Canada: When The Corporate Veil Should Not Be Pierced

Last Updated: March 17 2011
Article by Bryan Haynes

Originally published in the November/December 2009 issue of Canadian Lawyer Magazine.

The "separate entities" principle established over 100 years ago by the House of Lords in Salomon has widely been recognised as one of the fundamental principles of English law. This principle holds that a company is a distinct legal person, different altogether from its shareholders, and which must be treated like any other independent person with its own rights and liabilities. The corporate veil, it was held, may only be pierced in very rare and exceptional circumstances, namely, if the company was formed for an unlawful purpose or a fraud was committed. Regrettably, in the past couple of decades, a "just and equitable" test has insidiously crept into the jurisprudence and been occasionally (but wrongly) applied in determining when to pierce the veil. The result has been the injection of uncertainty into the law and a weakening of the principle, which for over a century has deftly served as a cornerstone of corporate law.

Aron Salomon was a leather merchant and boot manufacturer. His sons, who worked with him, wanted a share in the business. So Mr. Salomon did what many others have done in similar circumstances – he converted his business into a limited company. At the time of transfer, the business was solvent and the debts of the business had been discharged. Unfortunately, the company fell upon evil days with a depression in the boot trade. The company was unable to satisfy its debts and an order was made for the windingup of the company. The trial decision, affirmed on appeal, ruled that the company had a right of indemnity against Mr. Salomon on the basis that the subscribers (members of his family) were mere "dummies", that the company was Mr. Salomon in disguise and that he engaged the company as his agent. The House of Lords unanimously reversed the lower court decisions. In that reversal, Lord Macnaghten noted: "The company is at law a different person altogether from the subscribers to the memorandum, and, though it may be that after incorporation the business is precisely the same as it was before, 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."

The origins of the "just and equitable" test have been traced to Wilson J. in Kosmopoulos, where she framed the test for lifting the veil as follows: "The best that can be said is that the 'separate entities' principle is not enforced when it would yield a result 'too flagrantly opposed to justice, convenience or theinterests of the Revenue'." In Transamerica, plaintiff's counsel, relying on Kosmopoulos, creatively submitted that the corporate veil can be pierced simply when it is "just and equitable" to do so. This submission was sternly rejected by Sharpe J., a decision upheld on appeal, on the basis that it represented a significant departure from Salomon. Although there have been cases which have adopted variations of the "just and equitable" test, the preponderance of authoritative commercial case law (including the House of Lords decision in Rainham, the English Court of Appeal decision in Adams and the B.C. Court of Appeal decisions in Preeco and very recently in Tracy) has reaffirmed the "separate entities" principle and applied the test for piercing the corporate veil outlined in Salomon.

The introduction of a "just and equitable" test into the case law is detrimental and unwarranted. The test outlined in Salomon is sound and unambiguous, the proper application of which leads to predictable results. If the veil can be pierced whenever it is just and equitable to do so, we would inevitably be harking back to the days when equity was measured by the length of the Chancellor's foot. We would also be straying from a coherent system of rational law characterized by the application of clear and consistent legal rules. The test is inconsistent with our corporate legislation which: (i) permits the creation of corporations having the capacity, rights, powers and privileges of a natural person; (ii) prescribes the limited circumstances in which directors, officers and shareholders may be personally liable for their actions and the debts of a company; (iii) does not grant the judiciary carte blanche to pierce the veil whenever it sees fit to do so; and (iv) sanctions the legitimacy of business owners limiting their future liability by incorporating.

The object of incorporating is (and always was) to encourage enterprise and trade by facilitating borrowing and capital raising and limiting the personal liability of shareholders. Having relied on these rules to organise their affairs, business owners should naturally expect that the "separate entities" principle will be respected and that the corporate veil will only be pierced in exceptional, well-understood circumstances. The "just and equitable" test is indefinite and whimsical. From inception, it has been widely criticized and disregarded. It is time to abolish this vague and undeserving test and reap the rewards of clarity and consistency.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Bryan Haynes
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