The general rule is that a company is a legal person and is distinct from its members. The principle is regarded as a curtain, a veil, or a shield between the company and its members, thus protecting the latter from the liability of the former. The veil is impassable as an iron curtain. But when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud or defend crime the law will regard the company as an association of persons. In these cases the law disregards the corporate entity and pays regards to the economic realities behind the legal façade. The court may look behind the artificial person- the company and take account of the personalities of natural persons- the cooperators.
These cases are exceptions to the principle in Saloman v. Saloman & Co. Ltd are two fold: (1) Lifting by courts
(2) Lifting by statutes
(1) Lifting by courts
Courts while experiencing their inherent jurisdiction to do justice and fairness may lift a company’s veil so as to meet the ends of justice. The court may lift the veil because of the following reasons:-
(i) Determination of character
In times of war, the court will lift the veil to see whether a company is controlled by the enemy aliens.
Case Law: Daimler Co Ltd vs. Continental Tyre & Rubber Co. Ltd (1916)
A company was incorporated in England with a capital of £25,000 in £1 shares for the purpose of selling in England tyres made in Germany by a German company, which held the bulk of shares in the English company. The holders of the remaining shares (except one) and all the directors were Germans resident in Germany. The one share was registered in the name of the secretary, who was born in Germany, but resided in England and had become a naturalized British subject. After the outbreak of the war between England and Germany, an action was commenced in the name of the English company on the instructions of the secretary, for a payment of trade debt. One of the defenses was that the company was an alien company and that payment of the debt would be trading with the enemy.
In his judgment, Lord Parker stated:
“My Lords, the truth is that considerations which govern civil liability and rights of property in time of peace differ radically from those which govern enemy character in time of war. The law on the subject may be summarized in the following propositions:
(a) A company incorporated in the UK is a legal entity, a creation of law with the status and capacity which the law confers. It is not a natural person with mind or conscience.
(b) Such a company can only act through agents properly authorized and as long as it is carrying on business in this country through agents so authorized and residing in this country, it is prima facie to be regarded as a friend.
(c) Such a company may, however, assume an enemy character. This will be the case if its agents or the persons in defacto control of its affairs are resident in an enemy country or taking instructions from or acting under the control of enemies.
(d) The character of individual shareholders cannot itself affect the character of the company in times of peace. The enemy character of individual shareholders and their conduct may however, be very material on the question of whether the company’s agents in defacto control of its affairs are infact adhering to, taking instructions from or acting under the control of enemies. This will vary with the number of shareholders who are enemies and the value of their holdings. Given in the case the fact that the secretary held one share only out of 25,000 shares and was the only shareholder who was not an enemy might well suggest that he was acting under the control of, taking his instructions from, or adhering to the enemies.
(ii) Where the company is a sham
The court will lift the veil where the device of incorporation is used for some illegal or improper purpose. The courts have intervened on numerous occasions and lifted the veil inorder to circumvent a fraudulent or improper design by a bunch of scheming promoters or shareholders.
Case Law: Jones vs. Lipman
Lipman agreed to sell freehold land with registered title to the plaintiff (Jones) for £5,250. Pending completion he sold and transferred the land to the defendant company (having a capital £100, which he acquired and of which he and a clerk were sole shareholders and directors), for £3000 of which 1,564 was borrowed by the defendant company from a bank and the rest owing to him.
In an action by the plaintiff for specific performance, it was held that, the defendant company was a cloak for Lipman.
The Lord Lawrence in his judgment stated that the defendant company is the creature of Lipman, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity. The proper order to make is an order on both the defendants specifically to perform the agreement between the plaintiffs and Lipman.
(iii) Where the company is acting as the agent of the shareholders
One of the ratio decidendi in Saloman’s case was that “the company is not in law an agent of the subscribers. Under the ordinary rules of law, a parent company and a subsidiary company even 100% subsidiary company are distinct legal entities, and in the absence of an agency contract between the two companies, one cannot be said to be the agent of the other.
If a court held that a company acted in particular instance as an agent of its holding company the veil of incorporation would have been lifted.
Case Law: Firestone Tyre & Rubber vs. Llewellin
An American company formed a wholly-owned subsidiary company in England to manufacture and sell its brand of tyres in Europe. The distributors sent their orders to the subsidiary direct and the orders were met without any consultation with the American company. The subsidiary received the money for the tyres sold to the distributors and after deducting its manufacturing expenses pus 5 percent, it forwarded the balance of the money to the American company. All the directors resided in England except one who was the president of American company and they managed the subsidiaries affairs free from day-to-day control by the American company.
It was held that the American company was carrying on business in England through its English subsidiary ‘acting as its agent’ and it was consequently liable to pay UK tax.
(iv) Protection of Revenue
The courts may disregard the corporate entity of a company where it is used for tax evasion or to circumvent tax obligation. Further, where it is desired to establish for tax purposes in what country a company is resident the court will lift the veil and find out where the control management is and that determines the residential status.
(2) Lifting by statutes
(i) Membership fallen below statutory minimum (Section 33)
If at any time the number of members of a company is reduced below two in case of private company or below seven incase of public company and it carries on business for more than six months while the number is so reduced, every member who knows of this fact will become liable to unlimited extent for the payment of the whole debts of the company contracted during that time. It should be noted that the section limits the members liability to debts contracted after six months. It does not make the member liable for any debts incurred during the six months which follow the reduction in membership.
(ii) Non-publication of a Company’s Name (Section 109 (4)
The Act requires a company’s officers and other agents to write its name on its seal, letters, business documents and negotiable instruments. This is done for the benefit of third parties who might contract with a limited company without realizing that it is a limited company. Any officer or agent of the company who does not comply with the aforesaid statutory requirement shall be liable to fine not exceeding sh 1,000 and shall further be personally liable to the holder of the bill of exchange, promissory notes, cheque or for goods which did not bear the company’s correct name, unless the amount due thereon is duly paid by the company. The imposition of personal liability on the company’s agent is what is regarded in a somewhat loose sense as “lifting the veil of incorporation”.
(iii) Group Accounts (Section 150)
Section 150 requires a company which has subsidiaries to lay before the company in a general meeting accounts or statements dealing with the state of affairs and profit and loss account of the company and the subsidiaries at the time when the company’s own balance sheet and profit and loss account are laid before the company’s general meeting. This is regarded in a loose sense as a case of “lifting the veil” because a holding company is obliged to incorporate into its balance sheet the assets and liabilities of the subsidiary company as if they were its own assets and liabilities. This is a modification of the general principle that a company’s assets and liabilities are not a members assets and liabilities and would not therefore be incorporated into the members own balance sheet.
(iv) Investigation of company’s affairs
Section 167 gives an inspector appointed by the court to investigate company’s affairs the power to investigate the affairs of a company’s subsidiary or holding company, if the inspector thinks it necessary to do so for the purpose of his investigation.
An investigation instituted pursuant to this power would be regarded in a loose sense, as an instance of “lifting the veil” because the order to investigate a company sufficed to investigate the company’s member as if they were one entity.
(v) Investigation of company’s membership
Section 173(1) empowers the registrar to appoint one or more competent inspectors to investigate and report on the membership of any company for the purpose of determining the true persons who are or have been financially interested in the success or failure of the company or able to control or materially to influence the policy of the company.
For the purpose of that investigation, Subsection 5 of the same section confers on the inspector power to investigate the membership of the company’s subsidiary or holding company for the same purpose.
(vi) Take over bids
Section 210 provides that where a scheme or contract involving the transfer of shares to another company has been approved by the holders of not less that 9/10 in value of the shares whose transfer is involved, the transferee company may at any time within two months after the making of the offer by the transferee company, give a notice to the dissenting shareholder. The dissenting shareholder must then apply to the court within one month from the date on which the notice was given to restrain compulsory acquisition of his shares. The court may, in an appropriate situation, lift the veil of incorporation.
(vii) Fraudulent trading
Section 323 provides that if the course of the winding up of a company, it appears that any business of the company has been carried on with the intent to defraud creditors of the company or for any fraudulent purpose, the court on application of the liquidator or any creditor or contributory, if it thinks proper so to do, declare that any person who were knowingly parties to the carrying on of the business in manner aforesaid shall be personally responsible without any limitation on liability for all or any of the debts or other liabilities as the court may direct.
The personal liability of the person concerned is what constitutes an instance of “lifting the veil” of incorporation.