company law:piercing the corporate shell

COMPANY LAW- THE VEIL OF INCORPORATION THE MEANING & ORIGIN OF “VEIL OF INCORPORATION” The case of Salomon v Salomon Ltd. laid down the legal principle of corporate personality. What this means in law is that once a Company is registered, it is given an artificial personality. Subsequent to registration the Company can sue or be sued as a person. Further the Company and its members are separate and distinct from one another. If the Company owes money to the bank or its creditors, the creditors cannot sue its members but can only recover their debts from the Company. If the Company is unable to meet its debts, it goes into insolvency(closed down). Even if the Company’s owners are rich, the creditors are barred from sueing its Directors or shareholders. To summarize the above principle- the legal principle established by the case of S v S Ltd. is the separate legal entity principle. A Company is separate and distinct from its members and directors. This principle is also known as the “veil of incorporation.” Cases which applied this principle include Lee v Lee’s Air Farming Ltd. & Macaura v Northern_Assurance Co. Both these cases held that sole owners of a Company were separate persons and are distinct from the Company itself. WHEN A COMPANY IS INCORPORATED THE FOLLOWING PRINCIPLES WILL EMERGE. 1. Limited liability- The Company is liable for its own debts, but it obtains its capital from its members to conduct its business and when the Company makes a profit, it distributes the profits to its members in proportion to the number of shares each member holds. 2. Sucession- When any member sells his shares in the Company, there is no change in the Company itself. Although the shareholders change, the Company does not because of its separate legal personality. A person can buy and sell shares on the stock exchange, but the corporate personality does not change. 3. Shareholdings- A persons interest in the Company is represented in the amount of shares he holds. 4. Assets, rights and liabilities.- All assets which are held by the Company belong to the Company and not to the members. In Salomon v Salomon Ltd (1897), it was held that a Company had a legal existence separate from its members so Mr. Salomon could be a creditor of the Company and the Company had to pay him in spite of the fact that he was literally the owner of the business. 5. Capital- members of a Company make a payment to the Company in return for the shares issued. These payments are described as the Company’s capital. 6. Appointment of Directors- since the Company is an artificial person, clearly there must be someone to manage the Company. Members have the power to vote and appoint individuals to manage the Company. Such persons appointed are described as Directors. 7. Board of Directors.- The Company will be managed by Directors who will act as a group through a Board of Directors. The members will meet in a General Meeting where matters not delegated to the Board will be discussed. 8. Company’s Constitution- There are 2 main documents on which the Company is founded. One is the MA (Memorandum of Association) and the other is the AA (Articles of association) 9. Registration- In Malaysia, the Company is birthed into existence when it is registered under the Companies Act 1965.Thereafter it retains its separate legal personality until it is either struck off the Register at the CCM or liquidated by the process of winding up.( usually in cases of bankruptcy) INSTANCES WHEN A COURT OF LAW HAVE LIFTED THE VEIL OF INCORPORATION. In times of war- Daimler Co. Ltd v Continental Tyre & Rubber Co. This case was decided during the time when England was at war with Germany. Continental sued Daimler for money due in respect of goods supplied. Daimler claimed that the Company was actually owned by German Nationals and paying them was illegal under the Trading with the Enemy Act. The Court lifted the Corporate veil to discover if this was so, and found as a fact that it was the Germans who were operating the business. D was therefore successful in its defence. To Prevent a fraud from being perpetrated Gilford Motors v Horne [1933] Horne was at one time the Managing Director of Gilford Motors. One of the terms of his employment contract was that, in the event that he leaves the Company, he will not solicit the customers of the Company. Eventually Mr. Horne left the Company and setup his own Company by the name of JM Horne & Co Ltd. through which he had business dealings with the previous Company’s clients. Gilford Motors sued Mr. Horne. Horne’s claimed that it was not him that was doing the business but the Company and that under Company Law they were 2 different people. However the Court was not convinced and lifted the veil of incorporation. In this instance, Mr. Hornes was just trying to hide behind a Corporate veil to steal business from his former employer. Where a fraud is perpetrated, the Court will lift the Corporate veil. Aspatra Sdn. Bhd. v Bank Bumiputra Malaysia Bhd. (1988) It was held that the Court could lift the veil to determine whether the assets of the Company were really owned by them or whether there was an abuse of the principal that a Company is a separate legal entity. To enforce a legal obligation Jones v Lipman. [1962] Lipman contracted with Jones to sell him a house. But for some reason he later changed his mind. To avoid being sued by Jones he quickly set up a Company named Alamed Ltd. and transferred the title of the house to the Company. Jones sued him but Lipman claimed that the house was already sold to Alamed Ltd and therefore he was no more the legal owner of the house. The judge who heard the case was Russell L. After hearing Lipman’s story of the Corporate veil –the judge rejected it. He stated, “Alamed Ltd. is a creature of Lipman’s device and a sham, a mask which he holds before his face in an attempt to avoid the eyes of equity.” Mr. Lipman was ordered to sell the house to Mr. Jones. When a Court order anyone to do something- it is known as specific performance. When A Court prohibits anyone from doing something it is known as an Injunction. Where a group of Companies is regarded as a Single Corporate Entity. Hotel Jaya Puri Bhd v National Union of Hotel,Bar or Restaurant Workers [1980] Although technically a person working for the restaurant was an employee of the restaurant , the reality was that the workers were employees of the hotel. The Court unveiled the corporate veil and concluded that the workers were in fact and in law, the employees of the hotel. STATUTORY EXCEPTIONS 1) S36(4) Companies Act 1965 By this section if the number of members falls below 2 and the Company carries on business for longer than 6 months while it is so reduced, the remaining member who is cognisant of the fact that it is so carrying business will be personally liable for the debts of the Company incurred after 6 months. RESPONSIBILITY FOR FRAUDULENT TRADING In Re Williams C.Leitch Brs. Ltd.( No.1) [1932]All E.R. 892 at 895 the Company was insolvent but its Directors continued to carry on business and purchased further goods on credit . Maugham declared one of the Directors personally liable for the price of the goods, citing: “…..if a Company continues to carry on business and to incur debts at a time when there is knowledge of the Directors on reasonable prospect of the creditors ever receiving payment of those debts, it is, in general, a proper inference that the Company is carrying on business with intent to defraud.” DIFFERENT TYPES OF COMPANIES Business is usually done by a group of people except in the case of sole proprietors where one man runs the whole show. To set up a business, one needs to know the different kinds of Companies which is permitted by the law. Section 14 (1) of the CA 1965 –“… any two or more persons associated for any lawful purpose may, by subscribing their names to a memorandum and complying with the requirements as to registration , form an incorporated Company. 14(2) A Company may be 1. limited by shares. 2. limited by guarantee 3. limited both by shares and guarantee 4. an unlimited Company Company limited by shares This is the most safest kind of business arrangement. In situations like this, a person’s liability is only limited to the amount of shares he holds. If the value of the shares increases, he makes a profit. Many people have become rich by buying and selling shares on the Stock Exchange. However many people have also become poor by investing in the wrong Company. A Company is a person separate from its members. It can sue or be sued in its own name. Needs to be registered with the Registrar of Companies under the Companies Act 1965. One must deposit the MA and the AA with the ROC. Shares are transferable The MA and the AA of a Company (Ma & AA)usually include in their objects clause an express power to borrow. There is no limit to membership. There must be a Company constitution. Members to not play a practical role in the daily operation of the business. Company can use the Companys assets for borrowing $$ from the Bank. A Company can be wound up following certain procedures. Companies are required to supply certain information to the public. A members liability is limited to the amount of shares that person holds. In the event the Company goes bankrupt, creditors are barred from going after the members due to the concept of corporate personality. Question- Write short notes on the borrowing powers of the Company. Suggested Answer Companies are set up to conduct business and this includes the power to borrow money from outsiders- usually the Banks. The Memorandum and Articles of Association will usually include a clause that expressly gives the Company to borrow money. Clause 74 of Table A of the Companies Act 1965 gives powers to the Directors to borrow. But this clause does not place any limitations on the powers to borrow. That is left for the Company itself to decide. Every Company will have its own limitation on the powers to borrow. This is found in the MA and the AA of the particular Company. But this contains a potential problem. What is the legal situation if the Directors exceed or abuse their powers to borrow. Foe example, if the AA states that the Company’s borrowing powers must not exceed RM100,000 but the Directors borrow RM200,000? Or what happens if a printing Company buys land which is beyond the MA? In this situation, it depends on the knowledge of the lender. If the Bank knew about the Company’s limitation, than the Company cannot in law, recover the loan. But how are innocent outsiders to know what are the borrowing powers of the Company? In such a situation the rule in Turquand’s case will apply. This is known as the indoor management rule. Here the Company will be bound even though it exceeds its borrowing powers because outsiders cannot be held liable for the illegal acts of the Company and are not expected what goes on within the Company. Further Sect 20 of the Companies Act states, “No act of purported act of a Company … and no conveyance or transfer or property … to by a Company shall be invalid by reason only of the fact that the Company was without capacity or power to do the act to execute or take the conveyance or transfer” Lenders are advised to request a copy of the MA & AA and verify for themselves if there are any limitations as to the borrowing powers of the Company. In order to legalize acts which would otherwise be ultra vires, a Company may by special resolutions alter the articles in its MA with respect to the objects of the Company Section 28(1) Company’s ACT 1965. The effect of Section 20 is that the Company is estopped from claiming that a contract is ultra vires when the ultra vires contract is fully performed. This section is meant to protect outsiders and also holds the Company liable for its acts. Factors for courts to consider • Absence or inaccuracy of corporate records; • Concealment or misrepresentation of members; • Failure to maintain arm's length relationships with related entities; • Failure to observe corporate formalities in terms of behavior and documentation; • Failure to pay dividends; • Intermingling of assets of the corporation and of the shareholder; • Manipulation of assets or liabilities to concentrate the assets or liabilities; • Non-functioning corporate officers and/or directors; • Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances); • Siphoning of corporate funds by the dominant shareholder(s); • Treatment by an individual of the assets of corporation as his/her own; • Was the corporation being used as a "façade" for dominant shareholder(s) personal dealings; alter ego theory; It is important to note that not all of these factors need to be met in order for the court to pierce the corporate veil. Further, some courts might find that one factor is so compelling in a particular case that it will find the shareholders personally liable. • Berkey v. Third Avenue Railway, 244 N.Y. 602, 155 N.E. 914 (1927). Benjamin Cardozo decided there was no right to pierce the veil for a personal injury victim. • Perpetual Real Estate Services, Inc. v. Michaelson Properties, Inc. 974 F.2d 545 (4th Cir. 1992). The Fourth Circuit held that no piercing could take place merely to prevent "unfairness" or "injustice", where a corporation in a real estate building partnership could not pay its share of a lawsuit bill • Fletcher v. Atex, Inc., 68 F.3d 1451 (2d Cir. 1995)