Veil of Corporation

2.1. Company as a separate legal entity

On the winding up of A Salmon & Company, it was revealed that assets were
insufficient to satisfy the secured debenture holders and creditors. All the debenture
rights were vested with Salmon who formed the company as a major shareholder and he
was the only secured debenture-holder. His wife and five children were given one share
each. The creditors raised their objection to the payment of debenture out of assets on
the basis that the company and the Salomon were same and Salmon could not owe money
to himself. Making outstanding remark on the facts, it was held, that the company is a
separate entity differed from its composers and the rights over the issued debentures should
be paid off before the claim over the trade creditors applying general rules relating to
settlement of claim in winding up.

In Salomon case, Lord McNaughton stated that:

“The company is at law a different person altogether from the subscribers to the
memorandum; and though it may be that after incorporation of 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 them. Nor are the subscribers as
members liable, in any shape or form, except to the extent and in the manner provided by the
Act1

The House of Lords in this land mark case well known as Salomon v. A. Salomon & Co. Ltd
establishes the legal principle that, with the incorporation of a company it derives new legal
entity separate from its’ own shareholders as an artificial person. In relation to a group of
companies too, each member company has separate legal identity. Each company owns asserts
and can accrue benefits and liabilities. Directors or shareholders are not accountable or
personally liable for the acts of the company. They act on behalf of a company. The third parties
who deal with the company cannot invoke any action against the shareholders or the officials
of the corporate body. If otherwise specified by Articles or the statue, shareholders are
not liable to the debts of company. Shareholders of a company limited by shares are liable only

1
Salomon vs Salomon & Company Ltd (1897) A.C. 22 at P.51
to the extent of their unpaid share value. They are not liable for the debts of the company, once
they have fully paid to the shares they held. As an adherence to the said principle, Section 87(1)
of the Companies Act No.7 of 2007 of Sri Lanka specifically makes for the separateness of the
shareholders from the company’s legal entity. Hence under the concept of veil of corporation,
shareholders enjoy the protection of limited liability for the acts and debts of the corporate
body. This protection plays eminent role in commercial world in encouraging investment by
limiting or minimizing the risk involved in corporate ownership. The business carries on is the
business of company. The capital employs is the capital of company and neither the business
nor the capital belongs to the shareholders. Shareholders are not the controllers of company’s
management; though they formed it. Company is not an agent or the trustee of shareholders.
Company is an entirely independent body from its shareholders. This protection plays
outstanding role in encouraging investment by limiting the risk involved in corporate
ownership.

Though many scholars criticized the doctrine of corporate veil, separating shareholders,
directors and employees from the corporate body, with the decision of Salomon, mainly in
terms of the interest of creditors and the complicity nature of group of companies, the said
principle of separate legal entity has been applied often.

Similarly in Daimler Co. Ltd v. Continental Tyre & Rubber Co. (Great Britain) Ltd2
summarized the law as follows:
No one can question that a company is a legal person distinct from its cooperators; that a
relation of a shareholder to a company ... is not in itself the relation of principal and agent or
the reverse; that the asserts of the company belong to it and the acts of its servants and agents
are its acts, while its shareholders, as such, have no property in the assets and no personal
liability for those acts.

Likewise, in Macura vs. Northern Assurance Company Ltd 3 , it was held, despite the
fact that a plaintiff who is personally owned some assets and transferred those at later
stage to the company, in which all the fully paid shares were held by him, did not have

2
(1916)2 AC 307 at p. 338
3
(1925) A.C. 619
insurable or legal interest to those assets, though those properties were insured under his
name.

As per Evershed, L.J. in Short v. Treasury Commissioners 4 an incorporated company is

not the agent, trustee or nominee of its members. Supporting the doctrine of separateness, in
Lee Lee’s Air Fanning Ltd5, it was decided that though Lee was the controlling shareholder
and sole governing director of Lee's Farming Limited, compensation could be claimed on
his demise by his spouse under the workmen’s compensation legislation for the service he
rendered as an employee of the company.

In J. H. Rayner (Mincing Lane) Ltd vs. Department of Trade and Industry 6, it was held that
once a company was given the legal identity as a separate legal person, company is the
contracting party to transactions. There is no room for any further inquiry, to see what type
of legal person the contracting party is. Only the company is liable for its own actions
and liable for its own debts, not the shareholders of the company.

Further, In Kuwait Asia Bank EC vs. National Mutual Life Nominees Ltd 7 it was held that,
the members of a company cannot owe any duty of care in respect of the company's acts.
In other words, they cannot be liable in tort for the company's acts. These are examples for
upholding the general rule of separate legal entity of a company. The doctrine of separate
entity, is the shield of a company for engaging in transactions through the guarantee of limited
liability unless there are any specific statutory provisions or established norms in common law
to the contrary or some other binding contractual obligations.

While there exists a pool of cases in United Kingdom. Sri Lanka experienced only one relevant
cases in company law within the area of corporate veil. In Trade Exchange (Ceylon) Limited vs
Asian Hotels Corporation Ltd8. Justice Sharvananda held that Asian Hotels Corporation Ltd

4
(1947) 1 K.B. 116; (1947) 2 All E.R. 298, at p.122
5
(1961) A.C. 12
6
(1990) 2 A.C. 418
7
(1991) 1 AC 187, PC
8
(1991) 1 AC 187 PC - The Trade Exchange (Ceylon) Limited had, been carrying on business at Hotel Lanka
Oberoi owned by the Asian Hotels Corporation Ltd since April, 1975 upon a licence, and it was expired. Both
companies incorporated under the Companies Ordinance. Trade Exchange (Ceylon) Limited had resorted writ
of certiorari to quash the decision of the Asian Hotels Corporation Ltd refusing to grant them a licence and
argued that Asian Hotels Corporation Ltd was in fact a public in which the majority of the issued share capital
was drawn from public funds; the majority of the directors were nominated by the Minister of Trade and the
was a public commercial company incorporated under the Companies Ordinance and the fact
that most of the capital was contributed by the Government or that shares were controlled by the
Government did not make it an agent of the Government. The incorporated company was
recognized by the law as a juristic person separate and distinct from its members and was an
independent body corporate carrying on commercial activities. The company’s decisions, made
in the course of its business, cannot be reviewed by a superior court by way of writ, since the
company is not a government owned body although majority shares were held by the
government. It is to be noticed that the Supreme Court re affirmed the principle that the company
is a commercial entity is different from its shareholders.

The corporate entity of a company should rest on principle of separate legal personality and be
left undisturbed. If the veil were too recklessly lifted, shareholders of the company would lose
all protection. Hence it is obvious that courts defer the rule of corporate entity since the
inception of the decision of Salomon as the general rule; and ignorance of such rule is an
exception9.

company was under the purview of the Minister of Trade and therefore court could grant a wet against a public
body.)

9
In Adams v. Cape Industries PLC ( 1990) Ch. 433, CA at 536, Scott J. expressly stated that save in cases in which
turn on the wording of particular statues or contracts, the court is not free to disregard the principle of Salomon v
Salomon & Co. Ltd merely because it considers that justice so requires.
Exception to the separate entity principle

Long after S a l o m o n c a s e , strong criticism has been arose that separate legal entity
principle highly benefits shareholders at the great expenses of the creditors and negates the
beneficial interest of share creditors. Some even proposed to abolish the concept of
limited liability. 10 The courts realized the urgent need to look beyond the separate
legal entity of corporate body to the effect that the real person or corporate body in
control of a company could be held personally accountable or be liable for the acts of a
company. Gradually, this realization, in effect, was viewed as doctrine of piercing or lifting
the corporate veil.

The doctrine of piercing of corporate veil is an equitable remedy first had been coined
through as a concept of common law in earl y 19 t h centur y and gradually brought
into statutes. Piercing of veil is an exceptional situation to the said general principle
of separate legal entity whereby courts disregard the separateness of shareholders and a
company and treat both as one entity.

Under the concept of piercing of corporate veil, a company is considered as an

association of persons and shareholders are asked to be responsible for the
corporate obligations. Shareholders or directors are accountable and responsible for the
actions of corporation, as if it were the actions of the shareholders/directors. Piercing
the corporate veil is expressed as 'the judicial act of imposing personal liability on
otherwise immune corporate officers, directors and shareholders for the corporation’s
wrongful acts 11 The effect of piercing the veil is either to render shareholders or directors
jointly liable with the company for the liabilities of a company or to identify the shareholders
or directors with the company as a single person12.

10
Hanamann, H., Kraakmah R., `Toward unlimited shareholder liability for corporate torts, 100 YALE L.J. 1879(1991)
Law Quarterly Review commented that the House of Lords had recognized that one trader and six dummies
would suffice and that the statutory conditions were mere machinery. The decision recognized that one man
company fell within the policy of the Act. There was nothing startling in that. Once limited liability was recognized
the creditors must look at the capital, the limited fund, and that only, in (1897) 13 LQR 6, cited in Farrar H.J.,
Furey. N. E., Hannigan. B. M., Farrar's Company Law, 3'd Edition, publishers Butterworth & Co Ltd 19917, p. 72

11
Black's Law Dictionary, West, T. 2004, p. 1184
12
Gullick, J. M., (Ed), Ranking and Spicer's Company Law, 13 th Edition, published by Butterworth and
Company Ltd, p.5
Though it refers the phrase lifting of veil and piercing of veil as having similar
meaning, some of the judicial decisions expressly separate the meaning of the two phrases.
In Atlas maritime Co SA v Avalon13, Staughton LJ, stated that:

Piercing the corporate veil is an expression that … it would reserve for treating the
rights and 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 purposes.

According to the judicial expressions, lifting of veil is less offensive with respect to
the separate entity principle. The veil is lifted or peeped behind, only to obtain information
to identify the personnel of a company. Having gathered relevant information, the
veil is then pulled down and again the company is considered as separate legal entity.
But under the phrase of piercing of veil, courts reach through or crack or penetrate the veil and
grab the controlling shareholders personally. The purpose of piercing of veils is to make
shareholders responsible for the acts of company.14

C ourt s began t o pi erce t he vei l t o re ach i nt o t he perso nal asset s of a

shareholder. Today, it becomes one of the most litigated issues in other
jurisdictions within corporate law, permeating the entire business landscape; from ordinary
transactions to environmental disasters.15 Unfortunately Sri Lankan corporate system has
not yet experienced any such backdrop of application of piercing veil doctrine except the
scandal of Golden Key Credit Card Company. But the fallen out of Golden Key Credit Card
Company has not even been analyzed or handled in terms of company law rather cornered the
whole event into Fundamental Right litigation.

The doctrine of piercing veil in traditional approach is used to impose liabilities only on the
corporate shareholders who manipulate the legal principle of separate legal entity for engaging

13
(1991) 4 All ER 769
14
Ottolenghi, S., 'From Peeping behind the Corporate Veil, to Ignoring It Completely', The Modern Law Review,
Vol. 53, No. 3 (May, 1990), pp. 338-353
15
Peter B.O. Veil piercing unbound, Boston University Law Review (Vol.93:89) pp 89-136
in improper conduct or promoting frauds.16 Piercing of veil is viewed as very destructive
extremist act for the function of a company. Hence the courts are very reluctant to pierce the
veil of corporation against its shareholders due to economic determinism. But the
situation of imposing civil liability on directors who led the company for the destruction, is
much different from the situation of shareholders.

It is noted that, many jurisdictions extend their statutory provisions to pierce the veil, moving
away from the traditional approach17 for making accountable the real perpetrators. Sometime
those controllers may be a controlling company of a subsidiary or a director/ manager of a
company who uses corporate structure capriciously for an extraneous purpose without having any
legitimate commercial interest

Article 20 of Companies Law of the People’s Republic of China provides that the shareholders
of a company shall comply with the laws, administrative regulations and articles of association,
and shall exercise the shareholder's rights according to law. None of them may injure any of
the interests of the company or of other shareholders by abusing the shareholder's rights, or
injure the interests of any creditor of the company by abusing the independent status of legal
person or the shareholder’s limited liabilities.

Where any of the shareholders of a company evades the payment of its debts by abusing the
independent status of legal person or the shareholder's limited liabilities, and thus seriously
damages the interests of any creditor, it shall bear joint liabilities for the debts of the company.

16
Re Bugle Press Ltd (1961) Ch 270, CA.
Wallersteiner vs. Moir (1974) 1 KR 991
Adams v. Cape Industries PLC (1990) Ch 433
Creasey v Breachwood Motors Ltd (1993) BCLC 480

17
in Us v Milwaukee Refregator Transit Co. (142 Fed 242,247) "When the notion of legal entity is used to defeat
public convenience, justify wrong, protect fraud or defend crime, the law will regard the corporation as an
association of persons.

Article 369-4 of the Taiwan Companies Act imposes civil liabilities on the Controlling company and its
responsible persons

“In case a controlling company has caused its subsidiary company to conduct any business which is
contrary to normal business practice or not profitable, but fails to pay an appropriate compensation upon
the end of the fiscal year involved, and thus causing the subsidiary company to suffer damages,
the controlling company shall be liable for such damages.”
Article 64 of Companies Law of the People's Republic of China if the shareholder of a one-
person limited liability company is unable to prove that the property of the one-person limited
liability company is independent from his own property, he shall bear joint liabilities for the
debts of the company.

Securities Law of most jurisdictions has required the corporate insiders to be responsible for
the damage caused by them though it is in the form of activities of a company.18

18
Lin. A. J. G., 'Looking for the Responsible Persons- A Comparative Study of the Corporate Piercing Doctrine', 6th
Asian Law Institute Conference, 29th May 2009, Hong Kong, pp 2,14 ( Section 10(b) of United State Securities and
Exchange Act of 1934, Article 20-1 of Taiwan Securities and Exchange Act — those Acts provide provisions for private
rights for action against those who involve in the preparation of false or misleading financial reports and imposes
strict liability on the issuer, chairperson of the board of directors and the general manager.
 II. Theoretical framework – recognizing lifting of the veil
Though there are several theories related to the veil doctrine of corporate body, basically
three themes in two dimensional are addressed by all those theories for the justification the
doctrine of veil of corporate and the doctrine of piercing of veil of corporation19.

Under first theme, corporation is viewed as an entity with a real existence separate from its
shareholders which supports the doctrine of veil of corporation. Proving the said theme, the
dictum came from the decision in Salomon, company is at law a different person altogether
from the subscribers, has been consistently applied as a key feature of company law. Section
2(l) of the Companies Act No.7 of 2007 of Sri Lanka too adopts a similar approach with or
without knowledge of such theoretical foundation.

According to the theme corporation is a mere combination of natural individuals without

having a separate existence. The shareholders are personally liable and accountable for the acts
of the company. This dimension stands against the veil of corporation and support to pierce the
veil. Except at very few occasions this dimension will not be applied in company law as a
general rule. The protection of a limited liability plays very vital role in encouraging investment
by limiting the risk involved through the rule of separateness of shareholders and a company.
Mainly because of this factor, large undertakings are rested in world and huge sums of capital
is attracted to the society.
In terms of second theme, corporation viewed as a creation of State Law and secures as a
separate entity. This is called Concession Theory which emphasizes the concept of limited
liability as a given privilege by the government to operate for the public interest. Hence it
emphasizes the important of separate legal entity of a company. Article 14(1) (g) of the
Constitution of Sri Lankan may be considered as endorsing this theme.

Under the third theme, director acts on mere interest of its shareholders or behaves as
agents or trustees of shareholders. Under this theme, companies are considered as implicit
structured body which can't be detached from its' shareholders. This theme sometimes known

19
Millen, D.D., 'Theories of Corporation', Duke Law Journal, Vol. 1990, No. 2, Frontiers of Legal Thought I (Apr.,
1990), Published by Duke University School of Law, pp. 201-262
as organic theory, according to this theory director running business for a company and his
intention and actions are the intentions and actions of the company, which cannot act or think
by its own.

The next chapters of this extended essay will be focused on the statutory provisions which
permits the lifting of corporate veil in Sri Lanka with comparison to the provisions in the
Companies Act in UK. Those statues too reflect that the provisions contained therein are
based on those theories. The Forth Chapter analyses the flow of decisions in common law.