Companies and separate legal personality: Found when needed

I am having early thoughts about research in to this topic. The more I read on the separate legal personality of companies the more I seem to find instances of it being ignored or found depending on whether it suits the court or not.

Take the instance of Chandler v Cape plc [2012] EWCA Civ 525, for which I summarise as I have blogged about in more detail here. The individual was attempting to claim against his company's parent company for harm suffered from asbestos poisoning claiming the parent company owed a duty of care to its subsidiary employees. Here the court actively recognised both company's separate legal personality to find that the parent company was capable of owing a duty of care based on the criteria for owing such a duty. It was not ignoring the separate legal personality of the subsidiary though.

Now take the number of instances involving corporate directors i.e. a company as a separate legal entity serving as a director. On numerous occasions the court has found that individuals who control corporate directors cannot be shadow directors "without more". See Revenue and Customs Commissioners v Holland [2009] EWCA Civ 625 for an overview and example of this. Thus, they leave the door open to certain circumstances where an individual controlling a corporate director may be a shadow director. Generally speaking the court finds they are not. They often find that merely attending the meetings and voting will not open up the individual to personal liability where those decisions can be attributed to the corporate director, and it is not "without more" enough to constitute them as a shadow director, nor a de facto director.

However, in most these cases there has been individuals controlling a sole corporate director. It is difficult to perceive how an individual who makes all the decisions of the corporate director can do more so as to be classed a shadow director.

Ultimately the court is saying that an individual and the corporate director are separate and that all the decisions whilst made by the individual, are attributed to the corporate director as a separate legal entity. The difficulty is that it seems inconsistent with Chandler. The court is ignoring in this instances the ability of an individual to tell the corporate director as a separate legal personality what to do; whereas they acknowledged in Chandler the ability of the parent company to owe a duty of care. The courts would undoubtedly find such a circumstance to be a shadow directorship if the corporate director was a natural person instead. It seems absurd that the only reason they are not a shadow director is because they did not have communicate to anyone what they wanted the corporate director to do.

Ultimately section 155 of the Companies Act 2006 may remedy this anomaly, which I have blogged about here. Since this requires every company to have one natural person, where an outside individual controls a corporate director to avoid liability, they will undoubtedly have to control the individual in question as well and thus it is much more likely to be classed as a shadow directorship.

More cases will need to be examined to fully address these concerns.

On another note, blog post may be slightly less frequent over the next few months as I am in the writing up phase of my PhD.

Do companies actually require a natural director or is Section 155 not worth the paper it is written on?

Under the Companies Act 2006 section 155 all companies are required to have at least one natural director. This is different from the common law position which allowed companies to have a sole corporate director (i.e. a company itself being a director) as established in the case of Bulawayo [1907] 2 Ch 458.

For any rule there has to be deterrent or incentive to follow it. Section 156 gives the Secretary of State power to give direction to any company where it does not satisfy this requirement. Section 156(6) makes it an offence for failure to comply with that director and is committed by every officer in default including shadow directors.

But what if the company is simply a sole corporate director that has no officers and no other directors? How can anyone commit the offence?

Naturally one may assume, well it should be the one who controls the corporate director and thus makes them a shadow director.

Unfortunately that natural assumption is incorrect according to the courts of first instance and Court of Appeal. On a number of occasions courts have categorically denied that an individual who controls a corporate director is a shadow director "without more". What the courts have meant by without more is that it means that the individual must not simply be performing the functions of a de jure director (i.e. someone formally appointed) at another company, or simply discharging the functions of the corporate director in that capacity. For case examples of this denial see Re Hydrodam [1994] BCC 161 or Secretary of State for Trade and Industry v Hall and Nuttall [2006] EWHC 1995 (Ch)

Thus the courts have not denied that on the facts it is possible for someone to be classed as a shadow director. However, it seems fanciful that it will ever be the case on the facts when in the recent case of Holland [2009] EWCA Civ 625 at first appeal, better known for the Supreme Court ruling [2010] UKSC 51, the court found the individual was not a de facto director despite being the guiding mind behind the company and the only one involved in the process. It is most likely that the court also affirmed Holland would not have been a shadow director either if the liability in question extended to shadow directors. The obiter comments from the Court of Appeal seem to suggest as much.

Thus, whilst the common law reached the position that an individual who controls the corporate director is prima facie not a shadow director, it is possible that Parliament have altered that position through section 156(6) otherwise the deterrent of ensuring one natural director will have no substance.

However such a stance does not pierce the corporate veil, i.e. treating the individual and the corporate director as one. It recognises that section 251 of the Companies Act 2006 is designed to catch those trying to usurp the position of director without formal appoint. Section 251 defines a shadow director as someone who the de jure directors have become accustomed to act on their direction and instruction. Thus the courts would be recognising that the corporate director as a separate legal entity has become accustomed to act on the individual's instruction and direction.

Despite this the courts may still be reluctant to find as much since they were unwilling to extend the concept of de facto directorship in the Supreme Court case of Holland on the basis, inter alia, that to do so would be to say all individuals who control corporate directors are de facto directors. Thus the same would apply here that to rule as such would be to say all individuals who control corporate directors are shadow directors regardless of whether they have instructed or directed them. However, this may be defeated on the basis that shadow directorship is case sensitive and it is not to say it does extend it for every case. This would effectively reverse the ratio from Hydrodam that without more someone is not a shadow director. This is because it would create the assumption that someone controlling a corporate director is a shadow director unless shown they did not instruct or direct them, rather than the other way round that someone is not a shadow director without more i.e. they did instruct or direct the corporate director.

The distinction is very artificial that has been created by the common law and section 155 attempts to remedy that through the requirement of having one natural director responsible for every company. However, if that requirement is to have substance it must be acknowledged that someone who controls a corporate director is in some capacity connected to that company, and is suggest that connection is through shadow directorship, otherwise the common law principles will prevent that enforcement.

Corporate Law History: Where do we come from? Why are we here?

Ok I am not Prof. Cox but is it worth understanding the past of corporate law anymore? How much value does it add to current debates in this field such as corporate social responsibility, financial regulation, European company regulation and probably a few others.

This blog post is the first of a brief overview of some of the key events in the corporate law timeline.

Year 1720 - This was the year of the introduction of the "Bubble Act". The Act received Royal Assent on the 11th June 1720.

Scholars have debated its purpose. Two primary theses are: 1) was to enhance the importance of charters and to enhance Parliament's ability to raise revenue through the issue of charters. It was argued by one scholar, Henry Butler, that "the Bubble Act was a government created entry barrier designed to put out of business all business associations which were competing with Parliament's charter business"; 2) A now more established thesis is that it was the South Sea Company who initiated the Act to protect its own bubble from a wave of small bubbles that competed with the company's conversion scheme. (R Harris, 'The Bubble Act' (1994) 54(3) Journal of Economic History 610) This would, according to Harris, hinder investment opportunities and divert more capital to South Sea shares. By the 24th June share price at South Sea had peaked at £1050 but by the end of the year the bubble had burst and shares had dropped to below £200 at the end of the year. The crash constituted the first international stock market bust. It severely threatened English public finance.

The passage of the Bill demonstrates the problems a severe lack of independence can have when formulating legislation and decision making. Those responsible for debating the Bill in Parliaments were mostly connected to the company either as directors, friends or subscribers to shares. Also at the time of Royal Assent there was significant optimism over the success of the debt conversion scheme that would lower the national debt notably through payments by the company to the Treasury, meaning the Act was probably not a response to any impending crash.

The Act itself prohibited incorporation of new joint stock companies. Incorporation could only be achieved by charters granted by the Crown or private Acts of Parliament. However, as observed by Watson this did not stop the creation of unincorporated forms of business organisations ((2011) Journal of Business Law 597). Harris also notes that acting as a corporate body without incorporation was deemed illegal prior to the Act under common law under an ancient common law writ of scire facias. If anything, the Bubble Act only added new procedure and punishment to what had already been sanctioned.

As such Harris views the Bubble Act as less intrusive on the development of corporate law as others have made out. Harris notes the Act did little to prevent the South Sea bubble crash and it was not designed to regulate the market or practice of investors.

It was not until 1825 though that the Bubble Act was repealed. Despite the crash of the market Harris highlights that the events served to strengthen the market developing an integrated and efficient international financial market. So despite the crash the economy recovered and developed. It appears the South Sea Company was not too big to fail.

Watson argued that the Bubble Act in fact helped develop company law by forcing individuals to find new ways of creating organisations to run a business. However, the Bubble Act, as Harris showed, did nothing more than add additional punishment to something that was already sanctioned under the common law. The effect of the Bubble Act may not be as important though to the next phase of development since either way judges began to recognise and develop a body of law around these new forms of unincorporated business organisations.

In the next piece on corporate law history I plan to look briefly in to the Joint Stock Companies Acts and Limited Liability.

Much ado about nothing? Is Chandler v Cape significant?

A recent Court of Appeal in Chandler v Cape plc [2012] EWCA Civ 525 decision has found that a parent company owed a duty of care to its subsidiary employees.

This is the first time an employee has successfully established liability to him from the parent company. Some people are claiming this is an attack on the separate legal personality principles, fundamental to company law. The case of Adams v Cape [1990] Ch 433 affirmed that a group of companies was not one legal entity. Each individual company in a group has its own legal personality. Whilst at first glance one may think this is open to abuse by having a rogue trader set up a number of companies to avoid liability this very rarely happens in practice. On the contrary allowing a group company to have different legal personality is beneficial for reasons such as diversification in business or due to geographical locations. Arcadia may be a good example of this. Furthermore, there are market forces that, at some level, prevent the abuse by parent companies of their subsidiaries, especially if they have similar creditors or suppliers.

Returning to the Chandler case the court found a duty of care was owed by the parent company to the employee of the subsidiary. The court of first instance had applied the test for how a duty of care is established, which is highlighted from the case of Caparo Industries v Dickman [1990] 2 AC 605 that a duty of care is owed if there is:
1) Reasonable to foresee harm
2) Proximity
3) Whether it is fair, just and reasonable for a duty of care to be owed

So, it may not come as quite a surprise that a duty of care was owed by the parent company to the employees of the subsidiary when one looks at this test. If the facts of the case demonstrate this three criteria then stringent rules of separate legal personality should not prevent a duty of care being owed. That would effectively, and excuse my limited knowledge of tort, go against basic principles that developed from Donoghue v Stevenson [1932] UKHL 100. To the effect it would basically imply if the parent company could not be liable then a manufacutrer of goods could not be liable to an eventual purchaser due to an intervening supplier of the goods after production.

And one must argue that the facts of the case do support a duty of care being owed. Here the parent company had superior knowledge of the health and safety of the particular industry; the parent company knew, or ought to have known that the subsidiaries system of work was unsafe; The parent knew or ought to have foreseen that the subsidiary or its employees would rely on its using the superior knowledge for the employees' protection and it was not necessary to show the parent company often interfered with the health and safety practices of the subsidiary. The court will look at the relationship between the companies more widely.

So is this piercing the corporate veil and ignoring the principle of separate legal personality for different companies in a group. The court was emphatic in rejecting such a notion. They note the question was simply whether the parent company owed a duty of care. An article written by Eccles suggest that this does pierce the corporate veil. But his arguments as to why seem to be merely restating the facts and recognised law in relation to duty of care, rather than stating why the veil has been pierced here.

He notes this pierces the corporate veil...'but only on the basis of an existing concept of assumption of responsibility - Caparo Industries v Dickman'. As you can see he merely restates that a duty of care was owed under the existing principles. A person who takes certain responsibility will owe a duty of care if the facts satisfy the criteria above.

I would agree with Eccles though that in practice companies with subsidiaries may want to review any existing insurance policies if this has been overlooked.

For the corporate veil to be pierced one needs to ask if the two separate companies are being treated as one for the purposes of liability. The answer here is no. The parent took on a duty of care through its (in)actions. Thus, the court recognised the parent company's separate legal personality and was not piercing the corporate veil to say the parent and the subsidiary were one. Perhaps further work in light of quite a few new cases, see here here and here, on this topic needs to seek a more accurate definition or categories of when the corporate veil will be pierced.