Section 15 of the Companies Act 1993 (“Act”) states that a company has a legal personality in its own right and is separate from its shareholders. This is a principle known as the Salomon principle, originating from the case of Salomon v A Salomon & Co Ltd. The Salomon principle provides that a company is essentially regarded as a legal person separate from its directors, shareholders, employees and agents. This means as a separate legal entity, a company can be sued in its own name and own assets separately from its shareholders.
The corporate veil is drawn from the Salomon principle which separates the rights and duties of the company from the rights and duties of the shareholders and directors. Essentially, the corporate veil is a metaphoric veil with the company on one side of it and its directors and shareholders on the other and liability does not pass through.
The corporate veil does not provide protection to its shareholders and directors for their personal conduct or allow companies to be used for sham transactions. Accordingly, the courts may lift or pierce the corporate veil.
The corporate veil and Salomon principle were applied in Lee v Lee’s Air Farming Ltd. The Court ruled that although Lee was the controlling shareholder, sole director and chief pilot of Lee’s Air Farming Ltd, he was also considered an employee of the company and thus the company was a separate legal entity, even though Lee’s Air Farming Ltd was essentially a ‘one-man entity’. This ruling created the opportunity for the corporate veil to be misused and has since been regulated against by imposing reckless trading provisions.
Lifting the corporate veil
The corporate veil can be lifted by the courts if its presence would create a substantial injustice. This is the process used to look behind the corporate façade and identify the true nature of a transaction.
The corporate veil may be lifted in a number of circumstances, for example where a subsidiary company is in liquidation in the context of a group of companies as illustrated in Steel & Tube Holdings Ltd v Lewis Holdings Ltd. The subsidiary company was placed into liquidation and the plaintiff sought the debt owed by the subsidiary from the group of companies rather than the subsidiary as a separate entity. The Court of Appeal agreed with this approach as the subsidiary was not run as a separate legal entity. Some of the factors the Court considered were that the directors of the subsidiary managed the subsidiary as officers of the parent company and did not hold separate board meetings for the subsidiary. Technically, the subsidiary was a separate legal entity but it was not managed as a separate entity. Accordingly, the Court lifted the corporate veil to pool the assets of the related companies. The courts may not always apply this approach to groups of companies but this case identifies the importance of ensuring each entity within a group of companies is managed as a separate legal entity.
Piercing the corporate veil
The Courts may pierce the corporate veil and remove the protection of the Salomon principle to prohibit fraud. This was evident in Gilford Motor Co Ltd v Horne where a managing director agreed not to engage with his former employer’s customers but proceeded to do so through a newly formed company. The courts pierced the corporate veil to reveal the sham transactions occurring behind the façade of the company.
Generally, the courts are reluctant to pierce the corporate veil to protect creditors in the absence of fraud. However, where reckless trading takes place by directors, s 135 of the Act allows for the veil to be pierced.
In the case of tax evasion or unauthorised tax avoidance, the courts may look past the Salomon principle, pierce the corporate veil and declare the company a sham.
The courts will only lift or pierce the veil where an inequitable situation may be occurring behind the corporate façade based on the facts of each case. The corporate veil is vital for the legitimate use of the corporate structure and the protection of shareholders and directors and thus, by its very existence, promotes the playing field for taking commercial risks.