CHAPTER 3 EXAM RELEVANCE
This is a fundamental topic of company law. It is asked on virtually every exam paper in some form. It is most commonly asked as an essay question on either the principle of separate corporate personality or the circumstances in which the veil of incorporation will be lifted. It also forms a significant part of an answer to an essay question on the consequences of incorporation (see chapter 2). As is evident from the exam grid, it has been on every paper since April 2003 with the exception of two.
Upon incorporation, a company becomes a separate legal entity, distinct from its members. Thus it acquires rights, obligations and duties which are different and distinct from those of its members. Assets, debts, and obligations all belong to the company and not the members. This is the corporate personality used by the company to conduct its business.
THE SALOMON VEIL [3-2]
The seminal case which established the concept of the registered company having a corporate personality is Salomon v Salomon & company (1897)
1.Facts [3-3] Mr Salomon ran a successful leather business as a sole trader. He then set up a company with 20,007 shares, of which he held 20,001 shares and his wife and five children one each. He sold the business to the company for ? 38,782. The company was to pay him 20,000 fully paid-up 1 shares and 8,782 in cash. [3-4] The balance ? 10,0000 remained payable to Mr Salomon. He secured the payment of this debt when the company issued 100 debentures (loans) at ? 100. Each loan was secured by the creation of a floating charge in favour of Mr Salomon in the sum of ? 10,000 covering all the assets of the company. [3-5] Company law was at all times observed. There were seven members of the company, but Mr Salomon held all of the shares except six (held by his wife and five children). Thus he was the majority shareholder and the main creditor (owed ? 10,000 under the debentures) when the company was wound up. The Issue [3-6] The question for the court to decide was whether his secured debt of ? 10,000 should take precedence over unsecured creditors who were owed approx. ?11,000 having regard to the fact that company law gives precedence to the payment of secured debts when a company is wound up.
The unsecured creditors would receive nothing if Mr Salomon won. 1  A. C. 22. © Griffith College Professional Law School 2011-2012 41 The Argument [3-7] The liquidator argued that the sole purpose of transferring the business to the company was to use it as an agent for himself and accordingly he should, as principle, indemnify the company against the debts of unsecured creditors. Court of First Instance [3-8] At first instance, the liquidator’s view was accepted and it was held that the creditors should be paid by Mr Salomon.
The decisions were rooted in notions that the company was his nominee or agent. Court of Appeal [3-9] The Court of Appeal held that the creditors should be paid by Mr Salomon. This was because he had abused the privileges of incorporation and limited liability provided by the Companies Acts. These should only be enjoyed by “independent bona fide shareholders” who had a mind and will of their own and were not “mere puppets” of the individual who carried on his business in the same way as before, when he was a sole trader.
House of Lords [3-10] In the House of Lords, however, this view was unanimously rejected and the cornerstone of modern company law was put in place. It was held that the company was a separate legal entity and separate from its members. All that company law required was that there be seven subscribers to the memorandum, each holding at least one share and nothing was mentioned about independence. As the company was validly incorporated the debts are debts of the company and not of the members.
As Halsbury L. J. tated: “the business belonged to [the company] and not Mr Salomon. ” McNaughten L. J. stated: “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 at law the agent of the subscribers or a trustee for them. Nor are the subscribers as members liable, in any shape or form except to the extent and manner provided in the Act. [3-11] As Lindley L. J. had held in Farrar v Farrar’s Limited (1888)2: “A sale by a person to a corporation of which he is a member is not, either in form or in substance, a sale by a person to himself. ” The Result [3-12] A legal person could be created through the observance of the Companies Acts regardless of the fact that there is only one person involved. Priority was therefore given to Mr Salomon’s debentures. The Fall-Out [3-13] The Salomon principle is known as the veil of incorporation.
The law will not go behind the separate personality of the company to get at members, except in certain exceptional situations which will be dealt with later. 2 (1888) 40 Ch D 395. 42 © Griffith College Professional Law School 2011-2012 ?
The principle of separate corporate personality means that a company exists as a separate legal entity. Separate to its members and separate to its directors.
THE VEIL AT WORK [3-14]
In the Macaura v Northern Assurance Company (1925)3 case, this principle was followed. The plaintiff sold all the timber on his estate to a company in exchange for the whole of the company share capital. The timber was insured in the plaintiff’s own name. It was then destroyed by fire and the insurance company refused to pay on the basis that the plaintiff had no insurable interest in the timber as it was owned entirely by the company. The court applied the Salomon principle and found in favour of the defendant as the timber belonged to the company, and it had failed to insure its (the company’s) interest in the timber. [3-15] This case clarifies that the company owns the property and holds it in its own right.
A shareholder does not therefore have any proprietary rights in the company’s assets. Although a shareholder has no insurable interest in the company property, he can cover him/herself against loss by the company by insuring his shares (rather than the company’s assets) against a drop in their value. It is the shares and not the company’s assets in which he has any legal or equitable interest. 3-16] Where compensation is payable in respect of a loss suffered by the company, the shareholders have no right to payment as the loss is the loss of the company. In O’Neill v Ryan (1993),4 the plaintiff alleged that breaches in competition law by the four defendants had caused a diminution in the value of his shares in the second-named defendants, Ryanair Limited. The Supreme Court held that actions by four of the defendant companies did not entitle a shareholder to sue on the basis that the actions of the companies had reduced the value of his shares because this action did not cause personal loss to plaintiff as shareholder.
It was held that: ‘such a loss is merely a reflection of the loss suffered by the company. The shareholder does not suffer any personal loss’. [3-17] Blayney J. based his holding on a decision of the English Court of Appeal in Prudential Assurance company Ltd. v Newman Industries Ltd. (No. 2) (1982)5 wherein it was stated that: “the plaintiff’s shares are merely a right of participation in the company on the terms of the articles of association. The shares themselves, his [P] right of participation, are not directly affected by the wrongdoing.
The plaintiff still holds all the shares as his own absolutely unencumbered property. ” [3-18] This line of reasoning was recently affirmed in Stein v Blake (1998). 6 Here the plaintiff and defendant were 50/50 shareholders in a group of companies. The plaintiff claimed that the defendant, in breach of his fiduciary duties, had caused assets of the company to be sold at an undervalue. The plaintiff claimed that this action had deprived him of the ability to sell his shares at their fair value and this had caused him personal loss.
When faced with the argument that the proper plaintiff was the company itself, the plaintiff sought to rely on the decision of Heron International Ltd v Lord Grade (1983)7 where, as a result of a breach of a fiduciary duty to the shareholders, the directors had induced the shareholders to sell their shares at an undervalue to a prospective takeover bidder, and for which the shareholders could take personal actions. Millet L. J. distinguished the Heron case from the situation before him.
He observed that in that case no wrong had been done to the company as the company’s assets were not affected by the fact that the shares were sold at an undervalue. However, the circumstances in this case (1925) A. C 619. (1993) I. L. R. M. 557. 5 (1982) Ch 204. 6  1 All E. R. 724. 7  BCLC 244. 3 4 © Griffith College Professional Law School 2011-2012 43 were entirely different, in that here the plaintiff was claiming that he had suffered a loss by reason of a misappropriation of the company’s assets.
The plaintiff’s loss was merely a reflection of the company’s loss and would be fully compensated by restitution to the company of the misappropriated assets. Therefore the proper plaintiff in these proceedings was the company itself.
A drop in the value of the shares of a company is a loss suffered by the company. Any consequential loss to any individual shareholder is simply a reflection of the company’s loss. [3-19] The doctrine can also work in favour of the shareholder as in Lee v Lee’s Air Farming Company Ltd (1961)8 the plaintiff owned all but one share in the defendant company.
Thus, the defendant was a de facto single-person company as in the Salomon sense. He was also employed by the company and was the “driving force” of the company. The case related to his widow attempting to receive employee benefits after Mr Lee was killed. It was held that entrepreneurs can participate in employee benefits by incorporating their business and then becoming employees. The Salomon principle was applied and it was held that the company was a separate legal entity and he was an employee of that legal entity. She was entitled to recover. [3-20] The principal has however been used by the company to avoid obligations as in Roundabout Limited v Beirne (1959)9 which concerned a limited company owning and running a pub. All the staff then joined a trade union at the same time. The controllers of the company were unwilling to employ unionised staff, and the company closed the pub and dismissed all of the staff. The union legally picketed the pub. The controllers of the company then set up another company, being the plaintiff company herein, and leased the public house from the first company to it. Its barmen were non-union and were directors and therefore had no employees.
The new company could not be classed as an employer and therefore could not be subject to a trade dispute under the laws of the time. The new company then sought an injunction restraining the strikers. Dixon J. granted the injunction and stated that: “the new company is in law a distinct entity, as is the old company. Each company is what is known as a legal person. I have to regard the two companies as distinct in the same way as I would regard two distinct individuals. I must, therefore, proceed on the basis that a new and different person is now in occupation of the premises and carrying on business there. [3-21] In Battle v Irish Art Promotions Centre Limited (1968), it was held that the managing director (MD) of a company was separate and distinct from the company itself. The case related to the company being sued, but being unable to afford legal representation. The MD wished to represent the company himself as a judgment against the company would reflect badly on him as MD. The court refused to allow him to represent the company because the judgment would be against the company and not against him, and in law the company and the managing directors are distinct legal entities.
The correct procedure would be for the company to employ legal representation. [3-22] In State (McInerney) v Dublin company Co. (1985)11 it was held that a company and its wholly owned subsidiary were separate, and thus there was no locus standi for the parent company to appeal a planning permission decision when the land had been conveyed to the subsidiary. Carroll J. stated that: (1961) A. C. 12. (1959) I. R. 243. 10  IR 252. 11 (1985) High Court, Carroll J. 8 9 44 © Griffith College Professional Law School 2011-2012 ? the corporate veil is not a device to be raised or lowered at the option of the parent company or group. The arm which lifts the corporate veil must always be that of justice. ” [3-22A] In Re Heaphy (2004) the Plaintiff was principal shareholder in Springmound Holdings Ltd which owned two hotels. The Plaintiff went abroad and left his brother in charge of running the hotels. When he returned the hotels had been sold by his brother without his knowledge and consent. He claimed damages personally for fraud. The High Court concluded that the plaintiff could not bring this claim personally as the loss here was the company’s loss. His loss was merely indirect and reflected the company’s loss. The High Court also approved O’Neill v Ryan in this context.
LIFTING THE VEIL [3-23]
In Salomon, Lord Halsbury stated that the principle was to be applied provided that there was “no fraud and no agency” and only “if the company was real one and not a fiction or a myth”. [3-24] In the interests of preventing the abuse of the principle of separate legal entity, certain exceptions have been recognised where the veil will be pierced and the controllers of the company will be made personally responsible for the actions of the company, and the economic realities recognised. [3-25] Gower states: “the law either goes behind the corporate personality to individual members or ignores the separate personality of each company in favour of the economic entity constituted by a group of concerns”. 12 [3-26] Lifting the veil can be in one of the following contexts: Lifting the veil between the controllers (whether the management or a controlling shareholder) and the company, i. e. responsibility is shared; or Lifting the veil between a group of companies, e. g. etween subsidiaries or between a parent company and its subsidiary, i. e. the identity of one is consumed by the larger entity; or Ignoring the company altogether where the company is a “sham” or “device”. There are three categories of law where the corporate veil will be lifted. By Agreement [3-27] Corporate personality will be circumvented by agreement where, for example, an individual agrees to be bound to the company’s obligations. Common forms are personal guarantees, indemnities and certain agency agreements.
Equally a company can agree to be liable for the obligations of a member as long as the following formalities are respected: The action is not ultra vires; The action is not beyond the scope of directors authority; The action is not a fraudulent preference; The action is not a breach of s. 31 of the 1990 CA. Case Law [3-28] Concerning case law, the courts can decide to set separate legal personality aside without such an express agreement. The primary criterion for such decisions is control of the company’s day-to-day operations, rather than mere control of its general policies.
However, strict principles are difficult to extract, and cases often refer to inchoate concepts such as justice and equity. 12 13 Gower, Principles of Modern Company Law (5th ed. , London, 1992). See Courtney, p. 107 © Griffith College Professional Law School 2011-2012 45 [3-29] The courts will look behind the veil in certain circumstances as discussed below: Human characteristics; Fraud; Avoidance of legal duty; Agency; Single economic entity; Trust companies; Court injunctions and orders. Human Characteristics 3-30] The background of a company will be examined to find out more about the legal personality. Human characteristics required by law such as residence, culpability and mens rea, and character for licensing purposes may be vested in companies for certain purposes. [3-31] The residency of a company for tax purposes will often be called into question where the company is registered in one country but makes profits in another. The actual residence of companies which are incorporated in Ireland is now irrelevant for the purposes of the Tax Acts and the Capital Gains Tax Acts.
This is due to the Finance Act 1999, s. 82(2) which provides that “subject to certain limited exceptions, …a company which is incorporated in the State shall be regarded… as resident in the State”. [3-32] However, the actual residence of a company continues to be important for situations where a company is not incorporated in Ireland or for companies which fall under the exceptions of s. 82(2). The test for residency was laid down in De Beers Consolidated Mines v Howe (1906). 14 The case concerned whether a South African company was resident in England for tax purposes.
Lord Lorebun looked to where the company “keeps house and does business and the real business is carried on where the central management and control actually abides”. This is the “head and brains” test. In this case, the head office was in South Africa, and this is where the general meetings were held. Most of the directors lived in England, however, and most of the board meetings were held in England. It was at these meetings that the important business of the company such as negotiation of contracts, policy decisions, application of profits, etc. as discussed and decided. Thus, as the company was controlled from England, it resided there. [3-33] In the Irish case of John Hood & Co. Ltd v Magee (1918),15 a company was held to be controlled by its shareholders in the general meeting, and not by its managing director who resided in another jurisdiction. The shareholders’ power to remove the managing director indicated where the control lay. The factual situation is crucial. And in the licensing case The King (Cottingham) v The Justices of Co. Cork (1906)16 the conduct of the authorised agents was found to be that of the company in finding “good character”.
Fraud17 [3-34] Fraud or fraudulent intentions is another situation in which the corporate veil will be lifted by the courts. To do otherwise would result in the use of the corporate personality as a cloak for fraud. Fraud is used in the general sense to connote impropriety or misconduct. In Re Shrinkpak Limited (1909)19 Barron J. found that the company had been found using money fraudulently converted from the use of another company which had gone into voluntary liquidation.
Both companies had been under the control of the same person, and Barron J. granted an order, sought by the liquidator of the first company, to wind up Shrinkpak. A. C. 455.  2 I. R. 34. 16  2 I. R. 415. 17 See Jennifer Payne, “Lifting the Corporate Veil: A Reassessment of the Fraud Exception”, Cambridge Law Journal 56(2) July 1997, pp. 284–290. 18 High Court, December 20, 1989. 14 15 46 © Griffith College Professional Law School 2011-2012 ? [3-35] In Creasy v Breachwood Motors Limited (1993)20 a general manager was dismissed, and sued for wrongful dismissal. The company ceased trading, paid off all its creditors apart from the general manager, and transferred its assets to a new company, the defendant. It was held that the separate legal personality of the second company could be disregarded and the plaintiff could enforce the judgment for wrongful dismissal that he had against the first company. [3-36] The courts will lift the veil here to impose personal liability as in Re Bugle Press Ltd. 1961)21 Here the holders of 90 per cent of the shares in a company wished to buy out the holder of the remaining 10 per cent, but the minority shareholder refused to sell. The majority shareholders then set up a company to make a takeover bid for Bugle and under legislation, as this was a takeover bid, the company could then compulsorily acquire the minority shareholding. There had of course been no real takeover of the company and the new company had been formed solely with a view to expropriating the minority.
The court held that the new company was a “sham” and “bare faced attempt to evade a fundamental rule of company law”. [3-37] The courts do not allow this line of reasoning to extend as far as mismanagement. In Dublin County Council v Elgin Homes Limited (1984)22 a company which had been granted planning permission went into liquidation before it could comply with the terms of that permission. The plaintiff sought to compel the company and its directors to complete the works. Barrington J. efused to lift the veil and compel the directors qua individuals to complete the works, at their own expense, and drew a distinction between fraud and mismanagement. [3-38] In Dublin Co. Co. v O’Riordan (1986),23 Murphy J. refused to extend the fraud rule to the affairs of the company being carried on with “scant disregard for the requirements of the Companies Acts” because there was no evidence of “fraud or the misappropriation of monies. ” [3-39] This was relied upon by Hamilton P in Dun Laoghaire Corporation v Park Hill Developments (1989).
4 The company did not have general meetings or formal board meetings, did not pay dividends or directors’ fees to a second director and shareholder. One individual, Mr Parkinson Hill had financial knowledge of the company and managed it with total disregard for the Companies Acts. Hamilton P held that while that was the case: “I have found no evidence of any fraud or misrepresentation, no siphoning off or misapplication of funds, nor any negligence in the carrying out of the affairs of the company. [3-40] In Re H et al (1996), it was held that where the defendant had used a corporate structure as a device or facade to conceal its criminal activities, the court could lift the corporate veil and treat the company property as “realisable property” within the meaning of UK criminal law. Section 24 of the Criminal Law Act 1994 provides for similar measures in Irish law. Avoidance of Legal Duty [3-41] The courts will not allow a controller to avoid an existing legal obligation. In Cummings v Stewart (1911) related to a limited patent licensing agreement.
The agreement allowed Stewart to exploit Cummings’s patent for consideration but didn’t allow him to sublet, transfer or assign it without Cummings’s consent. A proviso allowed Stewart to transfer the licence to a limited company he formed for the purpose of a business connected with the licence. Stewart could not make a profit, and in an attempt to evade the royalties payable by him under the contract, he transferred the licence to a company formed by him, but not for the purpose of exploiting the licence.  BCLC 480. (1961) Ch 270. 22  I. L. R. M. 297. 3  I. L. R. M. 104. 24  I. R. 447. 20 21 © Griffith College Professional Law School 2011-2012 47 [3-42] Meredith M. R. stated that “it would be strange indeed if [the Companies Acts] could be turned into an engine for the destruction of legal obligation and the overthrow of legitimate and enforceable obligations. ” [3-43] In Gilford Motor Company v Horne (1933)25 the defendant’s contract of employment with the plaintiff provided that he would not compete with the plaintiff should his contract be terminated.
Upon termination the defendant set up a company with his son, in direct competition with the plaintiff and although he was neither a director nor shareholder of the new company, everyone referred to him as “the boss”. The court set aside the separate legal personality of the company. [3-44] In Jones v Lipman (1962)26 the defendant who had contracted to sell his house to the plaintiff tried to avoid a claim for specific performance to sell the house. He conveyed the house to a company which he owned and controlled in an effort to evade the plaintiff’s enforceable contract for sale.
Russell J. rejected a defence based on the company being a separate entity, describing the company as: “the creature of the defendant, a device and a sham, a mask which he holds before his face in attempt to avoid recognition by the eye of equity”. [3-45] However, it is important to remember that the formation of a company which has no genuinely separate existence, which may in truth be no more than a nameplate on an office building, is not in itself unlawful. It is only where the company has been formed for some fraudulent, illegal or improper purpose that the court may do so.
For example, in Roundabout Limited v Beirne (1959)27 it was argued that the court should look behind the formal legal structures to the reality, namely, the continuing control of the business and effective ownership by the same people. This request was refused and Dixon J. stated that although the scheme could be described as a subterfuge designed to circumvent the statutory protection of peaceful picketing, it was legally unassailable. [3-46] Furthermore this rule will not extend to the avoidance of prospective or future obligations, as held by the House of Lords in Adams v Cape Industries (1990). 8 Here the defendant UK company presided over a group of companies involved in mining asbestos. They had separate companies set up for the marketing of the asbestos in the US. The US subsidiaries were then subject to lawsuits for damage asbestos factory workers had suffered to their health from working with the defendant’s asbestos product. The plaintiffs then sought to enforce judgment against the parent UK company, saying that the actions of the US companies should be treated as those of the defendants.
The Court of Appeal held that the American Company had been set up so that the appearance of the defendant’s involvement in asbestos in the US would be minimised and also to reduce the possibility of Cape being made liable for US taxes or tort claims. But the court declined to treat this as a sufficient ground for lifting the corporate veil. Slade L. J. said arrangement of the corporate structure so as to ensure that legal liability (if any) in respect of particular future activities of the group will fall on another member of the group rather than the defendant company was a right inherent in our corporate law.
The Agency or Alter Ego Principle [3-47] A Company is not per se the agent of its members but such a relationship may be created between the two. This is an area where the courts have been prepared, in apparent conflict with Salomon, to infer the existence of a relationship of agency between companies in the same group. [3-48] Subsidiaries are frequently found to be the agent of the parent company. This is best illustrated by the case of Smith, Stone and Knight v Birmingham Corporation (1939)29 A  Ch. 939.  1 All E. R. 442. 27 (1959) I. R. 243. 28  Ch. 443. 9  4 All E. R. 116. 25 26 48 © Griffith College Professional Law School 2011-2012 subsidiary of the plaintiff company was treated like a department and the plaintiff was entitled to all of the profits of the subsidiary without the declaration of a dividend.
The defendant compulsorily purchased the land on which the subsidiary was based, and plaintiff successfully sought compensation. The defendant attempted to rely on the principle in Salomon and claimed the subsidiary was a distinct legal entity. However Atkinson J. tated that Salomon does not apply to a situation where there is a specific arrangement between the shareholders and the company whereby the company is an agent of its shareholders for the purpose of carrying on the business of the company. This will make the business of the company the business of the shareholders. The judge listed six factors, all based on the control over day-to-day operations, to be taken into account: 1. 2. 3. 4. 5. 6. Are the profits of the subsidiary treated as the profits of the parent? Were the persons conducting the business of the subsidiary appointed by the parent?
Was the parent the “head and brains” of the trading venture? Did the parent govern the adventure? Were the subsidiary company’s profits made by the skill and direction of the parent? Was the parent in effective and constant control of the subsidiary? 30 All six questions must be answered in the affirmative. [3-49] As Keane points out31 these criteria may not be capable of general application and the case should probably be limited to its facts. If an agency were to be inferred in every such case, a significant number of subsidiaries would be treated as the agents of their holding companies.
If this were so it would potentially expose those holding companies to direct liability for the debts and liabilities of their subsidiaries which would open a huge breach in the principle of limited liability. [3-50] The courts have also been far more willing to draw the inference of agency where the controlling shareholder is another company, rather than an individual. Some explanation was given for this in the case of Munton Bros Ltd v Secretary of State (1983). 32 Here Gibson J. found in favour of the parent company, holding that the subsidiary was in fact its agent.
He observed that while the courts are extremely reluctant to hold that a company is its shareholder’s agent, the same objections do not apply where it is sought to demonstrate that a subsidiary company is in fact the agent of its parent company because the conception of incorporation remains intact. [3-51] There has also been a tendency to draw this inference with greater readiness in cases where there is the possibility of tax evasion. In Firestone Tyre v Llewellin (1957) an American company formed a subsidiary in England for the purpose of manufacturing and supplying tyres.
The English company received the payments, deducted the cost of manufacture and a commission of 5 per cent, and then transferred the balance to the American parent company. Although the English company was independent in its day-to-day operations and only one of the directors was also a director of the American parent, it was held to be carrying on the business as the agent of the American company and thus the American parent was liable to pay tax in respect of profits of the English subsidiary. [3-52] In the recent case of Fyffes v DCC (2005)33 the agency principle was discussed. 4 In this case DCC plc was a parent company of Lotus Green. James Flavin was chief executive director of DCC. Lotus Green beneficially owned shares in Fyffes and sold these in February 2000. Lotus Green earned €106m from the sale. It was alleged that when these were sold James Flavin was in possession of insider or price sensitive information. Under the rel