LAW 200 (SECTION 6)

Veil of Incorporation
Final Assignment

Prepared for

Barrister Saheen Ahmed

Faculty Member

North South University

Prepared by

M Abu Saleh Chowdhury

ID # 072 407 030

Date of Submission: December 8, 2010

 Table of Contents

INTRODUCTION .......................................................................................................................... 1

WHAT IS “VEIL OF INCORPORATION”? ................................................................................. 4

ANALYSIS OF THE LEADING CASES ...................................................................................... 5

Salomon v Salomon & Co Ltd (1897) ........................................................................................ 5

Lee v Lee‟s Air Farming Ltd (1961) ........................................................................................... 7

Battle v Irish Art Promotion Centre Ltd (1968) .......................................................................... 7

State Trading Corporation of India Ltd. AIR (1963) SC 1811 ................................................... 8

In C.I.T. v. Meenakshi Mills Ltd. (AIR 1967 SC 819) ............................................................... 8

PIERCING THE CORPORATE VEIL .......................................................................................... 9

Factors for courts to consider ...................................................................................................... 9

CONCLUSION ............................................................................................................................. 10

BIBLIOGRAPHY ......................................................................................................................... 11

WEB REFERENCES.................................................................................................................... 11

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INTRODUCTION

"The company is at law a different person altogether from the subscribers to the Memorandum,
and though it may be that after incorporation of the business is precisely the same as it was
before and the same persons and managers, and the same hands receive the profits, the company
is not in law the agent of the subscribers or trustees for them. Nor are the subscribers or members
liable in any shape or form except to the extent and in the manner provided by the act."

This notation was made by the House of Lords in 1897, which has later emerged as one of the
most debated and talked about doctrines in the history of company law. This eventually had
given birth to the term “Veil of Incorporation” and afterwards helped solve many disputed cases
and also managed to carry negative remarks as well.

Against the backdrop of the possibility of that limited liability (which protects investors,
shareholders) can be a vehicle for facilitating fraud, parliament via statutory legislations and
judiciary via decided cases have sometimes intervened to mitigate the harsher effect of corporate
personality and limited liability but this does not mean that the two doctrines are no respected or
recognized by the courts as holding sway as rigid construct of English company law.

However it is in dealing with companies operating as group structures and their subsidiaries that
we have witness intensive statutory and judicial intervention/watchdog in the core area of
company law. As corporate affairs became more complex and group structures emerge, the
Companies Act began to recognize that treating each company in a group as separate was
misleading. Overtime a number of provisions were introduced to recognize this fact. For
instance, the English Companies Act 1985, section 227 provides that parent companies have a
duty to produce a group accounts and section 231 also requires that parent companies to provide
details of the names of subsidiaries country of activity/operation and the shares it holds in the
subsidiary.

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WHAT IS “VEIL OF INCORPORATION”?

One of the purposes of incorporating is to separate an individual from legal liability of a

company. The veil of incorporation ensures that a company is a separate legal entity from its
directors and shareholders, thus protecting the personal assets of owners and investors from
lawsuits.

Once a company incorporates, it becomes its own legal person, thus a legal entity, separate and
distinct from the people who formed, own or invest in it. It then retains its own rights and
responsibilities such as owning property or entering into contracts, and it can sue or be sued only
in its own name.

This principle behind the veil of incorporation is known as limited liability. The concept of
limited liability protects a company's members while furthering the company's commercial
endeavors. The significance of the veil of incorporation is that a shareholder or owner incurs no
debt that the business acquires. Furthermore if a company is sued and a judgment is granted
against said company, the shareholders only stand to lose the amount that they each invested.

There are situations when the veil of incorporation can be pierced or lifted, thus is not a legal
ground for defense. When a company carries on trading with less than 2 members, or when
fraudulent or wrongful trading is found to have occurred, action can be taken against individuals
of the corporation. Courts have also ignored the veil of incorporation in cases in which
companies have been established or used for fraudulent purposes. These types of companies are
often referred to as an alter ego, a sham or cloak corporation, and in these cases accountability
belongs to the person responsible for the illegal action.

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ANALYSIS OF THE LEADING CASES

Salomon v Salomon & Co Ltd (1897)

The Salomon principle has stood the test of time because it has meant that corporations do have
practical utility. As a separate legal entity subject to limited liability and defined by share
transferability, perpetual existence, flexible financing methods, specialized management,
majority rule and the other attributes or consequences of incorporation, the corporation has
many economically and socially beneficial functions.

Primarily, a corporation enables the investing public to share in the profits of an enterprise
without being involved in management. It also enables a single trader or a small partnership to
carry on a business. Similarly, a corporation provides a structure for joint venture; holding family
assets; continuing trusteeship; fund management; corporatized government enterprise; and, the
co-enjoyment of property. Marshalling participants in large commercial enterprises and acting as
a nominee to hold the legal title to assets are two other important functions.

Corporate personality is essentially a metaphorical use of language clothing the formal group
with a single legal identity by analogy with a natural person... [But] As Cardozo J said in the
American case of Berkey v Third Avenue Rly [(1926) 244 NY 84 at 94-5]: "metaphors in law
are to be narrowly watched, for starting as devices to liberate thought, they often end by
enslaving it."

In stressing the independent nature of corporate personality, the House of Lords legitimized the
usage of the corporate form by individual traders and small partnerships: private enterprises
which do not seek to raise capital from the public but are anxious to interpose an entity between
themselves and their creditors. The Law Lords concluded that once registered in a manner
required by the Act, a company forms a new legal entity separate from the shareholders, even
where there is only a bare compliance with the provisions of the Act and where all, or nearly all,
of the company's issued shares are held by one person. Furthermore, the Court held that it was
possible for traders not merely to limit their liability to the capital which they invested in the
enterprise but even to elude any serious risk to the major part of that by subscribing for
debentures rather than shares.

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As noted in The Law Quarterly Review, Salomon's case was not about "a dry point of
construction". The House of Lords had sanctioned a change in ideas about what the company
was and about the uses to which it could be put. It gave priority to the separate identity of the
legal form and essentially ignored the economic reality of a one-person company. Basically,
Goulding explains, the reason for criticism of Salomon's case is two-fold. First, the decision
gives even apparently honest incorporators the benefit of limited liability in circumstances in
which it is not necessary in order to encourage them to initiate or carry on their trade or business.
Second, the opportunities that the decision affords to unscrupulous promoters of private
companies to abuse the advantages that the Corporations Act gives them by achieving a "wafer-
thin" incorporation of an undercapitalized company.

First, limited liability attracts small traders to the corporate form not because it represents an
effective device with which to raise capital, but because it gives them access to an avenue via
which to escape the "tyranny of unlimited liability". Criticisms of limited liability are addressed
at its impact on creditors and on society at large.

The principle is that a limited company's creditors must look at the capital, the limited fund, and
that only. Limited liability discourages shareholders from monitoring and controlling their
company's commercial ventures. The company's creditors bear the burden of the risks inherent in
dealing with limited liability companies. At issue is whether it is right that limited liability
should operate to restrict the size of the company's capital. Different types of creditors have
different capacities to protect themselves against these risks. While banks and similar financial
creditors easily overcome such risks, the same cannot be said of trade creditors, employees and
tort creditors. Because trade creditors rarely insist on security before they supply goods on credit,
they bear a considerable part of the risk of corporate insolvency. Employees are in an even more
precarious position. In stark contrast to finance and trade creditors, employees have no
opportunity to obtain security or diversify the risk of their corporate employer's insolvency.
Moreover, the majority of employees has minimal information about their employer's financial
standing (but see the Corporations Act). While contract creditors bear a degree of risk when they
deal with a limited liability company, they at least enter into the contract by their own will. This
is not so for a company's tort creditors. Victims of torts committed by a company bear an
uncompensated risk in case of the company's insolvency.

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From a more technical perspective, the economic benefits brought about by limited liability are
absent with respect to closely held or private companies. The reduction in monitoring costs, for
example, is irrelevant because owners and managers are one and the same. Moreover, the benefit
of fostering an efficient market for shares through limited liability does not apply as there is no
market for the shares of closely held companies. Furthermore, limited liability encourages such
companies to take excessive risks because the directors of closely held companies have more to
gain personally by shifting the risk of commercial collapse to corporate creditors than is the case
with public companies' directors.

Second, ever since the House of Lords handed down its decision in Salomon's case, legal
doctrine regards each corporation as a separate legal entity. When coupled with the consequent
attribute of limited liability, the Salomon principle provides an ideal vehicle for fraud. Because
of its malleability and facility for protecting directors and members against the claims of
creditors, the corporate form has been responsible for the development of many different forms
of fraudulent or anti-social activity.

Lee v Lee’s Air Farming Ltd (1961)

In this case, Mr. Lee formed his crop spraying business into a limited company in which he was
director, shareholder and employee. When he was killed in a flying accident, his widow sought
social welfare compensation from the State, arguing that Mr. Lee was a „worker‟ under the law.
The State argued that Mr. Lee was self-employed and thus not covered by the legislation. The
court held that Mr. Lee and the company he had formed were separate entities, and it was
possible for Mr. Lee to be employed by Lee‟s Air Farming.

The following case is similar to Salomon and Lee, but the principle of separate personality
worked to the disadvantage of the plaintiff.

Battle v Irish Art Promotion Centre Ltd (1968)

The defendant company was involved in legal proceedings but did not have enough money for
legal representation. The plaintiff, who was the major shareholder and managing director of the
company, sought to conduct the company‟s defence. The court held that while a human person

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can represent him or herself in court, a legal person such as a company can only be represented
by a solicitor or barrister.

The principle in Salomon‟s Case that a company is a legally different person from those who
control it represents the current law in Ireland. For example, if I form a company called „Murphy
& Co Ltd‟ in which I own one hundred per cent of the shares and am a director and employee,
legally speaking the company and myself are two distinct people. The „corporate veil‟ surrounds
the company of Murphy & Co Ltd and prevents outsiders challenging the operation of the
company. However, although the principle of separation is central to company law, there are a
number of situations when the company and its members can be identified together and treated
as the same. These are the exceptions to the rule in Salomon‟s Case, when the corporate veil is
lifted and the reality of the situation is examined.

State Trading Corporation of India Ltd. AIR (1963) SC 1811

It was held that As soon as citizens form a company, the rights guaranteed to them by article
19(1)c has been exercised and no restraint has been placed on the right and no infringement of
that right is made. Once a company or corporation is formed, the business which is carried on by
the such company or corporation is the business of that company or corporation and is not the
business of the citizens who get the company or corporation incorporated and the rights of the
incorporated body must be judges on that footing and cannot be judged on the assumption that
they are the rights attributed to the business of individual citizens.

In C.I.T. v. Meenakshi Mills Ltd. (AIR 1967 SC 819)

The court held that the income-tax authorities were entitled to pierce the veil of corporate entity
and to look at the reality of the transaction to examine whether the corporate entity was being
used for tax evasion. In this case, a separate corporate entity was brought into existence outside
the taxable territory with the ulterior motive of evading the tax obligation by the assessee mills.

The Supreme Court observed: "It is true that from the juristic point of view, the company is a
legal personality entirely distinct from its members and the company is capable of enjoying
rights and being subjected to duties which are not the same as those enjoyed or borne by its
members.

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But in certain exceptional cases the Court is entitled to lift the veil of corporate entity and to pay
regard to the economic realities behind the legal facade. For example, the Court has power to
disregard the corporate entity if it is used for tax evasion or to circumvent tax obligation.

PIERCING THE CORPORATE VEIL

Piercing the veil of incorporation is one of the most litigated topics in business law. It is also one
of the most controversial. Courts have yet to provide a comprehensive definition of the corporate
being and specific circumstances in which the veil can be lifted. To fully protect themselves,
shareholders should stay abreast of the financial condition of the corporation as well as be able to
maintain that the company has a legal objective.

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;
 Other factors the court finds relevant;
 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.

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CONCLUSION

Despite numerous sophisticated attempts in recent years at providing theories which explain
company law, it is noteworthy that we have not yet fully understood the essence of the corporate
being. It will, suffice to say, that if three persons incorporate a company, the company will
become a fourth person separate and different from these three persons individually or
collectively. However, when the company or corporate form is a sham or a mere façade
concealing the true facts, the veil of corporate personality can be torn aside.

The question of whether the negative aspects of the decision in Salomon's case outweigh the
good ones is best left unanswered for it is far too broad. One is inclined towards the view that the
principle of separate legal entity established in Salomon's case has been instrumental in the
development of modern capitalism and the immense social and economic wealth which it has
generated. The House of Lords extended the principle so far as to cover small private enterprises.
This move has had several negative consequences over time. However, it is also true that these
have been largely neutralized by joint legislative and judicial action.

Indeed, "the legislature can forge a sledgehammer capable of cracking open the corporate shell."
And, even without statutory assistance, the courts have often been ready to draw aside the veil
and impose legal liability on members and directors where to apply the Salomon principle
strictly would lead to injustice, inconvenience or damage to government finances.

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BIBLIOGRAPHY

1. Sen, A. K. (2008). Commercial Law Including Company Law And Industrial Law (26th Ed.).
Kolkata: The World Press Private Ltd.
2. Zahir, M. Company Law.

WEB REFERENCES

1. http://www.lexvidhi.com/article-details/case-study-on-separate-legal-entity-of-a-company-129.html
2. http://www.murdoch.edu.au/elaw/issues/v7n3/puig73a_text.html
3. http://en.wikipedia.org/wiki/Piercing_the_corporate_veil
4. http://en.wikipedia.org/wiki/United_Kingdom_company_law
5. http://en.wikipedia.org/wiki/Salomon_v_A_Salomon_%26_Co_Ltd
6. http://www.jonesbahamas.com/?c=135&a=11675
7. http://www.law-essays-uk.com/resources/sample-essays/company/corporate-veil-extract.php
8. http://www.ehow.com/about_4727895_what-veil-incorporation.html

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