• Anna Modestou

Preventing abuses of the corporate form; any tools available?

Corporations are legal fictions that facilitate entrepreneurship. The financing of risky projects has not been a problem as ‘limited liability’ provides a shield against failure. Shareholders only contribute to the company’s capital the amount they have agreed to in order to obtain shares. As a result, during times of distress, creditors cannot reach shareholders’ personal property. The formation of companies for the limitation of liability is, therefore, the core of Company Law.


In English Law, the Companies Act 2006 does not contain any explicit or implicit limitation on the use of corporate form. This is also underlined by the leading decision in Salomon v A Salomon & Co Ltd [1] where the House of Lords affirmed the idea that English Company Law is merely formalistic. This means that by fulfilling the formal requirements for a company formation its members are enjoying the benefit of the separate legal personality and thus limited liability. Consequently, limited liability is often exploited by incorporators.


To avoid the responsibility associated with power, the structure of a corporate group is initiated to distance the liability of the parent company that arises from the tremendous consequences of irrational use of power. Thus, a variety of legal tools is deployed to provide assistance to creditors – involuntary included- in overcoming the abuses of corporate form.


Fraud


The fraud offense has been used to address the issue. In Standard Chartered Bank v Pakistan National Shipping Corp [2] the director of a company committed a deceit by backdating a bill of lading and inducing the receiving bank to complete payment that would have otherwise been prevented. It was held that the director could not escape liability in asserting that the fraud was committed on behalf of the company because it did not arise by virtue of his position.


In Hemsley v Graham [3], investors were induced to invest in a corporation due to fraudulent representations made by the corporation’s directors through ’cross-firing accounts’ that gave the false impression that the company was active. The directors were held liable. Despite the above, proving malicious intent is difficult it largely depends on the available evidence. Consequently, it converts to a tool of minimum utility.


Another major flaw is illustrated by VTB Capital plc v Nutritek International Corporation and others [4]. The facts relate to instances where the tort victim seeks redress from the persons controlling the corporation due to the distress of the latter but relies on a jurisdictional clause incorporated to the contract, signed by the legal rather than the natural person due to the latter’s residence in an unappealing jurisdiction. In this case, it was held that the director was not bound by the clause because of the legal formalism of privity of contract. The director was not and never intended to be a party in the contract. This leads to the argument that this legal tool confers no remedy if there is no jurisdiction; that is often the case in corporate groups which organize their affairs through subsidiaries located in ’dystopian’ destinations.


Negligence


Another legal tool, to fight abuses of the corporate form in corporate groups, is under the tort of negligence. As illustrated by the decision in Chandler v Cape plc [5], a parent company is liable when it owes a duty of care to the subsidiary’s employees and breaches that duty. The duty arises when the parent company has superior knowledge on safety and health issues in a particular industry which extends to the perilous operations of the subsidiary and results to its employees’ reliance on the parent company’s superior knowledge for protection against hazards. Such knowledge could be satisfied by the appointment of a manager in charge of safety issues, responsible for both businesses. This constitutes an assumption of responsibility of the parent towards the subsidiary, sufficient to impose liability.


Similarly, in Newton-Sealey v Armorgroup Services Ltd [6] the liability of the parent company towards a subsidiary’s employee was established on the basis that the parent company gave defective instructions and equipment to the employee and, thus, intervened in the operations of the subsidiary.


However, the ineffectiveness of proving the parent company’s negligence is underlined by recent case law. In Thompson v Renwick Group plc [7], the Court of Appeal held that there is no assumption of responsibility merely by the appointment of a subsidiary’s director charged with the safety and health by the parent company.


Additionally, in His Royal Highness Okpabi v Royal Dutch Shell plc [8], the liability of the parent was not established for the environmental damage caused by the subsidiary because it was very unlikely to have superior knowledge over the subsidiary’s affairs. It is, admittedly, extremely difficult to establish such involvement. The parent company’s involvement in the subsidiary’s operations is, undoubtedly, an exceptional scenario. Traditionally, the parent company’s affairs are organized to be as distant as possible to avoid the imposition of any liability.


Piercing the corporate veil


Piercing the corporate veil doctrine is of no greater assistance to the problem of abuse. In Petrodel Resources Ltd v Prest [9], the Supreme Court in an obiter dictum by Lords Neuberger and Sumption summed up the existing legal position. It is suggested that the application of this tool is restricted only to cases where the corporate form is used for the deliberate evasion of existing legal obligations. If this is the case, only then the veil is pierced, and the shareholders are held accountable.


Despite looking useful at first glance, English courts are extremely reluctant to apply it in cases before them. This unwillingness is due to its exceptional nature and the specific factual requirements that are not easily met. Corporate groups are normally formed to limit future liability. For instance, in Adams v Cape Industries plc [10] it was held that a subsidiary charged with the role of distribution in the US was not a mere sham despite the fact that the initiatives behind the corporate structure were to limit the (future) liability of the parent company.


Agency


Other legal tools can serve. The law of agency holds the parent liable if it is proved that the subsidiary operates as an agent within its parent’s authority. In Adams v Cape Industries plc[11] the agency argument was not established as the subsidiary earned profits and paid taxes, had its own creditors and debtors and the return to the parent company had the form of an annual dividend passed by a resolution. A successful agency claim requires the subsidiary to operate as a ’mere corporate name’. Thus, it is extremely unlikely for liability to be established as the subsidiaries’ operations can be traced, notwithstanding how limited they are.


Thoughts


English law is creative in inventing new techniques to address the exploitation of limited liability within corporate groups. Despite their variety, their successful application is dependent on strict legal norms and very specific factual requirements which usually, more often than less, prove the claims unsuccessful.




Case law citations

[1] [1897] A.C. 22 [2] [2003] 1 AC 959 [3] [2013] EWHC 2232 (Ch) [4] [2013] UKSC 5 [5] [2012] EWCA Civ 525 [6] [2008] EWHC 233 (QB) [7] [2014] EWCA Civ 635 [8] [2018] EWCA Civ 191 [9] [2013] UKSC 34 [10] [1990] Ch 433 [11] Ibid

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