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The principle of separate corporate personality

"'Adams v Cape Industries' was an excellent decision from a business perspective".

Introduction: Fundamental Principles

The principle of separate corporate personality is long established and a central pillar of modern company law. In the celebrated case of Salomon v Salomon & Co. (1897)[1], the House of Lords ruled that, irrespective of the degree of an individual shareholder’s interest a company, and regardless of the fact that the shareholder may exercise complete de facto control of the company’s affairs as its governing director, the company’s acts should not be deemed his acts, and that its liabilities cannot be considered his liabilities.

Therefore it is submitted that the fact that one shareholder wholly controls a company in practice is not at law a sufficient reason for ignoring the legal personality of the company. It should be noted that the operation of the Salomon principle will not always be to the advantage of the dominant individual within the company. In Macaura v Northern. Assurance Co.(1925) [2] recognition of the separate corporate personality caused the company’s director and major shareholder to suffer huge losses after he insured company property erroneously in his own name. That said, the separate legal persona of a company is sometimes conceptualised as a “veil of incorporation” and the general rule is therefore that it will not be pierced or lifted by a court so as to apportion the liabilities or rights of a company to its shareholders.

Adams v Cape Industries plc

The fundamental principle established in Salomon in relation to single companies was applied in the context of a group of companies by the Court of Appeal in the case under discussion in this paper, Adams v Cape Industries plc (1990)[3]. Cape Industries, a company registered in England, was engaged in mining asbestos in South Africa. The company’s products were marketed in the United States of America through a complicated network of subsidiaries and associated companies. In a series of class actions a number of factory workers who had contracted disease after inhaling asbestos dust managed to secured judgment in an American court against Cape (the holding company presiding over the corporate group).[4]

However, the litigants were subsequently unsuccessful in enforcing the judgment against Cape in the English Courts. The Court of Appeal held that an English trading company would only be treated as having been present and a possible a party to an action abroad if it had established a fixed place of business there at its own cost and either it or its representative had carried on business there for more than a minimal time.

Three arguments were raised (all unsuccessfully) in an effort to establish that Cape had been present in the United States. As discussed by Hicks and Goo, the first of these was a single economic unit argument contending that Cape and its subsidiaries were in reality one economic unit which should be treated by law as such. The second was a corporate veil argument - namely that the corporate form was nothing more than a façade concealing the true facts of a situation and which could be drawn aside if legally expediency dictated such a move appropriate. The third submission was an agency based argument (that the subsidiaries were merely agencies making contracts for their principal, the holding company).[5]

As stated, each argument failed. The Court of Appeal found that, on grounds of pure legal doctrine, it was not entitled to lift the corporate veil against a defendant company, which was a member of a corporate group, simply on the grounds that the corporate structure had been used so as to ensure that legal liability in regards to the particular future activities of the group would fall on another member of the group rather than on the defendant company. In practical effect, the Court of Appeal dismissed the contention that a corporate veil should be pierced merely because a group of companies operated as a single economic entity in terms of business reality.

On a strict application of the Salomon principle Cape was held not to have been present in the United States and as a consequence the judgments delivered in the American courts were deemed to be unenforceable in England.

To address the statement posed in the title directly, it is clear that Adams v Cape Industries was indeed an excellent decision for companies wishing to manipulate the structure of corporate groups for the purpose of diverting rights and liabilities. In that specific regard it is submitted that the ruling was highly beneficial to companies with a certain agenda, but whether that was the original intention of the Salomon court is dubious.

The Adams decision: the legal context

Prior to the seminal decision of Adams v Cape Industries Ltd the courts were confronted with two opposing decisions, which suggested that the Salomon principle was disposable in the interests of justice and alternatively that it was sacrosanct and deserving of almost universal application. The first decision was delivered by the Court of Appeal in DHN Food Distributors v Tower Hamlets London Borough Council.[6] In this case the company’s trading premises where compulsorily acquired. However, given that the premises in question were owned by a wholly owned subsidiary of the company, the local authority employed the Salomon principle to contend that the business of the owner had not been disrupted. The Court of Appeal, led by Master of the Rolls Lord Denning, unanimously held that it was entitled to look at the realities of the situation and lift the corporate veil. As a consequence, the company although not actually the owner, was able to recover for loss of trade. Quoting the eminent academic authority Gower, Lord Denning argued that there was evidence of a general trend to disregard the separate legal entities of various companies within a group, and to deal instead collectively with the economic entity of the whole group.

Lord Denning was an influential and gifted judge. He choose to remain as Master of the Rolls in the Court of Appeal, refusing offers of promotion to the House of Lords, because he felt he could influence the law better as leader of the busy lower court. He was not the kind of man to let strict legal principle get in the way of the ‘right’ decision in a particular case. Rather than blindly apply fundamental rules of English law Denning sought ways to circumnavigate them or elaborate on them where he deemed that such would be in the interests of justice in a case. In the context of Salomon, Denning recognised the importance of the principle but saw weakness and iniquity in its blinkered and slavish application.

The opposing decision to DHN Food Distributors was the ruling of the House of Lords in the case of Woolfson v Strathclyde Regional Council[7]. It was a case on all fours with DHN Food Distributors on its facts. Like DHN before it, Woolfson involved the compulsory acquisition of trading premises by a local authority and a claim for the loss of business by the trading company, notwithstanding the fact that the company did not own the premises itself.

Woolfson was distinguished from DHN Food Distributors by the Law Lords on the grounds that the company owning the property was only partially, rather than wholly, owned by the claimant company. Moreover, the House of Lords indicated that the decision in DHN Food Distributors was incorrect. Inter alios, Lord Keith speculated as to whether the Court of Appeal in DHN Food Distributors had improperly applied the guiding principle that it is appropriate to pierce the corporate veil only where special circumstances exist indicating that the veil is a mere façade concealing the true situation.

However, although Woolfson was a House of Lords decision, it was uncertain as to whether the case laid down a binding precedent for English courts in light of its Scottish provenance (where a separate legal system operates). Lord Denning’s supporters in the Court of Appeal failed to acknowledge it in subsequent cases where it was held, that the court should pierce the corporate veil whenever justice so requires. This set the scene for Adams several years later, which was decided at a point after Denning’s retirement when his influence on the law had waned considerably.

Analysis

Although uncertainty still persists, Adams v Cape Industries seems to have delivered a decisive word (at least for the time being) on the argument provoked largely by Denning’s intervention in the 1970s. The judgement given in Trustor AB v Smallbone and Others (No 2) (2002)[8] appears to confirm that the modern Courts will not countenance any further erosion of Salomon’s fundamental principle of English company law that a company is to be regarded as a legal entity with a separate legal personality, distinct from that of its members. Trustor, alongside cases such as North West Holdings v Backhouse (2001)[9], clarifies that the piercing of a corporate veil can only be justified in three categories. These include: (a) where the company is a sham or façade; (b) where the company is an instrument in impropriety; and (c) where it is necessary to do so in the interests of justice.

It is submitted that the title under discussion is a matter of opinion rather than a statement of fact. Adams is undoubtedly a seminal case. However, whether its contribution to the development of the law was positive or negative or a blend of the two is contestable. In taking a stand against Lord Denning’s more proactive and pragmatic line of authority, as best evidenced in the case DHN Food Distributors, and restating the purist policy of upholding the Salmon principle Adams is certainly a decision that can be celebrated by so-called ‘black letter’ lawyers.

However, Lord Denning was perhaps one of the greatest and deepest thinking judges of the twentieth century and his jurisprudence in this field should not be dismissed out of hand. The ‘business perspective’ mentioned in the title entails a broad and amorphous concept and perhaps it would be foolish to seek to assert that there is indeed one collective or unitary ‘business perspective’ in reality. In practice the so-called ‘business perspective’ is comprised of many interests, some collective but some diverging and many competing with each other. By way of example, the business perspective in Salomon was very different from that in Macaura so one should not rush to make broad statements on generalisations.

The Adams decision is clearly advantageous to companies seeking to avoid liabilities in certain situations, but it is far less useful and arguably even obstructive to those companies seeking to enforce rights in certain situations. It is submitted that Denning’s approach and attitude to Salomon at least brought with it the universal advantage of flexibility, which is perhaps something that should be elevated above those considerations of certainty, predictability furthered by dogmatic adherence to principle. On this ground it is argued that Adams v Cape Industries is far from a panacea for business, there is a darker, rigid face to the decision that will deny many companies rights and freedoms that they have a good practical and moral case to argue for.

The legacy of Adams v Cape Industries has failed to secure a compelling and all-encompassing principle as to when a court is able to tiptoe around Salomon to pierce a corporate veil. At the end of 2005, the circumstances in which the courts will apply the three exceptions stated in Trustor remain unclear.

The principles of the single economic entity and agency, notwithstanding the fact that they have been narrowly defined and limited in scope, in theory allow the court to circumvent the Salomon principle of the separate corporate entity, irrespective of the absence of mala fides or bad faith. That said the principle of lifting the corporate veil appears to have been limited to cases in which there has been a fraudulent attempt to conceal the identity of the incorporator in order to circumnavigate or deflect certain legal obligations.

Although the precise scope of the principle remains uncertain it appears that the court will be unwilling to lift the corporate veil in the absence of bad faith. Salomon will not be set aside simply because justice demands it. It remains to be ultimately decided by the courts as to whether it is desirable to reduce their power in such a way.

Lord Denning’s approach may now have fallen out of vogue in the courts, but it is submitted by this commentator that it is indeed appropriate to the strive for the development of the principle of piercing the corporate veil where justice demands it. Adams v Cape Industries, although ostensibly helpful to holding companies and corporate groups on its particular facts, represents an sclerotic and inflexible stance in general, and one from which companies may ultimately come to suffer as the law and commerce develops around it.

In closing it is argued that the flexible, equitable attitude expressed in DHN Food Distributors is still to be preferred over the black-letter dogma of Adams v Cape Industries and that a far stronger moral case, which should surely be the basis of all law, can be advanced for the former than for the latter. What is fundamentally wrong with the notion of adopting such a rule on a case-by-case basis and allowing justice to succeed in each individual case?

The arguments that justice can only be achieved when parties are able to depend upon clear and certain principles, and that it is impossible to encompass justice within an uncertain rule are simply not accepted by this commentator. By way of personal observation and to address the title directly Adams v Cape Industries was good for business in precisely the same way that chocolate is good for children.

THE END

WORD COUNT: 2365 (all inclusive)

BIBLIOGRAPHY

Hicks Andrew & Goo S.H., Cases & Materials on Company Law, 5th ed, (2004) Oxford University Press.

Dine Janet, Company Law, 5th ed, (2005) Palgrave Macmillan

Sealy L S, Sealy: Cases and Materials in Company Law, 7th ed (2001) LexisNexis UK

Smith & Keenan’s Company Law For Students, Keenan & Bisacre, FT Pitman Publishing

Company Law Fundamental Principles, Stephen Griffin, Longman

1


Footnotes

[1] AC 22 (HL).

[2] AC 619.

[3] Ch 433.

[4] For further comment see: Hicks Andrew & Goo S.H., Cases & Materials on Company Law, 5th ed, (2004) Oxford University Press.

[5] See for elaboration: Hicks Andrew & Goo S.H., Cases & Materials on Company Law, 5th ed, (2004) Oxford University Press.

[6] [1976] 3 All ER 462.

[7] 1978 SLT 159, HC.

[8] BCC 795.

[9] EWCA Civ 67.


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