International Journal of Law & Management

2014

Lifting the veil of incorporation under common law and statute

Chrispas Nyombi

Subject: Company law. Other related subjects: Administration of justice

Keywords: Breach of statutory duty; Corporate personality; Judicial decision-making

*Int. J.L.M. 66 Abstract

Purpose - The paper examines case law and statutory provisions related to lifting the corporate veil. The

aim of the paper is to explore recent case law in order to determine whether courts have moved away from

an overly restrictive approach when dealing with cases relating to the corporate personality. To offer a full

account of the exceptions to the corporate personality doctrine, this paper also examines cases where the

veil of incorporation is lifted due to a breach of a statutory provision.

Design/methodology/approach - The paper reviews recent case law and statutory provisions relating to

lifting the corporate veil. The paper critically reviews the exceptions to the corporate personality doctrine

which amount to lifting the corporate veil.

Findings - The paper finds that courts are more willing to lift the corporate veil compared to before. They

have moved away from the restrictive approach and this is demonstrated by the tendency to find new

exceptions to the corporate personality doctrine such as the interests of justice argument or lifting the veil in

tort cases.

Originality/value - The paper offers an up-to-date assessment of the exceptions to the corporate

personality doctrine and highlights the growing tendency to finding new ways of lifting the corporate veil.

Keywords Corporate personality, Company law, Lifting the corporate veil

Paper type Research paper

1. Introduction

Historically, corporate personality arose from the activities of organisations such as religious orders which

were granted rights to hold property and to sue and be sued in their own right (Dewey, 1926). In the

eighteenth century, the concept began to be applied to commercial entities involved in rail building and

colonial trade (Williston, 1888). By far the most significant legal reform in company law arrived in 1844 with

the enactment of the Joint Stock Companies Act1 . It brought a system for simple incorporation of a company

by registration. The Act granted companies full legal personality upon registration. However, the Joint Stock

Companies Act did not come with limited liability for members of joint stock companies. This feature arrived

in 1855 under the Limited Liability Act2 , which was hurriedly replaced by the Joint Stock Companies Act

1856. The Act limited the liability of members to the amount they have invested in the company (Machen,

1910). The company was given legal personality which divorced it from its founding members and thus

considered an entity by law upon incorporation. Limited liability reduced the risk faced by the promoters by

limiting their loss only to the amount invested in the company. However, both corporate personality and

limited liability have remained highly debated issues to this day (James, 2003).

Ever since the House of Lords landscape-shaping decision in Salomon v. A. Salomon Ltd3 , over a century

ago, there has been a number of legal development aimed at sidestepping the doctrine of corporate

personality and exposing the innards of the company. While statutory exceptions to the doctrine have a long

history, common law has only just started to gather pace in the past three decades. A reminder of the

statutory *Int. J.L.M. 67 and common law exceptions to the corporate personality doctrine, taking into

consideration all recent developments, is indeed a much-welcomed move, in an ever changing business

landscape. This paper explores the statutory and common law exceptions to the separate personality

doctrine.

The landmark decision of the House of Lords in Salomon v. A. Salomon & Co. Ltd4 cemented both limited

liability and corporate personality in English company law. It did not matter whether Mr Salomon was the

sole controlling member of the company, as Lord MacNaughton explained:

[…] the company is at law a different person altogether from the subscribers to the memorandum and,

though it may be that after incorporation the business is precisely the same as it was before and the same

persons are managers and the same hands receive the profits, the company is not in law the agent of the

subscribers or trustee for them5 .

Salomon v. A. Salomon is regarded by many academics and legal practitioners as the most significant case in

English company law. First, it recognised that a company could legitimately be set up to shield its members

and directors from liability. Second, it implicitly acknowledged the validity of the “one-man company” nearly

a century before single person companies could formally be created. And third, the mere fact that a person

holds shares is not sufficient enough to create a relationship of agency or trusteeship. Due to these three

reasons, there is no doubt that Salomon is the ground upon which English company law stands (Grantham

and Rickett, 1998).

On strict application of the separate entity doctrine, members are not personally liable for the company's

liabilities. Nevertheless, this does not mean that members are not liable to contribute anything. In the UK,

the majority of companies have limited liability and so the liability of the members is mostly limited. The

company can be limited by guarantee or by shares. In the case of guarantee, the liability of the members is

limited to the amount stated in the statement of guarantee6 . For companies limited by shares, the liability of

the members is limited to the amount that is unpaid on their shares7 . Due to the availability of limited

liability, members who have fully paid up their shares are legally not bound to contribute any further to the

company. Unsurprisingly, the both doctrines were greeted with disquiet in some quarters. It was argued

that whilst limited liability protects the members, it shifts risk and cost from members onto creditors (Moore,

2006). Professor Otto Kahn-Freund lamented that the courts had failed to give protection to business

creditors which should be accessory of the privileges of limited liability and described the House of Lord's

decision as “calamitous” (Kahn-Freund, 1944).

Over time, judicial discretion and legislative action has managed to find exceptions to the two doctrines. Lord

Denning in Littlewoods Mail Order Stores Ltd v. IRC took the view that incorporation does not fully “cast a veil

over the personality of a limited company through which the courts cannot see”8 . Going against the doctrine

of corporate personality, he observed that “the courts can and often do, pull off the mask. They look to see

what really lies behind”. On lifting the veil of incorporation, Staughten LJ in Atlas Maritime v. Avalon Maritime

(the Coral Rose) explained that:

[…] to pierce the corporate veil is an expression that I would reserve for treating the rights or liabilities or

activities of a company as the rights or liabilities or activities of its shareholders. To lift the corporate veil or

look behind it, on the other hand, should mean to have regard to the shareholding in a company for some

legal purpose9 .

*Int. J.L.M. 68 2. Common law

Given that corporate personality is granted by statute, the courts have been cautious to lift the veil of

incorporation and impose liability on those behind it. Courts have not been consistent when lifting the veil

and it has led some commentators to argue that each case is determined on its own facts. For example,

Herron CJ, in Commissioner of Land Tax v. Theosophical Foundation Pty Ltd stated that:

Authorities in which the veil of incorporation has been lifted have not been of such consistency that any

principle can be adduced. The cases merely provide instances in which courts have on the facts refused to

be bound by the form or fact of incorporation when justice requires the substance or reality to be

investigated […]10 .

The same point was emphasized by Rogers A.J.A in Briggs v. James Hardie & Co. Ptyt :

There is no common, unifying principle, which underlies the occasional decision of the courts to pierce the

corporate veil. Although an ad hoc explanation may be offered by a court which so decides, there is no

principled approach to be derived from the authorities11 .

Thus, the fundamental problem with the Solomon decision is not the corporate personality doctrine but the

House of Lords lack of guidance on when to lift the veil. Due to a lack of guidance, courts have been forced

to ignore corporate personality by taking a fact-based approach.

2.1 Agency and group companies

Agency is one of the most commonly used exceptions to the separate entity principle. It arises where a

shareholder or parent company has a degree of effective control to qualify as a principal. The acts of the

company are then deemed to be acts of the shareholder or parent company. For example, in Re F.G. (Films)

Ltd12 , an American company financed the production of a film by its British subsidiary. The Board of Trade

was against the registration of the film as a British film due to their lack of contribution. The court agreed on

the basis that the British company acted merely as an agent of the parent American company. However,

most cases are not as factually straightforward, as demonstrated in Salomon, the courts appear reluctant to

determine that a principal-agent relationship exists, particularly with respect to an individual controlling

shareholder (Wardman, 1994). For example, in Smith, Stone & Knight Ltd v. Birmingham Corporation13 , a

local government authority compulsorily acquired premises occupied by the Birmingham Waste Co. Ltd, a

wholly-owned subsidiary of Smith, Stone and Knight Ltd In order to succeed in an action for compensation

for loss of business, the parent company had to establish that the subsidiary was its agent in conducting

business on the premises. The King's Bench Division held that the two firms were one and the same entity

and compensation should be paid to the plaintiff. Atkinson J. identified several points which tend to establish

agency; namely, the parent company treating the profits of its subsidiary as its own, appointing the persons

conducting the business of the subsidiary, directing all that was done within the subsidiary and maintaining

effectual and constant control over the subsidiary. The decision appeared to have settled the problem of

determining agency in parent-subsidiary company cases.

However, Lord Denning's “single economic unit” argument raised in DHN Food Distributors Ltd v. Tower

Hamlets LBC14 , created a new approach to the agency exception. In DHN, the land upon which the parent

company conducted business was owned by its subsidiary. The land was compulsorily purchased and the

parent company argued that it was entitled to the compensation. Lord Denning M.R. in the *Int. J.L.M. 69

Court of Appeal advocated the treatment of a holding company-subsidiary relationship as a single economic

unit, such that the group was not defeated on a technical point. However, Slade LJ disagreed and stated

that:

There is no general principle that all companies in a group are to be regarded as one. On the contrary, the

fundamental principle is that “each company in a group of companies” is a separate legal entity possessed of

separate rights and liabilities15 .

Although DHN was approved in Amalgamated Investment & Property Co. Ltd v. Texas Commercial

International Bank Ltd16 and Lewis Trusts v. Bambers Stores17 , subsequent cases have not endorsed the

single economic unit argument (Rixon, 1985). In Australia, Else-Mitchell J. in Hotel Terrigal Pty. Ltd v. Latec

Investments Ltd18 , endorsed the ratio in Smith, Stone and Knight as the valid exception to the separate

entity principle. The case of Adams v. Cape Industries19 sets out this position. The main defendant was an

English registered company presiding over a group of companies whose business was mining (in South

Africa) and marketing of asbestos. The company had become the subject of a lawsuit in the USA and tried to

avoid fighting the case in the American courts on jurisdictional grounds. The plaintiff obtained a judgment

against the English company in the American courts, but as Cape had no assets left in the USA they then

sought to enforce the judgment against the principal company in the group in the English courts. In

reaching a decision, Slade LJ quoted a key passage from the judgment of Danckwerts LJ in Merchandise

Transport v. British Transport Commission :

[…] where the character of a company, or the nature of the persons who control it, is a relevant feature the

court will go behind the mere status of a company as a legal entity and will consider who are the persons as

shareholders or even as agents who direct and control the activities of a company which is incapable of

doing anything without human assistance20 .

The court accepted that the purpose of the corporate group structure set up by Cape Industries had been

used specifically to ensure that the legal liability of a particular subsidiary would fall only upon itself and not

the parent company in England. The court held that:

[…] whether or not this is desirable, the right to use a corporate structure in this manner is inherent in our

corporate law […] in our judgement Cape was in law entitled to organise the group's affairs in that manner

[…]21 .

In the light of Slade LJ's judgement in Adams v. Cape Industries, DHN is probably now best regarded as an

authority on compensation claims by multi-corporate groups in respect of compulsory acquisition of their

business premises. On this, Flaux J. in Linsen International v. Humpuss Sea Transport PTE observed that:

[…] it is not enough to show that a company or a group of companies is closely controlled by an individual or

a family or by a holding company. If the element of control were sufficient in itself, the English courts would

have accepted the concept of the “single economic unit” which […] has been consistently rejected by our

courts. The claimant who wishes to pierce the corporate veil must show not only control but also

impropriety, in the sense of misuse of the company or the corporate structure to conceal wrongdoing22 .

The rulings in Adams and Linsen have made DHN largely limited as an exception to the agency principle, but

both cases clearly set out a criterion courts should look at in order to lift the corporate veil in group company

cases.

*Int. J.L.M. 70 2.2 Fraud and sham companies

Although “sham” and “fraud” as exception to the corporate personality doctrine are looked at often examined

separately in literature, both relate to the alleged use of a corporate form to evade a legal or fiduciary

obligation. Courts have generally experienced little difficulty in lifting the veil on these two grounds due to

the existence of a clear breach of pre-existing obligations.

A sham exception is used where a corporate form was incorporated and used to hide the real purpose of its

controller. In Trustor AB v. Smallbone23 , Sir Andrew Morritt V.C. granted a summary judgment application

against the managing director of a company that had received funds from the claimant company. In his

view, the court was entitled to lift the corporate veil and:

[…] recognise the receipt of the company as that of the individual if the company was used as a device or

façade to conceal the true facts thereby avoiding or concealing any liability of those individuals […] In my

judgement the court is entitled to “pierce the corporate veil” and recognise the receipt of the company as

that of the individual(s) in control of it if the company was used as a device or façade to conceal the true

facts thereby avoiding or concealing any liability of those individual(s)24 .

Sham companies as an exception to the separate entity principle have surfaced in a number of cases and

courts have been very consistent when applying the exception. In Gilford Motor Co. v. Horne25 , Mr Horne

was employed by the plaintiff and in his contract it was stated that should he leave their employment, he

must not solicit customers of Gilford. However, on leaving the company, Mr Horne set up a second company

and attempted to entice Gilford's customers to his new company. The court held that his company was a

sham, a simple attempt to avoid a contractual liability (a restraint of trade clause)26 . The company was still

recognised as incorporated, but the veil was lifted to recognise Mr Horne's liability for a breach of contract.

Similarly, in Jones v. Lipman27 , the defendant entered into a contract to sell property and sought to avoid

the contract by transferring the property to a company which he controlled. The court held that specific

performance could be ordered against the company, which Russel J. described as:

[…] the creature of the First Defendant, a device and a sham, a mask which he holds before his face in an

attempt to avoid recognition by the eye of equity28 .

He was offered nominal damages for breach of contract.

For fraud to be argued as an exception to the separate entity doctrine, the controller “must have the

intention to use the corporate structure in such a way as to deny the plaintiff some pre-existing legal right”

(Payne, 1997). In Stone & Rolls Ltd v. Moore Stephens29 , a one-man company was set up solely as a vehicle

for defrauding banks. The House of Lords held that the company was primarily rather than vicariously liable

for the frauds perpetrated by the sole member or director. The company was denied the defence of turpi

causa (a wrongdoer cannot benefit from the wrongdoing) when they shifted the blame on company auditors

for not detecting the fraud the company was trying to conceal. The decision in this case clearly illustrates

that the corporate veil cannot be used to further fraud. This principle was applied in Kensington

International Ltd v. Congo30 where the court held that various transactions and company structures were a

sham set up with a view to defraud and defeat existing claims of creditors against the Congo.

*Int. J.L.M. 71 As one cannot further fraud using the corporate veil, one cannot also escape liability by

disclosing that they are committing fraud on behalf of someone else. In Standard Chartered Bank v. Pakistan

National Shipping Corp31 a director presented a bill of lading to a bank, knowing full well that the document

was outdated and the bank would suffer loss by relying on the document to pay the company. The court

lifted the corporate veil and made the director personally liable. However, if it was an employee who had

written the same letters on behalf of the company, it is unlikely that personal liability for the fraudulent acts

would have been imposed. Clearly, his status as a director influenced the court decision.

In fraud cases such as Standard Chartered Bank, Kensington International Ltd and Stone & Rolls Ltd, sham

companies were created to hide the fraud or breach an existing duty. Thus, both fraud and sham companies

as exceptions to the separate entity doctrine should no longer be looked at in isolation.

2.3 Enemy character

Although it troubles some lawyers who view it as a unjustified attack on the separate entity doctrine, a

company assumes an enemy character if the persons in the control of its affairs are residents of an enemy

country. The courts will examine the character of persons in control of the company and lift the corporate

veil if they have an enemy character. The leading authority is Daimler Co. Ltd v. Continental Tyre & Rubber

Co.Ltd32 where a company was incorporated in England for the purpose of selling in England tyres made in

Germany. During the First World War, the English company commenced action for recovery of a trade debt.

The Court of Appeal, in a majority decision, rejected the enemy company argument and reiterated the basic

principle of separate personality by stating that:

Justice should not be hindered by mere technicality, but substance must not be treated as form or swept

aside as technicality because that course might appear convenient in a particular case. The fallacy of the

appellants' contention lies in the suggestion that the entity created by statute is or can be treated during the

war as a mere form or technicality by reason of the enemy character of its shareholders and directors. A

company formed and registered under the Companies Acts has a real existence with rights and liabilities as

a separate legal entity. It is a different person altogether from the subscribers to the memorandum or the

shareholders on the register […].

The House of Lords disagreed and held that the payment of debt to the company would amount to trading

with the enemy33 . The House of Lords compared the character of the company's members to the company

before reaching the decision. However, the character of the company's members is not supposed to affect

the character of the company because a company is a separate entity from its members. The enemy

character remains subject to debate and is unlikely to be resolved anytime soon.

2.4 Tort cases

The courts developed the identification theory, or alter ego doctrine, which attributes the requisite intention

or knowledge of a person or persons controlling the company to the company, making the company

tortuously or criminally liable. In Lennard's Carrying Co. Ltd v. Asiatic Petroleum Co. Ltd34 , the appellant

ship-owners were sued for the loss of cargo caused by a ship running aground due to being unseaworthy

because of defective boilers. The House of Lords ruled that the necessary *Int. J.L.M. 72 fault and privity

to establish liability could be identified in respect of the company where the fault or privity existed in the

mind of a person who was “the directing mind and will” of the company.

The first conviction for corporate manslaughter arose from the deaths of four teenagers on a canoeing trip at

sea against a one-man company operating an activity centre in the case of R v. Kite and OLL Ltd35 . The

managing director's failure to heed previous warnings of potential danger by the company's instructors was

attributed to the company and both were convicted of manslaughter. Similarly, in Lubbe and Others v. Cape

Industries Plc36 , South African claimants were able to sue an English parent company in the UK for injuries

alleged to be the fault of a South African. As a result, UK based multi-national corporations could see

themselves exposed to large-scale industrial disease claims as a result of the actions of their overseas

subsidiaries37 .

In regards to the tort of negligence, the case of Williams v. Natural Life Health Foods Ltd38 establishes

liability for directors. The case dealt with negligent misstatements made by directors on behalf of the

company and the approach of the courts in this decision is that directors are not necessarily liable for their

negligent misstatements even though they were the persons who made the misstatements to the claimant

and who failed to take reasonable care and skill in doing so. The director could only be liable if he/she had

conveyed directly or indirectly to the claimant that he was assuming personal responsibility towards the

claimant in the giving of advice to the claimant. Lord Steyn stated that liability depended on an objective test

as to whether “the director, or anybody on his behalf, conveyed directly or indirectly […] that the director

assumed personal responsibility”39 . The directors had no reason to fear personal liability for negligent

misstatements or advice even if personally negligent unless they did something leading to a reasonably held

belief that they accepted personal responsibility. There must be a direct relationship and claimant must have

relied on statement.

In the context of a personal action against a director for the company's infringement of copyright, the court

expressly accepted the view that directors can be liable pursuant to ordinary principles of joint tortfeasance

in MCA Records v. Charly Records40 . The test applied by the court was based on the general tests of

secondary liability, namely that the director can be liable where he intended, procured and shared a common

design. Similarly, in Contex Drouzhba Ltd v. Wiseman41 , the defendant, an active director of a company

which he knew was unable to pay its debts, signed a contractual agreement with the claimants to pay for the

goods within 30 days after shipment. The Court of Appeal held that signing for a company might make an

implied representation of the company's capacity to meet payment terms and that can make a director

personally liable42 .

2.5 Justice

There is no definitive criterion on lifting the corporate veil merely because justice demands. Moreover, courts

have demonstrated inconsistency on this regard (Gallagher and Ziegler, 1990). The interest of justice

argument was postulated in Creasey v. Breachwood Motors43 . The plaintiff brought a claim for wrongful

dismissal against his former employer. The company ceased trading shortly after the writ was issued and its

assets were transferred to another trading company which had the same controllers. No consideration was

paid for the company's assets although they did pay off all of the company's existing debts. The company

was subsequently dissolved. *Int. J.L.M. 73 The judge ruled that the claim could be brought against the

new company. The court was justified in lifting the veil because the controllers had deliberately shifted

assets out of the company into another in full knowledge of the plaintiff's claim. But Creasey was overruled

by the House of Lords in the later case of Ord v. Belhaven Pubs where Hobhouse LJ observed that:

[…] it seems to me inescapable that the case in Creasey v. Breachwood as it appears to the Court cannot be

sustained. It represents a wrong adoption of the principle of piercing the corporate veil and a misuse of the

power granted by the rules to substitute one party for the other following death or succession […] it is

appropriate to pierce the corporate veil only where special circumstances exist, indicating that it is a mere

façade concealing the true facts44 .

Rather successfully, in Re H (Restraint Order: Realizable Property)45 , the court lifted the corporate veil

merely to impose justice because inability to lift the veil would have allowed the defendants to benefit from

the tax evasion. In that case, the commissioners of customs and excise alleged that the three defendants

had, through two family-run companies, evaded tax duty amounting to £100 million. The commissioners

obtained an injunction on the use of certain property belonging to the two companies. The defendants

argued that this was unlawful as it was they, and not the companies, that had been charged with tax

evasion. It was held that if the companies' separate personalities were observed, the court would have

lacked the jurisdiction to grant the injunction. Accordingly, the court treated the property as if it belonged to

the defendants and the injunction was upheld.

Although justice can sometimes warrant lifting the corporate veil, courts have been very reluctant to rely on

this exception. This is reflected in the inconsistency of court decisions. For example, in Re a Company46 ,

the Court of Appeal stated that “the court will use its powers to pierce the corporate veil if it is necessary to

achieve justice”47 whereas in Adams v. Cape Industries plc, Slade LJ stated that: “the court is not free to

disregard the principle of Salomon […] merely because it considers that justice so requires”48 . Thus, the

interest of justice argument remains largely underdeveloped and clarity is needed in order to cement it as a

valid exception to the separate entity doctrine.

3. Statute

Section 16(2) of the Companies Act 2006 grants corporate personality to companies. However, the Act can

set aside corporate personality and impose liability on those behind the veil if some of its provisions are

contravened. A breach of an Insolvency Act 1986 provision and the Company Directors Disqualification 1986

can also result in lifting the corporate veil.

3.1 Failure to obtain a trading certificate

The trading certificate entitles the company to do business and exercise any borrowing power; therefore

without it, the company will not only be liable for any offence committed, but every officer of the company

will be49 . The consequences will be:

• on conviction on indictment, to a fine; and

• on summary conviction, to a fine not exceeding the statutory maximum.

*Int. J.L.M. 74 This does not affect the validity of a transaction entered into by the company. However, if

the company enters into a transaction in contravention of Section 761, the directors are jointly and severally

liable to indemnify any other party to the transaction for any loss or damage suffered.

3.2 Failure to use company's name

Previously, Section 349(4) of the Companies Act 1985 provided that if an officer of a company or a person

acting on its behalf signs a cheque, bill of exchange, cheque or another document on behalf of the company,

where the company's name is not mentioned, that person will be personally liable to the holder of the

instrument for the amount in question (unless it is duly paid by the company). The liability changed under

the Companies Act 2006 which imposes a criminal penalty for failure to use the company name on relevant

documents50 . There is currently no equivalent provision in the 2006 Act that imposes personal liability.

3.3 Phoenix companies

Phoenix companies are established where a company goes into insolvent liquidation and its assets are moved

to another legal entity, typically, some or all of the directors remain the same and in other cases, the new

company takes the same or a similar name to the failed company. Section 216 of the Insolvency Act 1986

prohibits any person who was a director (or shadow director) of a failed company during the previous 12

months, for a period of five years afterwards, from setting up a new company with a name suggesting an

association with the old company. For example, in Thorne v. Silverleaf51 , Mr Thorne was Director of three

separate companies all bearing different variations of the same name. Two of these three companies had

entered liquidation while Mr Thorne was a Director. The third company then borrowed money from a Mr

Silverleaf and agreed to pay it back at a set rate. When the company defaulted on this agreement, Mr

Silverleaf demanded an accountants' report which showed he was owed the sum of £135,000. Mr Silverleaf

took Mr Thorne to court and it was argued that as Mr Thorne was a Director of a company with a prohibited

name under Section 216 and that he was personally liable for the outstanding debt under Section 217. The

court ruled in favour of Mr Silverleaf, making Mr Thorne personally liable for the debt.

Phoenix companies are often used because they allow a company to start again and for the profitable

elements of the failed business to survive, offering some continuity to the suppliers. However, phoenix

companies carry a bad reputation because, in the past, some directors deliberately forced their companies

into insolvency in order to buy back the assets at a reduced price while absolving their responsibility for the

liabilities. It is important to mention that under Company Directors Disqualification 1986, the courts can

disqualify directors whose companies had failed as a direct result of their misconduct, for a period of up to

15 years52 . The Insolvency Act 1986 also gives the liquidator recovery powers to investigate sale

agreements53 .

3.4 Fraudulent trading

On the winding up of a company, where it appears that any business of the company has been carried on

with intention to defraud creditors, or for any fraudulent purpose, the court may declare any person who

was knowingly involved in the fraud to make such contribution to the company's assets as the court thinks

fit54 . This applies to *Int. J.L.M. 75 a person who has knowingly carried on a business with “intent to

defraud” or for a “fraudulent purpose”. But “fraud” demands a high standard of proof and so is difficult to

apply as in Re Patrick & Lyon Ltd :55 “actual dishonesty […] real moral blame”. The problem would be

establishing intent. Since there is also the criminal offence attached to fraudulent trading, the proof required

to establish civil liability is the criminal test: beyond reasonable doubt. In Re Augustus Barnett & Son Ltd56

(“letters of comfort”), an attempt to make a parent company (Rumasa) responsible for the debts of its

subsidiary failed. This was largely because the case was decided under the fraudulent trading provisions

where the rule is that in order for liability to arise there has to be evidence that some party has carried on

the company's business in a fraudulent manner beyond reasonable doubt.

Rather successfully, in R v. Grantham57 , Mr Grantham was tried for fraudulent trading, contrary to the

Companies Act 1948 section 332(3) (now Insolvency Act 1986 Section 213). The jury were directed that

they could find dishonesty and intent to defraud if they thought Mr Grantham obtained credit when he knew

there was little chance the company would be able to repay the debt when it is due. Mr Grantham was

convicted. He appealed that the jury was given the wrong direction. Lord Lane LCJ, Boreham J. and Stuart-

Smith J. dismissed Mr Grantham's appeal. They held there was no error in the direction. Applying the House

of Lords decision in Welham v. DPP58 , under Section 332 (now Section 213, IA 1986) an intent to defraud

was established on proof of intention to dishonestly prejudice creditors in being repaid.

3.5 Wrongful trading

On the winding up of an insolvent company, the court may declare a company director liable to make such

contribution to the company's assets as the court thinks fit, if some time before the commencement of the

winding up of the company, he knew or ought to have concluded that there was no reasonable prospect of

the company avoiding going into insolvent liquidation59 . The court will ascertain based on the view of a

reasonably diligent person having both the general knowledge, skill and experience that may reasonably

expected of a person carrying out the same functions. In Re Brian D Pierson (Contractors ) Ltd Hazel

Williamson QC, observed that:

[…] the office of a director has certain minimum responsibilities and functions, which are not simply

discharged by simply leaving all management functions and consideration of the company's affairs to

another director […] one cannot be a “sleeping director”60 .

These minimum functions extend, for instance, to compliance with statutory requirements with regard to

maintenance of proper accounting records and maintaining a minimum knowledge of the company's

business and its financial position.

Similarly, in Re Continental Assurance Co of London plc61 , there was an allegation that the company applied

inappropriate accounting policies which showed the company to be solvent. However, the court found that

for the directors to reach these conclusions would have required of them knowledge of accounting concepts

of a particularly sophisticated nature. Park J. held that an unrealistically high standard of skill is not what is

required. On the facts, he found that the directors took a responsible and conscientious attitude to the

company's position and their responsibilities as directors. The directors did not just accept the figures

which were put before them but they questioned them and were satisfied with the explanations given.

*Int. J.L.M. 76 The rule applies to a person who “knew or ought to have known” that the company was

insolvent and who did not take every step to minimise the loss to creditors. This does not require any

evidence of fraud but can be hard on those seeking to save their company. In Re Continental Assurance Co.

Ltd, the question was “whether to close down and go into liquidation or to trade on and hope to turn the

corner”62 . Similarly, in Re Produce Marketing Consortium63 , the company acted as an import agent in the

fruit business and it ran into financial difficulties after a long period of trading. After a few years of

deteriorating results, the company went into creditor voluntary liquidation. The liquidator pursued the

directors for a contribution to the company's assets on the grounds that they ought to have known that there

was no reasonable prospect of the company avoiding insolvent liquidation. The court held that the directors

should not have continued trading. In light of the fact that they went on trading after the poor results

established their failure.

Once liability is established, the court will need to address the extent of any contribution to the company's

assets. According to Knox J. in Re Produce Marketing Consortium Ltd :

[…] prima facie the appropriate amount that a director is declared to be liable to contribute is the amount by

which the company's assets can be discerned to have been depleted by the director's conduct which caused

the discretion […] to arise. But Parliament has indeed chosen very wide words of discretion64 .

The directors were jointly ordered to make a contribution of £75,000. Park J. said in Continental Assurance

Co. Ltd that the quantum of liability can be summed up as one of an increase in net deficiency reflecting the

loss to the company of the continued trading but even then there must be a connection between that

increase and the conduct of the directors which resulted in wrongful trading.

To escape liability, the court must be satisfied that every step with a view to minimising the potential loss to

creditors was taken. It is not sufficient for a director to claim that in continuing to trade with the intention of

trying to make a profit that he is within this defence65 . The provision is intended to apply to:

[…] cases where, for example, directors take specific steps with a view to preserving or realising assets or

claims for the benefit of the creditors, even if they fail to achieve that result […]66 .

Steps such as attempting to secure additional financing, reaching agreements with creditors and taking

professional advice are often accepted (Hawkes and Hargreaves, 2003).

3.6 Pre-incorporation contracts

In practice, it is common that promoters of a pre-incorporated company will execute contracts with third

parties in order to comply with the needs of the future company, for example, to obtain supplies and

premises. A company has the capacity to enter into contracts with such persons, but only until incorporation

has been completed and the certificate of incorporation is issued. Prior to that, the company does not exist

and will lack contractual capacity. Thus, according to Section 51 of the Companies Act 2006, if the

promoters attempt to contract on behalf of, or in the name of pre-incorporated, then they will be personally

liable for such contracts.

*Int. J.L.M. 77 Prior to UK joining the European Community in 1973, it was already established under

common law that pre-incorporation contracts were largely unenforceable and promoters risked personal

liability. First, where a promoter signed the contract as the company's agent, or on behalf of the company,

the promoter would be held personally liable on the contract. The contract would be regarded as being

between the promoter and the third party. For example, in Kelner v. Baxter67 , Baxter and two others

entered a contract on behalf of a pre-incorporated company to purchase trade stock for its future business.

Later, the company was formed, executed the contract and used the trade stock, but failed to pay for the

stock. The company was not liable as it could not ratify a pre-incorporation contract with retrospective effect

to a date before the company existed. Baxter and others were personally liable. Second, where the promoter

signed the contract using the company's name, or merely added his own name to authenticate that of the

company, then the contract would be with the non-existent company and so would not exist and could not

be enforced by either party. For example, in Newborne v. Sensolid (Great Britain) Ltd68 , a company

purported to sell goods at a time when it had not been incorporated. The company's name was appended to

the contract as Leopold Newborne (London) Ltd and underneath was the name of Leopold Newborne. When

it was discovered that the company had not been formed, Leopold Newborne commenced proceedings for

breach of contract against the buyers in his own name. The Court of Appeal held that the plaintiff had never

purported to contract to sell nor sold the goods either as principal or agent. The contract was supposed to

be made by the company and Leopold Newborne had merely added his name to verify that the company was

a party. In the circumstances, the contract was a nullity.

As a result of the UK joining the European Economic Community, the UK implemented the First EC Company

Law Directive, of which article seven states:

[…] if, before a company has acquired legal personality […] action has been carried out in its name and the

company does not assume the obligations arising from such action, the persons who acted shall without

limit, be jointly and severally liable therefore, unless otherwise agreed.

This article has its replica in Section 51(1) of the Companies Act 2006, which states:

A contract that purports to be made by or on behalf of a company at a time when the company has not been

formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act

for the company or as agent for it, and his personally liable on the contract accordingly.

Section 51 renders a promoter personally liable for the pre-incorporation agreements in all circumstances. In

case the company, once incorporated, wishes to take advantage of a pre-incorporation contract, it cannot

ratify or adopt it. The company would need to enter a new contract with the third party to carry out previous

agreements69 .

The imposition of personal liability under Section 51 is “subject to any agreement in contrary”. This means

that a promoter can avoid personal liability by showing that there was an agreement with the other party to

the contract that, upon incorporation, the company would enter a second contract with the other party on

the same terms as the first contract. Novation can be express or implied, but courts need clear evidence that

such an agreement exists70 . Simply acting as a promoter or agent of a pre-incorporated company is not

enough to infer the existence of a contrary agreement. For example, in Phonogram Ltd v. Lane71 , before

incorporating a company called Fragile Management Ltd Lane contracted with the plaintiff for a loan of

12,000 to finance a pop *Int. J.L.M. 78 group called Cheap, Mean & Nasty. The plaintiff wrote to Lane in

which reference was made to him undertaking to pay. He nevertheless was required to sign and return a

copy for and on behalf of Fragile Management Ltd The company was never incorporated and the group never

performed. The court held that the defendant was personally liable to repay the money advanced.

The same principle applies when the promoters enter into a contract before purchasing an “off the self”

company, provided that the company existed at the time the contract was entered into, then Section 51

would not apply as a valid contract will exist between the company and the third party. Similarly, Section 51

would not apply where a company changes its name, but the name change has not been registered at the

time the contract is made, as exemplified in Oshkosh B'Gosh Inc v. Dan Marbel Inc Ltd72 . A company had

passed a resolution to change its name to Oshkosh B'gosh. The contracts were made before the new name

was registered. The director was held not personally liable because a change of name does not affect any

rights or obligations of the company.

4. Conclusion

Having explored the exceptions to the separate personality doctrine, the conclusion is obvious, over a

century after the landscape-shaping House of Lord's decision in Salomon, courts have finally mustered the

courage to look behind the corporate veil and impose liability on agents of the company. The courts have

created five exceptions to the corporate personality doctrine. Of the five exceptions, fraud and sham

companies represent the main exception as it merely recognises a breach of a common law or statutory duty.

However, courts have been able to exercise their powers and recognised the possibility of lifting the

corporate veil on the interests of justice and in tort cases. Although both exceptions remain largely

underdeveloped, the willingness to find new exceptions to the corporate personality doctrine indicates that

courts have moved away from peeping behind the veil of incorporation to staring behind it. However, for the

sake of legal development, courts need to be more consistent when applying the agency exception. Although

courts generally follow the criteria set out in Adams v. Cape Industries, the single economic entity argument

raised in DHN continues to divide opinion in the UK and Australia. Courts need to be more consistent in

applying agency exception. Less controversially, the veil of incorporation can be lifted under statute. There

has been little in terms of development on the statutory exception to the corporate personality doctrine.

However, the challenges of yesteryear remain, especially the high standard of proof required to prove

fraudulent trading and the fear of wrongful trading that leaves many directors unsure on whether to enter

insolvency or not. Thus, common law exceptions to the corporate personality doctrine are slowly being

developed by courts while statutory exceptions have remained largely unchanged.

*Int. J.L.M. 80 References

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Corresponding author

Chrispas Nyombi can be contacted at: cnyomb@essex.ac.uk

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