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Subsequently, Hung Tak transferred its business to a second company Hua Xin which was controlled by the same person or group of persons as Hung Tak. The Hong Kong Court of First Instance held that this was a classic case where the corporate veil should be pierced on the basis of the principle that the corporate structure cannot be used to evade legal obligations. The second and third defendants were the only shareholders and directors of Linkwaters and of the first defendant Kelly McKenzie Ltd at the relevant times.
Kelly McKenzie Ltd was incorporated shortly after the plaintiff had given notice of resignation and before Linkwaters summarily dismissed the plaintiff before expiry of the notice period. Kelly McKenzie Ltd took over the business of Linkwaters, with Linkwaters allowed to be wound up without sufficient funds to pay the judgment debt.
The court held all three defendants to be jointly and severally liable for the debt. Cape Industries plc Cape was an English company involved in the asbestos industry. The company presided over a group of subsidiary companies engaged in asbestos mining in South Africa. NAAC assisted in the marketing of asbestos in the United States, acted as liaison between the US purchasers and the sellers other companies in the Cape group and also purchased asbestos on its own account and sold the asbestos in the US market.
In , some plaintiffs brought actions in Texas for personal injuries allegedly suffered as a result of exposure to asbestos dust against Cape, NAAC and other companies in the Cape group. Those actions were settled in The court accepted that these arrangements were made to enable Cape asbestos to continue to be sold in the United States while reducing, if not eliminating, the appearance of any involvement therein of Cape or its subsidiaries.
Cape allowed default judgments to be entered against it in the United States where Cape did not have any assets while resisting their enforcement in England. The Court of Appeal held in the negative. Three main arguments were made for the presence of the English companies in the United States: The focus of the discussion below is on the third argument. Whether or not this is desirable, the right to use a corporate structure in this manner is inherent in our corporate law. This may be so. Using a corporate structure to evade legal obligations is objectionable. But using a corporate structure to avoid the incurring of any legal obligation in the first place is not objectionable.
The leading decisions and the cases outlined above on the evasion principle deal with evasion of contractual obligations or liabilities. However, the evasion principle is not stated in terms which confine it to the contractual context. Accordingly, it should be clear that it is possible for the evasion principle to be applied to tort obligations or liabilities. A company Red Rose Restaurant operated a restaurant at the premises during the day, while the plaintiffs operated a nightclub business at the premises from 8 p.
Subsequently, the directors of Red Rose Restaurant prevented the plaintiffs from entering the premises and from operating their pre-existing nightclub business at the premises. This was held to have been a breach of the injunction and the directors were held to be in contempt of court. However, the court rejected this defence on the basis of piercing of the corporate veil. The court emphasized that the directors were not entitled to mask themselves by making use of Hotel Berjaya to say that Red Rose Restaurant was dispossessed of the premises and that they and Red Rose Restaurant were helpless and had nothing to do with locking of the premises.
The Red Rose Restaurant case, discussed above, dealt with an obligation in the tort context which was imposed by the court through the court order. But the prevailing assumption seems to be that the corporate veil could not be pierced merely where a company is formed for the purpose of evading tortious liabilities that arise in the future, on the basis that this is merely avoidance of future liabilities, which is permissible. It is submitted that this view is incorrect.
Before analysis of the principles, an initial comment needs to be made on the precedent value of Adams v Cape Industries. Muchlinski further argues that the jurisdiction issue is different to the issue of:. Accordingly, the approach in Adams v Cape Industries may not be the last word on the matter regarding substantive liability. The doctrine that the parent corporation is not deemed to be doing business through its subsidiaries, in the eye of the law, may be regarded as a somewhat arbitrary power exercised by the various states over foreign corporations.
The distinction between evading existing liabilities and avoiding future liabilities is no doubt correct in the context of future contractual liabilities. The objectives of the separate entity and limited liability doctrines would be significantly eroded if an intention of using a company to incur future contractual liabilities without the proprietors or agents themselves being personally liable under the contracts would be sufficient for piercing of the corporate veil. However, the position is arguably different in the tort context.
It is submitted that even within the bounds of the existing common law principles on piercing of the corporate veil, there is a possibility of taking into account certain differences between contractual and tort creditors. Application of the distinction between existing and future legal obligations requires a determination of what is an existing or future legal obligation. In the context of contractual obligations, it seems that the obligation comes into existence when the contract is entered into.
It should be clear that it is unnecessary for there to be a liability that is finally determined to exist under a court judgment or a liability that is admitted or agreed to in a settlement. In Gilford Motor Co v Horne 54 itself, at the time when the proceedings were brought seeking the injunction, there was no pre-existing judgment against, or agreed liability of, the employee. The employee was simply subject to the contractual restraint of trade clause.
The case of Jones v Lipman 55 also dealt with a legal obligation that had not yet crystallized into an order of the court. At the time of commencement of the proceedings against the vendor and the company, the only obligation that the vendor was under was the contractual one under the original contract with the plaintiff purchaser which had not yet been converted into any obligation under a court order. The analysis in the case of tort obligations is less straightforward compared with the contractual analysis. Contractual obligations are agreed to by the parties. As a factual matter, it is not always easy to ascertain the time of agreement of the parties.
However, from the legal perspective, there is a time from which there is effective agreement and from which the contract is taken to be in force. By contrast, obligations in tort are imposed under the law. Where a judgment in favour of the tort victim is in existence, there is clearly an existing legal liability of the defendant to pay the tort victim. However, as noted above, the need for there to be an existing court order or agreed liability before there is an existing legal obligation cannot be correct.
Even on the facts of Adams v Cape Industries , it should have been possible for the court to find that there was an evasion of existing liabilities of NAAC when Cape closed down the company and transferred its business to the other entities with the clear intention of minimizing the liabilities to the potential claimants. It can properly be said that the transfer of the business of NAAC was engaged in to evade the existing legal obligations or liabilities of NAAC and the parent companies.
The obligations or liabilities did not involve future activities but arose from activities which had already been carried out. The US court did not, however, pierce the corporate veil in that case because the element of domination by the parent over the subsidiary was not established in the case. However, the only reason why evasion of tort liability was not sufficient under the US case law principles was because of the need to establish domination by the parent as well. On the above analysis, it is incorrect to say that a tort obligation can only be an existing one if there is a court order or binding agreement for liability.
Even in the case of contractual obligations, there can be an obligation in existence even before a cause of action in contract arises. The cause of action in contract is only complete when there is a breach of contract. However, in both the Gilford Motor and Jones v Lipman cases, there was no breach of contract that existed prior to the use of the companies to evade the existing legal obligations. Clearly, reflecting on causation and logic, legal obligations may arise when, for example, knowledge of the harm is communicated to employer companies about asbestos induced diseases amongst its employees.
In short, this may include knowledge of a foreseeable legal obligation. This is a particularly useful example given the fiduciary obligations that arise in employer and employee relationships. The moment a company learns that its practice resulted in harm to employees, and that it may be liable for damages in prospective litigation, legal obligations should arise to act in good faith and not use the corporate structure capriciously or for an extraneous purpose unrelated to legitimate commercial interests, including winding up the company once it is sued or transferring assets from that company.
The above argument can be taken further. In the case of a duty of care in negligence, logically, it can be said that there is an existing legal duty on a person even before the person is aware that his or her conduct can be harmful to others. As soon as the person is engaging in the activities where a duty of care would be imposed, it should be accepted that there is an existing legal obligation even before any victim has suffered injury and even before the firstmentioned person is aware of the risk of the activities.
For example, if a company was engaging in production of toxic materials, then there is an existing legal obligation on the part of the company arising in tort to take reasonable care to prevent injuries to its employees. If the company, at that time, establishes a new company to engage in the activities with a view to minimizing any potential liabilities it may have by continuing with the activities, there is arguably an evasion of existing legal obligations giving rise to the possibility of piercing of the corporate veil.
Although the legal obligation had not yet resulted in an identified liability at the time of the establishment of the new company, the position is, so far as is material, no different to the position where there is an existing contractual obligation which had not yet resulted in liability because no breach had yet occurred at the time of the creation of the new company. From both the factual and legal perspective, the company was already subject to the existing legal duty of care in tort at the time when it establishes a new entity to take over the activities.
It might be countered, however, that there can be a difference between, on the one hand, existing employees of the first company or other identifiable persons to whom the duty of care is already owed , and on the other hand, future employees of the second company or other persons who are only affected by the activities of the second company and who cannot be ascertained at the time of establishment of the new company.
It might be argued that, whatever the position with respect to pre-existing employees, there could not have been any duty of care owed to future employees at the time when the second company took over. The position with respect to the latter is similar to the situation where a company has never itself engaged in the activities but from the outset sets up another company to engage in those activities. At first sight, the above scenarios involving unascertained persons who might only be injured in the future seem like the paradigm situation where a company is simply formed to avoid incurring new legal obligations rather than to evade existing legal obligations.
However, it is submitted that even here there is scope for application of the evasion principle for piercing of the corporate veil. That statement suggests that if there is an intention to escape liability for a specific tort or class of torts, then there is scope for piercing of the corporate veil.
Accordingly, in situations where the particular nature of the activities gives rise to serious risks of harm if the activities are carried out without reasonable safety measures, courts ought to be prepared to pierce the corporate veil if a parent company or other person establishes a company for the purpose of evading the tort obligations.
The above situation does not have a close analogy with the contractual context, but here different considerations peculiar to the tort context should be taken into account. Contractual duties can only arise once there is a contract. However, tortious duties arise as imposed by the law. Conceptually, there is no difficulty in treating a tortious duty as arising at the time when a person initiates or procures the initiation of activities that can give rise to harm. The fact that the particular tort victims may not be specifically identifiable at the time when a person is required to exercise reasonable care for the safety of others in tort should not be a relevant factor in determining whether there is an existing duty in tort.
Accordingly, it is submitted that courts should be entitled to pierce the corporate veil under the evasion principle by treating the point as to when the tortious duties arise as the time when a parent company or other person first initiates the venture, whether to be conducted by the parent or by a subsidiary or other company created or acquired by the parent.
The above approach on veil piercing may be compared to an approach that recognizes that there are certain non-delegable duties in tort.
It appears that in the United States, there are some cases which have adopted an expanded doctrine of non-delegable duty to impose liabilities on parent companies Strasser, A similar approach has also been adopted in India. The Supreme Court of India has stated that:. An enterprise…engaged in a hazardous or inherently dangerous industry…owes an absolute and non-delegable duty to the community that no harm results to any one on account of the dangerous nature of the activity it has undertaken…If the enterprise is permitted to carry on the hazardous or inherently dangerous activity for its profit, the law must presume that such permission is conditional on the enterprise absorbing the cost of any accident.
In tort law, strict liability is applied in respect of activities that entail extraordinary risk to others, either in the seriousness or frequency of the harm threatened. However, the concepts under those tort principles can serve as a useful comparison with the veil piercing approach propounded above. It should be borne in mind that the approach advocated above does not mean that parent companies or other shareholders will be liable for all torts of any subsidiary or company which they establish.
The evasion principle involves an element of impropriety by the controllers of the company before the corporate veil can be pierced. Merely setting up a company to carry on business with the possibility of the company engaging in torts does not on its own involve impropriety or dishonesty in the above sense. For example, consider the situation where a person establishes a company to carry on a taxi business. But if there was no intention of using the corporate form to prevent tort victims from being able to recover compensation, then there is no dishonesty and hence no impropriety involved.
On the other hand, there is impropriety if there is an intention of a parent company or other controlling shareholder to minimize the opportunity of potential victims from being able to seek compensation for injuries arising from inherently hazardous activities which they initiate. There are two aspects to this statement of the principle which are critical. Firstly, there must be an intention to evade legal obligations.
The situation is not simply one where the persons forming the company wish to have the tort liabilities borne by the company instead of themselves. Rather, there is impropriety arising from the fact of an intention of minimizing the prospect of successful recovery by tort victims. It is submitted that such conduct involves dishonesty within the sense discussed by Lord Sumption. Such impropriety that is attendant with a deliberate evasion of tort obligations ought to be within the evasion principle since there is a deliberate frustration of the law of tort.
Intention could be established by direct evidence.
Also, it is submitted that the requisite intention can be inferred from the circumstances, including, for example, the degree of knowledge of the controller about the risks or dangers of the proposed activities of the company and the degree of capitalization of the company. Secondly, the intention to evade legal obligations must relate to hazardous or inherently dangerous activities. The element of dishonesty or impropriety would be more readily evident in cases where the intended activities of the company are of a nature which is especially dangerous to others or which by their nature is inherently likely to lead to injuries.
For example, such a situation arises where a company is set up to engage in activities involving toxic chemicals or products where it is known that health and safety policies and risk management would be paramount. Munby J in that case pointed out that the relevant wrongdoing the breaches of contract in Gilford and Jones v Lipman had nothing to do with the company. If Munby J is correct, then there would be doctrinal difficulties in seeking to incorporate the notion of setting up a company to evade existing tort duties or obligations within the existing common law principles on veil piercing.
This is because the company is also itself involved in the wrongdoing the tortious conduct. It is submitted though that there is no absolute requirement for the impropriety to be dehors the company. The decision in Antonio Gramsci was disapproved of by Lord Neuberger in VTB Capital plc v Nutritek International Corp 70 but that was only in relation to a rejection of the conclusion in Antonio Gramsci that the corporate veil could be pierced to treat the controller of a company as if it was a party to a contract that the company had entered into.
A further issue to consider is what remedies are available under veil piercing principles.
In Prest v Petrodel , a majority of the UK Supreme Court affirmed by way of obiter the existence of the doctrine of piercing of the corporate veil under the common law; however, Lord Sumption JSC who gave the main judgment on this issue held that there is only a limited basis for piercing under the common law. What Happens if the Veil is Pierced? Although G-P may have acted unscrupulously, no fraud was found, so they won the case. Contractual duties can only arise once there is a contract. Creditors In general, creditors have no recourse against corporate shareholders, as long as formalities are satisfied. Secondly, where an offender does acts in the name of a company which with the necessary mens rea constitute a criminal offence which leads to the offender's conviction, then "the veil of incorporation is not so much pierced as rudely torn away":
If the evasion principle for piercing of the corporate veil is taken to its logical conclusion, then it should mean that where a person sets up or uses a company to evade an existing legal obligation, that person can be liable notwithstanding that the company is the entity carrying out the acts that breaches the existing obligation. Yet, overemphasis of the corporate law doctrines of separate entity and limited liability has meant that wrongdoers can escape liability for their tortious activities carried out through corporate vehicles.
Not only is this inappropriate on moral grounds, but it is also inefficient on economic grounds.
In the absence of any statutory reforms to deal with this problem, the common law doctrine of piercing of the corporate veil provides an important mechanism for addressing the issue. It has been argued in this article that the scope of application of the veil piercing doctrine under the common law in the context of tort liabilities is wider than is generally recognized. Whatever the precise scope of the common law principles on piercing following Prest v Petrodel , it is at least generally accepted that the corporate veil can, in the absence of any other available remedy, be pierced to deprive the controller of the company the benefits of the separate legal personality of the company.
However, in applying this evasion principle, the courts have distinguished between the use of a company for the evasion of existing obligations or liabilities from avoidance of future obligations or liabilities, with the latter being permissible. The prevailing view appears to be that where a company is established or used to carry on activities in the future that may give rise to tortious liabilities, there is only an avoidance of future liabilities and hence the veil cannot be pierced in such a situation.
However, it is submitted that there should be scope for application of the veil piercing doctrine in such circumstances. Where the risk of harm is high or where the activity by its nature is intrinsically dangerous, the person should not be permitted to escape personal liability by use of the corporate vehicle to engage in the risky activities. This should be possible by treating the person as being subject to an existing legal duty in tort to take reasonable care to avoid injury to others. By using a corporate vehicle for the purpose of escaping that responsibility, there is an evasion of an existing legal obligation.
Such impropriety should be sufficient for piercing of the corporate veil. For example, Muchlinski Companies and Securities Advisory Committee See, for example, Ramsay and Noakes Lo and Qu See also French Sappideen and Vines See further Witting ; Witting Hong Kong courts have permitted this: However, it seems that the position in England is that this is not possible French et al.
Issues related to transfers of assets to defeat the claims of creditors are not peculiar to the corporate context and can arise in relation to debtors who are natural persons. To some extent, the remedies to deal with such problems can be seen to lie in bankruptcy or insolvency law generally: As such, discussion of successor liability and related principles is not pursued further in this article.
Skip to main content. The subsidiary can likely be accused of being the alter ego of the parent company. Amongst the factors identified by the court, the court found that the following were indicia of a showing that the subsidiary was merely an instrumentality of the parent corporation: We know from case law that courts will carefully scrutinize the relationship of a parent corporation and its subsidiary. Thus, for companies who set up a corporate scheme with a parent company and one or multiple subsidiaries, the officers should ensure that the business of the separate entities is kept separate — separate bank accounts, separate contracts, etc.
Failure to maintain separate identities of the company and its owners or shareholders. This factor is somewhat similar to number two listed above but instead of the intertwinement being with other companies, this is an intertwinement with the owners or shareholders of the company. Again, the business tip is to ensure distinctness in the company and the owners.
Owners, shareholders, and officers should avoid commingling funds and must treat assets of the business separate from personal assets. The issue of adequately capitalizing a company is never enough, in and of itself, to pierce the corporate veil by itself. Practically speaking, business owners are not punished by the court system for not making enough money or running a business haphazardly.
However, a commonality amongst cases is the undercapitalization of the business. The measure of assets is directly correlated to the business purpose so businesses are not all held to the same standard. Owners cannot just open a business and use their personal account, with hopes of turning a profit and putting money back into the business. This behavior is too risky and jeopardizes your corporate liability shields. The final red flag that could lead to piercing the corporate veil is the failure to follow corporate formalities. Again, business owners are not necessarily punished because they fail to observe every corporate formality.
In cases where formalities are not properly followed, courts have held that the legal liability protection of the shareholders was effectively waived and the personal assets of the owners could be reached by the claimant. This is most often seen in smaller, family owned businesses, which tend to be less meticulous in maintaining the corporate records. Oftentimes, this is not a purposeful neglect of the formalities but merely a lack of resources and staff necessary to meet filing and compliance requirements. Nevertheless, the takeaways from this factor are as follows: Taking the proper steps to insulate personal liability could make the difference between the effective creation of a corporate structure versus the daunting effects of personal liability.
From the creation of the business to everyday business decisions, owners, officers, and shareholders should be mindful of the separate corporate structure and acting in a manner that maintains that distinctiveness. If you wish for further counseling on how to avoid these potential pitfalls in corporate operations or are a creditor looking to pursue a debtor in an individual capacity, our firm is well versed in all areas of pertaining to piercing the corporate veil. If you would like to learn how Lexology can drive your content marketing strategy forward, please email enquiries lexology. I like the fact that the email contains a short indication of the subject matter of the articles, which allows me to skim the newsfeed very quickly and decide which articles to read in more detail.
We use cookies to customise content for your subscription and for analytics. If you continue to browse Lexology, we will assume that you are happy to receive all our cookies. For further information please read our Cookie Policy. Follow Please login to follow content. My saved default Read later Folders shared with you. Register now for your free, tailored, daily legal newsfeed service. USA March 2 A few worth noting are set forth as follows: Failure to adequately capitalize the company.