Piercing or Lifting the Corporate Veil

• Author: Christopher C. Nicholls
• Pages: 185-214

185

CHAPTER SEVEN

Piercing or Lifting the

Corporate Veil

FRAMING THE ISSUE

The House of Lords’ decision in Salomon1 appeared to leave no doubt that the incorpor-

ated company was indeed—just as the English Companies Act had declared it to be2—a

body corporate or corporation and, accordingly, a separate, distinct legal person. It is not

inconceivable, perhaps, that later courts or legislators might have determined, in the

interests of certainty or perhaps simply logical consistency, that no deviation from this

principle ought ever to be permitted, no matter how harsh or unjust might be the result.

Suppose, for example, that a highly paid employee, as a condition of obtaining his

well-remunerated position, were to agree to have special restrictions included in his

employment contract. Specifically, in this contract, he expressly covenants never to

compete with his employer. But this employee is cunning. Hoping to avoid the operation

of this non-competition clause, he incorporates a business corporation—a corporation of

which he is the sole shareholder, director, and officer. This new corporation, a separate

legal entity after all, that has not signed any such inconvenient non-compete covenant,

then enters into aggressive competition with the original employer.

We might perhaps imagine a world in which the courts felt obliged to apply the doctrine

of Salomon inflexibly, and so hold that the disloyal but shrewd employee’s covenant had

not technically been breached. In such a world, the corporation—although under the

complete control of the restricted employee—would be permitted to compete unabash-

edly with its sole shareholder’s employer. This seems a rather hard result: a triumph of

legal form over economic substance. But perhaps such strong medicine is just what

business people need. Just as Salomon’s case reminded creditors to be on their guard

when dealing with corporate borrowers, so our (hypothetical) non-competition clause

judgment could stand as a powerful warning to employers and solicitors. In future, they

must take care to ensure that such covenants are drafted explicitly to catch corporate

subterfuge of this sort.

1[1897] AC 22 (HL). See the discussion of this case, and some of its implications, in chapter 3.

2The Companies Act, 1862, 25 & 26 Vict., c. 89, s. 18.

Copyright © 2005 Emond Montgomery Publications. All Rights Reserved.

186 Chapter 7 Piercing or Lifting the Corporate Veil

Or, again, suppose that a holder of a certain unique piece of real estate, having entered

into a binding agreement to sell the property to a buyer, experiences a sudden change of

heart. He resolves to keep the property, and so dishonour the sale contract. He knows he

will be found liable for breach of contract. He has steeled himself to the possibility that

he will have to pay damages. But he wants to be sure that the property itself remains in

his hands. To avoid any possible court order of specific enforcement of the contract, he

quietly conveys the property to a corporation of which he is the sole shareholder, officer,

and director. This conveyance is completed just days before the originally agreed sale

transaction had been scheduled to close. If the corporation is to be treated as a truly

separate legal person, a claim for specific performance of the original sale contract might

appear—according to Salomon—to be quite impossible. The corporation itself—that is,

the current owner of the disputed property—was never, after all, a party to the original

sale contract sought to be enforced.

As the reader has no doubt suspected, the facts described in these examples are based

(albeit rather loosely) on disputes that have come before the courts. However, in both of

these cases, the real-world courts, in fact, were not prepared to let a rigid application of

Salomon stand in the way of a just result. They chose, instead, to disregard or, at the least,

to look behind the corporate form.

Nor are these isolated examples. Numerous courts have also been prepared to disre-

gard the apparent rigidity of the separate legal entity doctrine, notwithstanding the fact

that Salomon’s case is said to continue to be good law and, indeed, is said to form the

very cornerstone of Anglo-Canadian corporate law.

Thus, we see that although courts might have chosen, everywhere and always, to

adhere to a strict formalistic interpretation of Salomon or, alternatively, might have

chosen, more radically, to overrule Salomon altogether, they have, in practice, followed

neither of these extreme paths. Instead, various judicial “exceptions” to the Salomon

doctrine have been admitted. But the essential soundness of the doctrine itself has been

consistently reaffirmed.

On those occasions (still rare) where courts have elected to relax the strictness of

Salomon, they have come to refer to their decisions as instances in which they have

decided to “pierce” or “lift” the veil of corporate personality. As Lord Denning put it in a

famous (and oft critiqued) statement in Littlewoods Mail Order Stores v. IRC:3

The doctrine laid down in Salomon v. Salomon & Co. … has to be watched very carefully. It has

often been supposed to cast a veil over the personality of a limited company through which the

courts cannot see. But that is not true. The courts can and often do draw aside the veil. They

can, and often do, pull off the mask. They look to see what really lies behind. The legislature

has shown the way with group accounts[4] and the rest. And the courts should follow suit.

3[1969] 1 WLR 1241, at 1254 (CA).

4Lord Denning’s reference is presumably to the use of consolidated financial statements. Accounting

rules require a corporation that has subsidiaries to consolidate the financial results of these subsidiaries

when preparing its financial statements. In other words, a parent company’s balance sheet, for example,

would include all of the assets and all of the liabilities (other than intercorporate liabilities) of its

subsidiary companies. Thus, for accounting purposes, all of the separate companies in a corporate group

are treated very much as though they are, collectively, a single corporation.

Copyright © 2005 Emond Montgomery Publications. All Rights Reserved.