UK: Piercing The Corporate Veil — Recent Developments

Last Updated: 10 April 2012
Article by Charles Pugh

Two judgments handed down in the last year have caused renewed interest in the court's ability to 'pierce the veil of incorporation'. The starkly contrasting decisions given by Mr Justice Burton in Antonio Gramsci Shipping Corp v Stepanovs [2011] EWHC 333 (Comm) ("Gramsci"), and by Mr Justice Arnold in VTB Capital plc v Nutritek International Corp [2011] EWHC 3107 (Ch) ("VTB Capital") have provoked debate about the scope of the concept. This article will explore whether the parameters are being altered, or are set to be in the near future, which may have far-reaching implications for those seeking redress against parties who seek to protect themselves behind a relatively impenetrable shield of incorporation.

The principle in Salomon

It is a fundamental principle of law that a company is an independent legal person distinct from its members. This principle derives from the observation from Lord Macnaghten in Salomon v A Salomon & Co Ltd that a 'company is at law a different person altogether from the subscribers to the memorandum'.1 This concept of separate legal personalities applies equally within groups of companies. In Adams v Cape Lord Justice Slade described subsidiary companies as being 'separate legal entities with all the rights and liabilities which would normally attach to separate legal entities' despite 'in one sense [being] creatures of their parent companies.'2

Counsel for the defendants in VTB Capital described piercing the corporate veil as a 'convenient label which is used to identify cases in which the courts have granted relief which involves, or perhaps more accurately appears at first blush to involve' disregarding the principle in Salomon.3 The courts are only willing to take this step for certain purposes and in very limited circumstances. In order to understand the significance of the conflicting positions adopted in Gramsci and VTB Capital it is helpful, as Arnold J did in VTB Capital, to look at the circumstances where the courts were first willing to grant relief and pierce the veil of incorporation.

Piercing the Corporate Veil – some early examples

The House of Lords emphasised in Woolfman v Strathclyde Council that it is only appropriate to pierce the corporate veil where the circumstances indicate that the company is merely a 'façade concealing the true facts'.4 Two of the earliest and best known examples where such a finding was made are Gilford v Horne [1933] Ch 935 ("Horne") and Jones v Lipman [1962] 1 WLR ("Lipman").

In Horne, the Court of Appeal granted an injunction against both Mr Horne and J.M. Horne and Co Ltd, a company owned by his wife and a friend. The court found that the company had been created as a 'cloak' under which Mr Horne had attempted to conceal his business activities, which were in breach of non-compete and non-solicit covenants he had made with his former employer.5 Relief was therefore granted despite J.M. Horne and Co Ltd not being a party to Mr Horne's restrictive covenants, and Mr Horne not being the legal personality acting in breach of those covenants.

Similarly, in Lipman, an order for specific performance was granted against both Mr Lipman and a company which he controlled. Mr Lipman had contracted to sell land to the claimants but had subsequently transferred it to his company in an attempt to defeat their right to specific performance.6

In each case the defendant's company was described as a 'sham', and it is this term which has become closely associated with the court's ability to pierce the corporate veil. Mr Justice Russell explained why he felt able to grant the order against both Mr Lipman and his company in the following terms:

"The defendant company is the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity."7

In VTB Capital Arnold concluded, quoting a passage from Justice Mumby in Ben Hashem v Ali Shayif, 8 that the courts have only taken the step of piercing the corporate veil when 'the company was being used by its controller in an attempt to immunise himself from liability for some wrongdoing which existed entirely dehors the company'. He went on to explain that a wrongdoing 'dehors' the company is one which is 'anterior or independent' of it. This was the case in both Gilford and Jones; both Mr Horne and Mr Lipman attempted to avoid liability for their own wrongdoing by using a company that they controlled as a shield. In those circumstances the courts were willing to grant relief against their respective companies in order to prevent the claimants being denied an effective remedy. It is important to note that in both cases it was an equitable remedy, rather than damages, which the court awarded after piercing the corporate veil.

The third case of significance is Trustor AB v Smallbone (No 2) [2001] 1WLR 1177. Unlike the other two decisions, Trustor did not involve the granting of an injunction. Mr Smallbone had transferred out monies in breach of his fiduciary duties to a company he owned, known as Introcom. Trustor sought an order that Mr Smallbone be liable for the monies received by Introcom as if he was the company. In reviewing the authorities and upholding the claim, Sir Andrew Morritt V.C, stated the following:

"In my judgement the court is entitled to 'pierce the corporate veil' and recognise the receipt of the company as that of the individual in control of it if the company was used as a device or facade to conceal the true facts thereby avoiding or concealing any liability of those individuals"

The recent decisions in Gramsci and VTB Capital

In Gramsci the claimants successfully argued that the corporate veil should be pierced and Mr Stepanovs treated as a party to certain agreements entered into between the claimants and five companies registered in the British Virgin Islands and Gibraltar, one of which was beneficially owned by Mr Stepanovs. 9 Mr Justice Burton held that there was a good arguable case that the claimants should be able to enforce a contract against Mr Stepanovs, the 'puppeteer', despite the contracts being entered into by his 'puppet' company. This was a potentially radical decision as it raised the prospect of non-parties being made liable on a contract to which it was not a signatory and at the same time raising the issue as to whether the 'puppeteer' was bound by all the terms of the contract. In reaching his conclusion Burton made a number of findings regarding the court's ability to pierce the corporate veil, which have subsequently received strong criticism from Mr Justice Arnold in VTB Capital.

In VTB Capital, the claimants applied to amend their particulars of claim in order to bring a contractual claim against Mr Malofeev, Marcap BVI and Marcap Moscow, despite these defendants not being parties to the loan facility under which the claimants claimed to have been defrauded.10 Arnold J was therefore required to consider the law regarding piercing the corporate veil, and in declining to follow Gramsci took the opportunity to criticise the judgment given by Burton and to set out the circumstance he believed would justify the courts taking this step and the remedies available once the corporate veil is pierced.

In Gramsci, Burton J held that the corporate veil could be pierced, and a claim for damages made, if the conditions in Trustor v Smallbone (No 2) [2001] WLR 1177 ("Trustor") 11 were satisfied. These are (1) fraudulent misuse of the company structure, and (2) a wrongdoing committed 'dehors' the company.12 Arnold J rejected this finding, stating in particular that he did not agree that there can be a claim for common law damages, as distinct from an equitable remedy, whenever the Trustor conditions are satisfied.13 Arnold J went on to say that a number of authorities show that it is 'inappropriate', where a claim of wrongdoing is made against the controller of a company, to pierce the corporate veil to enable a contractual claim against that person. 14In Arnold J's eyes, Trustor is instead authority for the proposition that, in a claim for knowing receipt, the court will treat receipt by a company as receipt by the individual who controls it if both conditions above are satisfied.15

Mr Justice Arnold was also critical of what he perceived to be an anomaly created by Burton J's reasoning in Gramsci. The decision in Gramsci, he states, turns on whether the wrongdoer has attempted to conceal his identity by using the company as a facade. The result is that if the wrongdoer conceals his involvement in the company then the corporate veil can be pierced, but if he does not conceal his involvement then it cannot. As a consequence the successful claimant in the former case is entitled to the contractual measure of damages, but in the latter he is restricted to the tortious measure.16 Arnold could see no justification for this divergence.

Arnold J concluded that the effect of the decision is Gramsci was to ignore privity of contract rather than to pierce the corporate veil. Burton had found that there was no good reason why a claimant should not be able to enforce a contract against both the 'puppet' company and the 'puppeteer' who at all times was pulling the strings. He compared this to the circumstances in Gilford and Jones where, on his reading, the claimants sought to enforce their respective contracts against both the puppeteer and the puppet company.17 Arnold J , conversely, pointed out that in neither of those cases were damages awarded against the puppet for the puppeteer's breach. Instead, equitable relief was granted against the puppet company to stop the puppeteer evading contractual liability.18

Finally, Arnold J was dissatisfied with Burton J's acceptance of the submission that the notional puppeteer can be made liable for a contract, but that "as a matter of public policy" he cannot enforce it.19 Arnold J asked why such a defendant, who is being treated by the courts as a party to a contract, should not be able to enforce rights within it such as a set off or cross claim for unpaid sums.

Conclusion

It is rare that the Courts had down judgements so patently at odds with each other. The contrasting decisions in Gramsci and VTB Capital suggests the law regarding piercing the corporate veil is ripe for further clarification by a higher court. An indication that the Courts may favour Arnold J's reasoning approach of Arnold can be seen from the Court of Appeal's refusal to grant the claimants in Linsen International v Lumpuss permission to appeal, after they failed at first instance to persuade Justice Flaux to pierce the defendant's corporate veil. Lord Neuberger MR held that the fact that the third defendants had knowingly received assets from the first defendant for the purpose of avoiding the first defendant's liability under a contract already entered into and breached by the first defendant could not justify effectively treating the third defendant liable as a contractual party.20

VTB Capital is understood to be on appeal to the Court of Appeal. It is anticipated that the court will be required to consider the law regarding piercing the corporate veil or to provide clarification. To the disappointment of many would-be claimants, it is Arnold J's more restrictive approach from VTB Capital, which it is anticipated, the higher courts are likely to prefer. To do otherwise would require the Court of Appeal to explain how a 'puppeteer' made liable under a contract, to which he was not a party, can benefit and/or be bound by all other terms of the contract and the consequential effect.

Footnotes

1. Salomon v A Salomon & Co Ltd [1897] AC 22

2. Adams v Cape Industries Plc [1990] Ch. 433

3. VTB Capital v Nutritek [2011] EWHC 3107

4. Woolfson v Strathclyde Regional Council 1978 S.C. (H.L.) 90

5. Gilford Motor Company v Horne [1933] Ch 935

6. Jones v Lipman [1962] 1 WLR

7. Jones v Lipman [1962] 1 WLR

8. Ben Hashem v Ali Shayif [2008] EWHC 2380 Fam

9. Antonio Gramsci Shipping Corp v Stepanovs [2011] EWHC 333 (Comm)

10. VTB Capital v Nutritek [2011] EWHC 3107 at 65

11. Trustor AB v Smallbone (No 2) [2001] WLR 1177 at 23

12. Antonio Gramsci Shipping Corp v Stepanovs [2011] EWHC 333 (Comm) at 15. Incidentally, it was pointed out in VTB Capital that Burton's judgment in Gramsci states that the 'wrongdoing must not be dehors the company' [emphasis added]. Arnold J concluded that this must simply have been a typographical error, although he did conclude that the 'dehors' concept had caused Burton J 'some difficulty'. (See VTB Capital v Nutritek [2011] EWHC 3107 at 98).

13. VTB Capital v Nutritek [2011] EWHC 3107 at 97

14. At paragraph 99, Arnold J points to the decisions in Yukong v Rendsberg, Ben Hashem v Ali Shayif, Dadourian v Simms, and Lindsay v O'Loughnane.

15. VTB Capital v Nutritek [2011] EWHC 3107 at 81

16. VTB Capital v Nutritek [2011] EWHC 3107 at 100

17. Gramsci v Stepanovs [2011] EWHC 333 (Comm) at 26

18. VTB Capital v Nutritek [2011] EWHC 3107 at 101

19. Gramsci v Stepanovs [2011] EWHC 333 (Comm) at 27i and VTB Capital v Nutritek [2011] EWHC 3107 at 101

20. See VTB Capital v Nutritek [2011] EWHC 3107 at 95.

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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