002).
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