Editorial Committee of the Cambridge Law Journal

Lifting the Corporate Veil: A Reassessment of the Fraud ExceptionAuthor(s): Jennifer PayneSource: The Cambridge Law Journal, Vol. 56, No. 2 (Jul., 1997), pp. 284-290Published by: Cambridge University Press on behalf of Editorial Committee of the Cambridge LawJournalStable URL: http://www.jstor.org/stable/4508342 .

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Cambridge Law Journal. 56(2), July 1997, pp. 284-290 Printed in Great Britain

LIFTING THE CORPORATE VEIL:

A REASSESSMENT OF THE FRAUD EXCEPTION

Jennifer Payne*

If students of company law know just one case, that case will be

Salomon v. A. Salomon & Co. Ltd} which firmly established the

English law principle that a company is a legal person entirely separate and distinct from the members of that company. It is trite law that a

rather hefty veil is drawn between these two that can be lifted2 only in

a limited number of circumstances that seem to fluctuate according to

current judicial thinking. However, it "is well established that the

courts will not allow the corporate form to be used for the purposes of fraud or as a device to evade a contractual or other legal obligation",3 a principle which is referred to hereafter as the "fraud exception" to

the Salomon principle.4 That looks straightforward enough, but unfortunately the shape

and form of the fraud exception seem to have become confused, as

demonstrated by the decision of Creasey v. Breachwood Motors Ltd.5

in which the opportunity for the court to utilise the fraud exception was raised. It was not accepted, and the veil was eventually lifted on

the basis that to do so was necessary in order to achieve justice. This

is surprising, given the very clear statement of the Court of Appeal

just three years earlier that ".. . save in cases which turn on the

wording of particular statutes or contracts, the court is not free to

disregard the principle of Salomon v. A. Salomon & Co. Ltd. [1897]

Fellow of Robinson College, Cambridge. I would like to thank Professor Len Sealy for his comments on an earlier draft of this article. Any errors are, of course, entirely my own.

1 [1897] A.C. 22. 2 There has been a great deal of discussion as to the correct word to use in order to describe the

process of bypassing the Salomon doctrine; see, for example. S. Ottolenghi, "From Peeping behind the Corporate Veil to Ignoring it Completely" (1990) 53 M.L.R. 338. Staughton L.J. in Atias Maritime Co. SA v. Avalon Maritime Ltd. (No J). [1991] 4 All E.R. 769, 779 said "(t]opierce the corporate veil is an expression that 1 would reserve for treating the rights or 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 purpose." [original emphasis] To be clear, in this article, the cases which involve the use of a company to evade legal obligations require the activities of the company (which continues to be recognised as a separate entity, see p. 289 below) to be ascribed to one or more of the shareholders of that company. Although the phrase "lifting the veil" will be used throughout, this process would be termed "piereing the veil" in Staughton L.J.'s assessment.

3 CoreBrowne on Companies, 44th ed., vol. 1, para. 1.3.1; and see Re Darby [1911] 1 K.B. 95. 4 lt has been referred to in other ways by different eommentators; for example, Professor

Schmitthoff referred to it as the "abuse ofthe corporate form exception" in (1976] J.B.L. 605. 5 [1993] B.C.L.C. 480.

284

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286 The Cambridge Law Journal [1997]

properly. There will be circumstancess in which it can and should be

applied, as the case of Creasey v. Breachwood Motors Ltd., as properly

understood,14 demonstrates.

Three aspects of the fraud exception will be discussed: (1) are

the motives of the fraudulent person relevant? (2) is the character of

the legal obligation being evaded relevant? and (3) is the timing of the

incorporation of the "device" company relevant?

1. Are the motives of the fraudulent person relevant?

It is clear that an element of deception is necessary. In Hilton v.

Plustile Ltd]5 the plaintiff and the defendant agreed to use the medium

ofa company in tenancy arrangements in order to evade the application ofthe Rent Act 1977. The Court of Appeal held that the plaintiff was

not entitled to lift the veil since he had full knowledge of the matter at

all times. This does not fully answer the matter, however, since it must

still be decided whether the motives of the person practising the

deception on the other party are relevant.

This question was discussed by the Court of Appeal in its thorough review of this area in Adams v. Cape Industries plc.16 In Adams v. Cape the issue for determination by the court was whether judgments obtained in the United States against Cape, an English registered

company whose business was mining asbestos in South Africa and

marketing it world wide, would be recognised and enforced by the

English courts. In the absence of submission to the foreign jurisdiction this depended upon whether Cape could be said to have been present in the United States through its American subsidiary. In considering whether the corporate form in Adams v. Cape had been used in such a

way as to justify the corporate veil being lifted, the court stated that

the correct test in reiation to groups of companies was whether the

company had been used as "a mere fagade concealing the true facts".17

Applying this test to the facts, Slade L.J. said that the "motives ofthe

perpetrator may be highly material".18

However, the difficult question is to decide what those motives

need to be. In Gilford v. Home and Jones v. Lipman the defendant

clearly intended to deceive the plaintiff by using the corporate form to

deny the plaintiff a legal right, but is that motive necessary for the

fraud exception to exist? There was no suggestion in Adams v. Cape that there had been any unlawful purpose or impropriety on the part of Cape in the sense of an intention to deny the plaintiff a legal right

14 See p. 288 below. 15 [1989] 1 W.L.R. 149. 16 [1990] Ch. 433. 17 Ibid., at p. 539. This follows the judgment of Lord Keith of Kinkel in Woolfson v. Strathclyde

Regional Council 1978 SLT 159, 161. 18 Ibid.% atp. 542.

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C.L.J. Lifting the Corporate Veil 287

which it already possessed. Cape's intention was merely to conceal, as

far as lawfully possible, the connections between Cape and its

subsidiaries.,9The Court of Appeal held that one of Cape's subsidiaries, a Liechtenstein company, was a fagade since it was "little more than a

company name" which was "merely a creature of Cape"20 although, since this subsidiary could not be said to be carrying on business in

the United States, this finding did not help Adams. Is it enough for

the defendant to intend to set up a company and intend thereby to

create a smoke screen between himself and the plaintiff, as Cape did, but without intending to deny the plaintiff any legal rights? This is

really a question of the quality of the legal right which the defendant

is seeking to evade. The Court of Appeal in Adams v. Cape were right that motive is relevant, but without more that statement is singularly

unhelpful.

2. Is the character ofthe legal obligation being evaded relevant?

In the introduction it was stated to be a well established principle that

the courts will not allow limited companies to be used as a device "to

evade a contractual or other legal obligation".21 Does the nature of

this obligation affect the ability of the courts to lift the veil? Again a

clear distinction can be drawn between Adams v. Cape and the two

classic fraud cases. In the latter cases the legal obligation which the

defendants sought to avoid existed before the evasion, that is, before

the use of the limited company to place a legal barrier between the

plaintiffs and the defendants was effected. In Adams v. Cape there was

some discussion about the need to allow the veil to be lifted in order

to prevent Cape avoiding publicity as to its involvement in the sale of

asbestos in America and to prevent Cape having the practical benefit

of the group's asbestos trade in the States without the attendant

risks of tortious liability. However this tortious liability was purely

speculative. If some litigation had actually existed which Cape had

been attempting to evade in this manner, the reasoning of the court

would have to have been quite different. As it was, however, the Court

of Appeal did not accept

as a matter of law that the court is entitled to lift the corporate veil as against a defendant company which is the member of a

corporate group merely because the corporate structure has been used so as to ensure that the legal liability (if any) in respect of particular future activities of the group . . . will fall on another member of the group rather than the defendant company.22

' Ibid, alpp. 540-541. 1 Ibid, at p. 543. See n. 3 above. [1990] Ch. 433, 544.

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288 The Cambridge Law Journal [1997]

This may seem harsh and in America the concept of inequitable

incorporation23 has been used to curb the worst ofthe problems caused

by such a principle. Despite the urgings of some eommentators to

introduce this doctrine into England24 the Court of Appeal is clear

that "[w]hether or not this is desirable, the right to use a corporate structure in this manner is inherent in our corporate law".25

For the fraud exception to succeed the defendant must intend to

deny the plaintiff a pre-existing legal right. If no pre-existing legal

right is present, any intention on the part of the defendant to deceive

the plaintiff must be of a speculative and accordingly less substantial

nature. It is the mental element of the fraud exception which is vital

to the question of timing. If the legal right crystallises before the

corporate form is used to evade the right then all well and good because the defendant intends to use the company to deny the plaintiff that legal right, and the mental element is satisfied. If the legal right

crystallises after the corporate form has been created, does that

automatically mean that the mental element can never be satisfied?

This depends on whether the courts regard the relevant date as being the creation of the corporate vehicle or the use of that vehicle to evade

the legal right. In the latter instance, if the legal right crystallises after

incorporation but before the use of the corporate form to evade the

legal right, the fraud exception would be satisfied.

3. Is the timing ofthe incorporation ofthe device company relevant?

In Creasey v. Breachwood Motors Ltd.26 the reason for the failure of

the fraud exception argument turned on the timing ofthe incorporation of the sham company. Creasey v. Breachwood certainly looked like a

good candidate for the application ofthe fraud exception. Mr. Creasey

brought an action for wrongful dismissal against his ex-employers, Breachwood Welwyn Ltd. ("BW"). BW served a defence but four

months later informed Mr. Creasey that it was insolvent. Breachwood

Motors Ltd. ("BM") then took over the business, assuming all the

liabilities of BW's business except for Mr. Creasey's outstanding claim.

The same two people were the shareholders and directors of BW and

BM and transferred the business of BW to BM in this way in order to leave Mr. Creasey without any recourse to the assets of BW. Mr.

Creasey obtained an order for damages and interest against BW but

before he had received anything, BW was struck off the register and

dissolved, without going into liquidation. Mr. Creasey sought an order

substituting BM for BW and eventually succeeded on the ground of

23 See Whincup, "Inequitable Incorporation" (1981) 2 Company Lawyer 158. 24 E.g. Whincup, op. cit. 25 [19901 Ch. 433, 544 (Slade LJ.). 26 [1993] B.C.L.C. 480.

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C.L.J. Lifting the Corporate Veil 289

justice,27 but the judge was clear that the fraud exception was not

applicable. It was clear that the defendants had intended to deceive the plaintiff

by using the transfer of business from BW to BM to create a legal barrier between Mr. Creasey and his ex-employers. It was also clear

that the liability which they sought to evade was pre-existing, albeit

that it was contingent on Mr. Creasey obtaining judgment establishing such liability. This was not an Adams v. Cape type speculative liability. However, Richard Southwell Q.C, sitting as a Deputy Judge,

distinguished Gilford v. Horne2* and Jones v. Lipman29 on the basis that in those cases the sham companies had been formed with a view

to carrying out the fraud. In Creasey the device company, BM, was

already in existence and carrying on its own business.

Counsel for Mr. Creasey submitted that what was important was

the recognition that the separate legal personality ofa company should not be allowed to be used as a vehicle for fraud, at whatever date that

company is incorporated. Surely this is the correct view? Of course in

both Jones v. Lipman and Gilford v. Horne the sham companies were

incorporated for the purpose of the fraud, but this fact was not made a pre-condition of the lifting of the veil. In fact the statements in

Gilford v. Horne are much wider than that, with no reference made to the timing of incorporation. Reference is made in Jones v. Lipman to

the fact that the sham company was acquired with the sole purpose of

evading Mr. Lipman's obligations to the plaintiffs, but the emphasis is on Mr. Lipman's intention, rather than on his acquisition of the sham company. The ratio in both cases is that the separate legal personality of a company will not be upheld if the company has been used as a device to allow another (whether a company or an individual) to evade its existing legal obligations. To try to stretch the cases to say more than that is to distort them.

It should be irrelevant that the device company is an existing, solid

company with its own business, as long as it has been used as a tool to effect the fraud. It is clear that the court in Gilford v. Horne and Jones v. Lipman did not regard the device company as being so flimsy that it could be totally ignored, otherwise why grant an injunction against it in Gilford v. Horne or an order for specific performance

against it in Jones v. Lipmanl In both cases the court regarded the device company as being a living, breathing entity, so why should it make a difference that the device company was a living, breathing

The judge in this case was undoubtedly heavily influenced in allowing the substitution of Breachwood Motors by the fact that Mr. Creasey was funded by the Legal Aid Board. He doubted very much whether, in view of the sums in issue, justice could be done for Mr. Creasey if Mr. Creasey were to be required to start fresh proceedings against Breachwood Motors. [1933] Ch. 935. [1962J 1 W.L.R. 832.

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290 The Cambridge Law Journal [1997]

entity before the evasion took place, or even before the legal obligations existed?

Conclusion

In order for the fraud exception to the Salomon principle, as enunciated in Gilford v. Home and Jones v. Lipman, to be successfully invoked, the defendant must have the intention to use the corporate structure

in such a way as to deny the plaintiff some pre-existing legal right. As

long as these elements of the fraud exception are present, the sham

company should not need to be incorporated for the purpose of the

fraud. A fraud is no less of a fraud because a pre-existing company is

used and an intention is no more of an intention because a wholly new

company did not need to be set up for the purpose. The existence of

the legal right needs to pre-date the use of the corporate vehicle, not

the incorporation of that vehicle. Creasey v. Breachwood should have

been decided on this basis rather than the much less satisfactory, and

indeed probably non-existent, ground of justice.

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