UNIT 4 (WEEKS 4 & 5): CORPORATE PERSONHOOD – SOME SPECIFIC ISSUES AND PROBLEMS

Figure 4: “Occupy Wall Street” protest

ALT: A sign is held up during the “Occupy Wall Street” protests in New York City which began September 17, 2011. The handwritten sign says: “IF CORPORATIONS ARE PEOPLE, THEN WHY CAN’T WE PUT THEM IN JAIL?”

Source of image - <a href="http://mulevariations.com/columns/trust-me-im-doctor/occupy-mule">http://mulevariations.com/columns/trust-me-im-doctor/occupy-mule</a>

UNIT OVERVIEW:

This unit will be devoted to exploring some of the limitations and conundrums, both legal and practical, which arise out of the assignment of “personhood” to the corporation and how does the law deal with them.  What are the limits to this idea?  Can other “non-persons” have legal personhood?  Can a chimpanzee?  Can corporations commit crimes and make contracts?  Do corporations have privacy rights, or the right to free speech, or religious freedom or other constitutional protections? Can a corporation be defamed? If you are driving in the HOV lane with only a copy of your certificate of incorporation in the passenger seat, are you violating the requirement that there be two persons in the car? In what circumstances and for what purposes may the personhood of a corporation be disregarded, whether by “piercing” or, as may appeal to some of the more prurient minded among you, “lifting” the “corporate veil’?  Are these the same thing?

In the end this unit prepares you to ask in a myriad of ways, what function does “personhood” perform in the analysis of legal problems relating to the corporation?

UNIT OUTCOME:

By the end of this unit you should be able to identify the core tensions arising from corporate personhood – and the profound contradictions which arise as a result and which the law must grapple with. The most obvious of these is the tug of war between shareholder financial expectations and management prerogatives. You will also understand, starting from the seminal case of Salomon v. Salomon how tempting it is for the courts to “pierce the corporate veil” and the inevitability of the connection between corporations being separate people and the countervailing force that is the doctrine of “piercing the veil”. Finally you will appreciate that the two forces and how frustrating it is in a legal sense that these two forces working against each other have not yielded and elegant yin and yang, but rather a messy set of legal doctrines that seem more whimsical than principled.

UNIT READINGS:

Please read the following material:

Casebook pages 83-91,134-226

BCBCA sections 30, 33, 136, 142, 227

Prest v. Petrodel 2013 UKSC 34 <a href="http://www.bailii.org/uk/cases/UKSC/2013/34.html">http://www.bailii.org/uk/cases/UKSC/2013/34.html</a>

373. Todd Henderson, “Everything Old Is New Again: Lessons from Dodge v. Ford Motor Company” (2007) U of Chicago Law & Economics, Olin Working Paper No. 373: <a href="http://www.law.uchicago.edu/files/files/373.pdf">http://www.law.uchicago.edu/files/files/373.pdf</a>

TOPIC 1: CORPORATIONS AND THE CHARTER

Please read pages 83-91 of the Casebook. The extent to which corporations enjoy the protections of the Charter is considered on these pages. There is little to add.

1. v. Agat Laboratories (1998) 17 C.R. 95th) 147 (Prov.Ct.) which is found at pages 84-88 of the casebook is generally accepted as describing the proper approach. The question in issue is whether s.7 of the Canadian Charter of Rights and Freedoms applies to corporations who, after all, are not natural persons. S.7 provides:

“Life, liberty and security of person

7. Everyone has the right to life, liberty and security of the person and the right not to be deprived thereof except in accordance with the principles of fundamental justice.”

Blog Activity 4.1:

Then please consider the questions in Notes 1 and 2 on page 88 of the Casebook.

How would you answer them?  Why would you answer them that way?

Please succinctly summarize the present state of the law on the rights of corporations to use Section 7 of the Charter. Please blog your summary in no more than one page under the heading called “Corporations and the Charter”.

As you should now be able to appreciate, the fiction of corporate personhood can potentially result in some very real confusions and contortions when it comes to legal analysis. Sometimes it feels like the approach is somewhat akin to “Companies are people, except when they are not”.

Query whether such legal stretching and contorting is really necessary to accommodate the fiction of corporate personhood, or whether alternative approaches may be possible.

Blog Activity 4.2

Please consider whether s. 30 of the BC Business Corporations Act could simply be eliminated and replaced by an inclusive list of rights, powers and privileges, but without invoking any form of “personhood”. Would this be advisable or useful? Why or why not?

“Capacity and powers of company

30. A company has the capacity and the rights, powers and privileges of an individual of full capacity.”

Please blog your views on this question and your reasons in no more than one page under the heading “Eliminating Corporate Personhood?”

TOPIC 2: Some practical consequences of “personhood”        

Please read pages 134-143 of the Casebook.

We have previously identified some of the practical consequences of “personhood” – e.g., corporation is the only proper plaintiff for a wrong done to it and that an individual shareholder cannot sue for an alleged pro rata share of losses derived from those suffered by the corporation – as in the Robak case.

Now start to explore some other implications

The material on pages 134-143 of the Casebook deals with some of these. 

Please refer to the questions on page 135 of the Casebook:

Question 1:

Principal shareholder and de facto controller testifies on behalf of corporate plaintiff.  Disbelieved.  Corporation still wins.  Should the corporation be deprived of costs because “it” lied?

Question 2:

Can a corporation be held in contempt of court for failure to comply with a court order? See Northern Counties Securities v. Jackson & Seeple, [1974] 2 All ER. 625 referenced in note 2 on page 135 of the Casebook.

Question 3:

Macaura v. Northern Assurance [1925] A.C. 619 at pages 135-137 of the Casebook.

Owner of timber sold it to a company that was owned almost solely by him. He was the company's largest creditor. In his own name he insured the timber against fire. Timber was in fact destroyed by fire. Insurer denied the claim on the basis that the timber now belonged to the company and not to the previous owner or to the largest shareholder in the company.

Their argument was that the company being in law a legal entity separate from shareholders had an insurable interest but held no policy. Mr. Macaura had a policy, but no insurable interest. This left him with only a debt due by the company as a result of the fire that destroyed the timber he had sold.

The House of Lords held this way, finding that “…Neither a simple creditor nor a shareholder in a company has any insurable interest in a particular asset which a company holds.”

Does this really make policy sense?

In thinking about this question note the words of Lord Buckmaster on where the benefits and burden lie (at p.136 of the Casebook). In this case all the benefits and burdens effectively fell on Mr. Macaura.

Suppose I am convinced that a building I have no interest in beyond that of any other citizen will collapse within a year.  I contract with an insurer to pay me $50K if it does.  Isn’t this just betting – my object is to make a windfall gain not to protect against loss. That situation is clearer then the Macaura case.

Might it be suggested that Macaura was wrongly decided because it’s definition of insurable interest is too narrow?

To try and answer you will have to ask yourself what the point of “insurable interest” is?

In an early case on the subject (Lucena v. Crawford (1806) 127 E.R. 471), one judge found that an insured could recover if she suffered “factual expectation of loss”.  Unfortunately, another judge in that case required that, in addition to “factual expectation of loss”, the plaintiff must also have a “legal or equitable interest” in the property. The test of  “legal or equitable interest” in the property is the one that prevailed. Under it for example, a lender who lent money for a construction project would have no insurable interest unless he had taken out a security interest in the property.

Which bring us to the important case of Kosmopoulos v. Constitution Insurance and how the separate corporate personality doctrine can have unintended and unforeseen consequences. The decision of the Ontario C.A. is found at page 137 of the Casebook.

Mr. Kosmopoulos was the sole shareholder and director of leather goods company. He originally ran that business as a sole proprietor and the lease for its office was in the name of Mr. Kosmopoulos, as was the insurance on office. His lease for the company office was under his own name from when he originally ran the business as a sole proprietor. Even after the incorporation of his company the insurance on the office remained in his own name. The insurance agency he was dealing with knew that he was personally on the lease but carrying on business as a corporation.  A fire in a neighboring lot damaged his office.

When a claim was made insurance coverage was denied.

The trial judge found that Mr. Kosmopoulos could not recover damages as the owner of the assets as the company, and not he, owned them. However he could recover as an insured because of his insurable interest in the building.

The Ontario Court of Appeal agreed, restricting the application of the Macaura precedent to cases involving multiple shareholders.

The Supreme Court of Canada upheld the ruling of the lower courts.

Wilson J. obseved that there was no consistent principle as to when a court may disregard separate personhood by “lifting the corporate veil” and regarding the company as a mere “agent” or a “puppet” of its controlling shareholder or a parent corporation”.  Though the corporate veil would not be lifted, Mr. Kosmopoulos as sole shareholder of the company was found to be so placed with respect to the assets of the business as to have benefit from their existence and prejudice from their destruction. He had a moral certainty of advantage or benefit from those assets but for the fire. He had, therefore, an insurable interest in them capable of supporting the insurance policy and is entitled to recover under it.

McIntyre J. preferred the approach of Zuber J. in the Ontario C.A.  That is that the Macaura rule should not be accepted to compel a holding that a sole shareholder and sole director of a company could not have an insurable interest in the assets of the Company. Underlying this conclusion is that modern company law permits the creation of companies with one shareholder. The identity then between the Company and that sole shareholder (and director) is such that an insurable interest in the Company's assets may be found in the sole shareholder.

Now please consider questions 2, 3 and 4 on page 140 of the Casebook.

Please read Lee v. Lee’s Air Farming at pages 140-142 of the Casebook which helps bring some clarity to the question of how to separate different roles in a corporate structure, even where they seemingly reside within the same physical being.

Mr. Lee formed a company, held nearly all its shares, was managing director, and a pilot. Lee appointed himself the chief pilot for the company, and in this way became in effect both employer and worker. The contract of employment was between him and the company, but in effect Mr. Lee both gave orders and obeyed them.

The New Zealand Courts held that the two offices were clearly incompatible. On appeal the Privy Council reversed finding that it was the company who gave the orders, not Mr. Lee personally.

Please read Notes 1-3 on page 142 of the Casebook.

Blog Activity 4.3

Please consider the hypothetical in Note 4 on page 142 of the Casebook. What do you think? Would “x” be able to avoid liability in by “springing out” the corporation in the scenarios provided?  Please blog your views on this question and your reasons in less than one page under the heading “Ambiguities of Corporate Personality”.

TOPIC 3: QUESTIONING THE PRINCIPLE - THE CORPORATE VEIL THEORY

Please Read Pages 143-149 Of The Casebook.

It is noteworthy that clear doctrines and explanations of when “the corporate veil” will be lifted are few and far between.

Since the decision in Salomon v. Salomon a steady stream of common law decisions and legislative enactments has eroded the immutability of the separate legal entity doctrine. These decisions and enactments are conveniently seen as ways to “lift or pierce the corporate veil”. Piercing seems to happen freakishly ... rare, severe and unprincipled - almost like lightning. This lack of clarity perhaps suggests that using a fiction such as “personhood” is a poor and impractical fit. This is not just a bit of critical analysis with some normative pedagogic purpose. Rather it may be the unifying thread of virtually all aspects of this course. Because the ethical reasons underlying the principle of separate corporate personality seem to not be particularly present, know or understood, we should perhaps not be surprised at the degree of judicial flailing and uncertainty that many of the cases we are studying seem to manifest.

What Little Is Clear Is That Limited Liability Is No Longer Sacrosanct: The Principle In Salomon's Case No Longer Rules.

See the quotation from Clarkson v. Zhelka [1967] 2 O.R. 565 (H.C.) at page 144 of the casebook:

“The cases in which the Courts…have seen fit to disregard the corporate entity or personality, and instead to consider the economic realities behind the legal façade, fall within a narrow compass. The Legislature, in the fields of revenue and taxation…has made much greater departure in this respect. Such cases as there are illustrate no consistent principle. The only principle laid down is that in the leading case of Salomon v. Salomon & Co. Ltd., [1897] AC 22; and in general such principle has been rigidly applied. Briefly stated, it is that the legal persona created by incorporation is an entity distinct from its shareholders and directors and that even in the case of a one-man company, the company is not an alias for the owner.

The exception would appear to represent refusals to apply the logic of the Salomon case where it would be flagrantly opposed to justice.

…If a company is formed for the express purpose of doing a wrongful or unlawful act, or, if formed, those in control expressly direct a wrongful thing to be done, the individuals as well as the company are responsible to those to whom liability is legally owed.”

Note Welling’s critique of this part of Clarkson as obiter dicta (at page 148 of the Casebook).

Note Sharpe J. statement in Transamerica Life v. Canada Life (1996) 28 O.R. (3d) 423 at 433-434 (which can be found at the pages 144-145 of the Casebook):

“There are undoubtedly situations where justice requires that the corporate veil be lifted…[I]t will be difficult to define precisely when the corporate veil is to be lifted, but that lack of a precise test does not mean that a court is free to act as it pleases on some loosely defined ‘just and equitable” standard…

[T]he courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct. The first element “complete control”, requires more than ownership. It must be shown that there is complete domination and that the subsidiary company does not, in fact, function independently…

The second element refers to the nature of the conduct: is there “conduct akin to fraud that would otherwise unjustly deprive claimants of their rights?” (References omitted.)

Note Welling at page 149 of the Casebook:

“Courts in Canada have yet to take the final step and acknowledge that they have no inherent power to pretend that a corporation does not exist. I suspect the reason is simple. Most barristers concede the judgers has power to “pierce the corporate veil”, then argue this is not an appropriate case in which to use the power. They are conceding too much and they are ignoring the clear wording of Canadian corporate statutes. It is time for someone to stand up and say “quo warranto?”

It is clear from commentators and judges that the immense confusion around when the “corporate veil’ is to be pierced relates directly to principle of Salomon v. Salomon and the separate personality of companies. This being so it is quite curious why the fiction of “corporate personhood” does not itself draw as much attention as it might. It is at least arguable that if we chose to dispense with the fiction that corporations are “persons”, we would more easily and clearly be able to identify and define permitted corporate action strictly in terms of what is permissible.

TOPIC 4: corporate personality in practice: some problem areas              

1. Corporate Character Traits

Please read extract from Welling at page 150 of the Casebook.

Please note in particular the last three sentences:

“A fully capable corporation may well have been born yesterday. Does the law permit us to look inside of the corporation’s equivalent of a family to establish a pattern of behaviour? A cautious “yes” can be advanced, provided the principle of corporate personality is not sacrificed.”

Please read Big Bend Hotel Ltd. v. Security Mutual (1980) 19 BCLR 102 at pages 150-152 of the Casebook.

This is an example of the corporate veil being lifted to prevent improper conduct or fraud.

Vincent Kumar was the president and sole shareholder of Big Bend Hotel Ltd. Big Bend had obtained insurance from Security Mutual on the hotel, its sole asset.  The hotel burned down.

Kumar had previously been the president and sole shareholder of another corporation whose hotel had burned less than three years earlier. This fact had not been disclosed to security Mutual.

The court held that this was a material non-disclosure.  It was found to be appropriate to lift the corporate veil here because equity will not allow an individual to use a co as a shield for improper conduct or fraud.

Callaghan J. found that Kumar knew the prior loss had to be disclosed and that his failure to do so was intended to mislead or deceive the insurers who would have declined risk had they known.

In other words the fact of a separate corporate entity was not allowed to interfere with the obligation to disclose, and the veil would be pierced to put the sole shareholder corporate president to the same standard he would be held to if no company existed as a shield.

Please read Note 1 at page 152 of the Casebook:

Wasn’t it enough to decide the case to conclude that had they known, the insurer would have declined risk?

Should the insurance company have had an application form that asked for disclosure not only from the company applicant but from all its principals.

Please read Note 3 at page 152 of the Casebook:

London Computer Operators Training Ltd and others v British Broadcasting Corporation and others  [1973] 2 All ER 170 deals with how separate corporate existence can have real impact on other legal areas, such as defamation.

Two speakers on BBC radio alleged that a computer school was “a financial racket”, that their advertising was misleading, and that the founder had “woeful” business record.  The school and two of its directors bought an action for libel against BBC Radio who pleaded justification (that the statements were in fact true) and fair comment.  The founder, who was still running the school, was not joined as a plaintiff. The defendants subsequently discovered that the founder had a criminal record and sought leave to amend their particulars of justification (truth) by adding details of his convictions and sentences.  Leave to amend was granted. The court found that the words complained of were capable of the meaning that the company was being run by people of questionable honesty and background who were unfit to run a computer school.

If the company is separate from its shareholder how is the shareholders criminal record of convictions and sentencing relevant to an action involving the company only, and not the shareholder?

Read Hercules Managements Ltd. v. Ernst & Young [1997] 2 S.C.R. 165 at page 155 of the Casebook

Two companies, Northguard Acceptance Ltd (‘NGA”) and Northguard Holdings Ltd. (‘NGH”) carried on business lending and investing money on the security of real property mortgages.  Hercules Managements Ltd. was a shareholder in NGA.  Ernst & Young were hired as auditors of NGH and NGA, prepared financial statements and provided audit reports to the companies’ shareholders. NGA and NGH went into receivership and Hercules Managements Ltd. sued Ernst & Young alleging that their audit reports had been negligently prepared.

Ernst & Young sought dismissal on the ground, inter alia, that the claims asserted by the plaintiffs could only properly be brought by the corporations themselves and not by the shareholders individually. La Forest J. agreed with Ernst & Young holding that “the shareholders’ reliance on negligently prepare audit reports…will result in a wrong to the corporation for which the shareholders cannot, as individuals, recover.”

Blog Activity 4.4

What is the policy justification for this result in your view? Please blog your views on this question and your reasons in less than one page under the heading  “Justifying Ernst & Young”.

1. Corporations as Agents and Partners

Please read pages 157-158 of the Casebook.

The question is: When is it appropriate to treat a company as being the agent or partner of its controlling shareholder?

Note that the parameters of partnership can be reviewed in Unit 3.

In this regard please read Smith, Stone & Knight Ltd. v. Birmingham Corp. [1939] 4 All E.R. 116 at page 158 of the Casebook.

Birmingham Corporation expropriated premises owned by a wholly‑owned subsidiary of Smith, Stone & Knight Ltd. (“SSK”). 497 of 502 issued shares in the subsidiary were held by SSK; the other 5 shares were held for SSK.  The subsidiary had no staff and no separate accounting records. The subsidiary was effectively treated as a department of SSK.

SSK claimed compensation for loss of business as a result of the expropriation.  Birmingham Council’s response was that the loss was suffered by subsidiary ‑ a separate legal entity and for that reason SSK’s claim should fail.

It was held that compensation was indeed payable by Birmingham to SSK. The court found that the subsidiary was carrying on no business of its own, but was in fact carrying on SSK’s business as agent.

The court identified six factors to be shown before agency found and veil lifted:

• Profits of the subsidiary must be treated as profits of the holding company;
• Those conducting the subsidiary's business must be appointed by the holding company;
• The holding company must be the head and brain of the trading venture;
• The holding company must be in control of the venture and must decide what capital should be spent and what should be done;
• The profits made by the subsidiary's business must be made by the holding company's skill and direction; and
• The holding company must be in constant and effective control.

Does this make sense? Are economic realities such that a group of companies trade as a group, raise capital as a group, and are viewed as a group by those dealing with them?

Should one attach obligations and responsibilities to the group and not to individual companies?

Lifting the corporate veil on the basis of agency involves examining the relationship between two or more separate legal entities and attributing the acts of one of the entities as the acts of the other entity.

The key issue involved in the case was whether the parent had suffered any loss as a result of the council's compulsory acquisition of the property, causing disturbance to the subsidiary's business. Atkinson J. decided that the relationship between the parent and subsidiary was really an agency relationship, with the business of the subsidiary being carried on an apparent basis only. The relevant facts were:

1. The directors of the parent were also directors of the subsidiary but did not take a salary from their positions on the subsidiary’s board;
2. The business purportedly carried on by the subsidiary company was purchased by the parent and never formally assigned to the subsidiary;
3. The subsidiary had no staff apart from a manager;
4. The subsidiary's books were kept and maintained by the parent and were not the property of the subsidiary or accessible by the manager of the subsidiary;
5. The work purportedly carried out by the subsidiary was beneficially owned by the parent without any agreement to transfer the business to the subsidiary; and
6. The subsidiary was treated for accounting purposes as if it were merely a department of the parent, including, significantly, appropriating the profits of the subsidiary for payment to the parent (by direct payment rather than dividend).

Smith, Stone & Knight Ltd. v. Birmingham Corp. [1939] 4 All E.R. 116 can be seen as a poor example of lifting the corporate veil on the basis of agency.  It is preferable not to use the case for the purpose of lifting the corporate veil for two reasons:

1. Maclaine Watson & Co Ltd v. Department of Trade and Industry [1988] 3 All ER 257 at 310-311 per Kerr LJ:

“…the facts [in Smith, Stone and Knight] were so unusual that they cannot form any basis of principle"

2. See Note 4 on page 159 of the Casebook:

“Is there any reason why corporate shareholders should be made to answer for the liabilities of the corporations in which they hold shares, to a greater degree than individual shareholders?”

Read Notes 7 and 8 on pages 159-160 including excerpts from the decision in DHN Food Distributors Ltd. v Tower Hamlets London Borough Council [1976] 1 W.L.R. 852  (Eng. CA).

DHN Food Distributors Ltd. (“DHN”) owned and controlled a business of importing and distributing groceries, operating out of a warehouse owned by a subsidiary of DHN, Bronze Investments Ltd.  Vehicles used in the business were owned by yet another subsidiary of DHN. DHN held all the shares in both subsidiaries and the companies had common directors.

In 1969 the local council made a compulsory purchase order to acquire the land on which the warehouse sat.  DHN was unable to relocate and the business subsequently closed down.

The question was whether DHN was entitled to compensation for disturbance in having the business closed down. Council argued none payable since the subsidiary was not disturbed. They further argued that even if both subs were disturbed, the subsidiaries were not entitled to any compensation because they had no interest in the land. Moreover the argument continued,  DHN itself was not entitled to compensation under the provisions of a statute. The council argued that DHN was only a licensee of Bronze Investments Ltd.

The English Court of Appeal treated the companies as one economic entity and following from this, DHN could be treated as owner of the property and was thus entitled to compensation for disturbance to its business.

Lord Denning found that the corporate veil could indeed be lifted – finding that the companies were in reality a group, and should be treated as one. 

“These subsidiaries are bound hand and foot to the parent company and must do what the parent company says … virtually the same as a partnership … They should not be treated separately.”

This notion is not so easily reconcilable with other cases. Denning’s views were disapproved by the House of Lords in Woolfson v Srathclyde Regional Council, 1978 SC 90 (HL). There Lord Keith expressed doubt as to whether the decision in DHN correctly applied the principle that it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere facade concealing the true facts

TOPIC 5: CORPORATE PERSONALITY - SOME INNOVATIVE APPROACHES                  

Please read the short web article “Corporation not person in carpool lanes” which can be found at <a href="http://www.sfgate.com/bayarea/article/Corporation-not-person-in-carpool-lanes-4173366.php">http://www.sfgate.com/bayarea/article/Corporation-not-person-in-carpool-lanes-4173366.php</a>

Then please read page 160 of the Casebook:

“Judges have rarely been clear when explaining how corporate personality works. This is due in part to the facile notion that they are at liberty to disregard the separate existence of the corporate entity. There are, however, some reported cases that clearly illustrate the application of some well-known remedies, mostly in tort situations, but some from the field of equity.  Using them as examples one can formulate a principled approach that treats corporate personality as a solution rather than a problem.”

1. Inducing Breach of Contract

Please read Garbutt Business College Ltd. v. Henderson Secretarial School Ltd. [1939] 4 D.L.R. 151 (Alta. C.A.) at pages 161-162 of the Casebook. It helps illustrate yet another way that “separate” corporate personality might be manipulated in an attempt to evade responsibility.

Henderson a teacher was subject to a restrictive covenant governing employment. It specifically restrained him from engaging in or managing a rival business college for 5 years.  He resigned and started a rival college that used his name and employed him to teach.  He held all but 3 shares. His wife and daughter held those 3 shares. Garbutt Business College Ltd. lost students to new college.

The court upheld the restrictive covenant against Mr. Henderson but found there could be no corporate liability as against Henderson Secretarial School Ltd. in the contract. Any such liability must be in tort, and accordingly the court found liability against Henderson Secretarial School Ltd. in damages for interference with business relations and inducing breach of contract between Mr Henderson and Garbutt Business College Ltd.

Please note Questions 1 and 3 on pages 162-163 of the Casebook

1.This question is in effect: What if Henderson only incorporated a rival entity using his name but did not teach or manage?

3. In looking at this question consider the facts in Jones v. Lipman [1962] 1 WLR 832. In that case Mr. Lipman contracted to sell a house to Jones for £5,250. He changed his mind and refused to complete. To try and avoid specific performance, he conveyed the house for £3000 to a company formed for that purpose alone, which he alone owned and controlled. In the end specific performance against Mr. Lipman and his company was ordered: “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.”

In this regard please consider the following excerpt’s from Lord Sumption’s judgment in Prest v. Petrodel 2013 UKSC 34 (especially paragraph 30 on Jones v. Lipman) which can be found here: <a href="http://www.bailii.org/uk/cases/UKSC/2013/34.html">http://www.bailii.org/uk/cases/UKSC/2013/34.html</a>

As you will see Lord Sumpton of the United Kingdom Supreme Court had the following observations:

“27. In my view, the principle that the court may be justified in piercing the corporate veil if a company's separate legal personality is being abused for the purpose of some relevant wrongdoing is well established in the authorities….[T]he recognition of a limited power to pierce the corporate veil in carefully defined circumstances is necessary if the law is not to be disarmed in the face of abuse…

28. The difficulty is to identify what is a relevant wrongdoing. References to a "facade" or "sham" beg too many questions to provide a satisfactory answer. It seems to me that two distinct principles lie behind these protean terms, and that much confusion has been caused by failing to distinguish between them. They can conveniently be called the concealment principle and the evasion principle. The concealment principle is legally banal and does not involve piercing the corporate veil at all. It is that the interposition of a company or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming that their identity is legally relevant. In these cases the court is not disregarding the "facade", but only looking behind it to discover the facts which the corporate structure is concealing. The evasion principle is different. It is that the court may disregard the corporate veil if there is a legal right against the person in control of it which exists independently of the company's involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement. Many cases will fall into both categories, but in some circumstances the difference between them may be critical. This may be illustrated by reference to those cases in which the court has been thought, rightly or wrongly, to have pierced the corporate veil.”…
29. Jones v Lipman [1962] 1 WLR 832 was a case of very much the same kind. The facts were that Mr Lipman sold a property to the plaintiffs for £5,250 and then, thinking better of the deal, sold it to a company called Alamed Ltd for £3,000, in order to make it impossible for the plaintiffs to get specific performance. The judge, Russell J, found that company was wholly owned and controlled by Mr Lipman, who had bought it off the shelf and had procured the property to be conveyed to it "solely for the purpose of defeating the plaintiffs' rights to specific performance." About half of the purchase price payable by Alamed was funded by borrowing from a bank, and the rest was left outstanding. The judge decreed specific performance against both Mr Lipman and Alamed Ltd. As against Mr Lipman this was done on the concealment principle. Because Mr Lipman owned and controlled Alamed Ltd, he was in a position specifically to perform his obligation to the plaintiffs by exercising his powers over the company. This did not involve piercing the corporate veil, but only identifying Mr Lipman as the man in control of the company. The company, said Russell J portentously at p 836, was "a device and a sham, a mask which [Mr Lipman] holds before his face in an attempt to avoid recognition by the eye of equity." On the other hand, as against Alamed Ltd itself, the decision was justified on the evasion principle, by reference to the Court of Appeal's decision in Gilford Motor Co. The judge must have thought that in the circumstances the company should be treated as having the same obligation to convey the property to the plaintiff as Mr Lipman had, even though it was not party to the contract of sale. It should be noted that he decreed specific performance against the company notwithstanding that as a result of the transaction, the company's main creditor, namely the bank, was prejudiced by its loss of what appears from the report to have been its sole asset apart from a possible personal claim against Mr Lipman which he may or may not have been in a position to meet. This may be thought hard on the bank, but it is no harder than a finding that the company was not the beneficial owner at all. The bank could have protected itself by taking a charge or registering the contract of sale.” (Emphasis added.)

The next few cases should help you bring separate corporate personality into focus as applied to the rough and tumble of “modern” business dealings.

Please read Einhorn v. Westmount Invesments Ltd. (1969), 6 D.L.R. (3d) 71 at pages 164-166 of the Casebook.

This was an application to strike out a Statement of Claim. Accordingly the facts alleged did not have to be proven in this limited context.

Jacob Einhorn was a licensed real estate agent who provided services to Westmount Investments Ltd. a company that three brothers, Hyman, William and Samuel Belzberg, were “at all material times in complete control” of. Westmount Investments Ltd. never paid Mr. Einhorn what he was owed. It was alleged that instead the Belzberg brothers “siphoned off the assets” of Westmount Investments Ltd. to another company they controlled Regina Midtown Centre Ltd.  leaving Westmount an empty shell incapable of satisfying its contract with Mr. Einhorn.

Note that neither the Belzberg’s nor Regina Midtown Centre Ltd. induced a breach of contract (as was the case in Garbutt Business College Ltd. v. Henderson Secretarial School Ltd.), they just prevented Westmount Investments Ltd. from executing their contract with Mr. Einhorn.

The court considered whether the Belzberg brothers could be individually liable. The answer was yes, because they met the test for the tort of interference with contractual relations. This was because it appeared that the Belzberg brothers interfered with Westmount’s performance of the contract and each of the parties to a contract have a right to performance of it. There are three ingredients to the tort:

1. Interference in execution of contract: This interference is not confined to breach of contract; it extends to case where a third person prevents or hinders a party from performing the contract.
2. The interference must be deliberate.
3. The interference must be direct.

Please also read McFadden v. 481782 Ontario Ltd., (1984), 47 O.R. (2d) 134 (H.C.) at page 166 of the Casebook.

In this case two directors authorized payments to themselves as shareholders that put the corporation in a position where it could not fulfill its contractual obligations to an employee. The employee sued the directors on the basis that they induced the corporation to breach its contract with him.

It was held that the directors were liable. They acted with a view to their own interests not those of the company.

They are not protected, therefore, by the exception to the rule in Said v. Butt that they would be excused if they were acting "under the compulsion of a duty to the corporation." The court held that the directors could not fall within the exception Said v. Butt [1920] 3 K.B. 497 that: “…if a servant acting bona fide within the scope of his authority, procures or causes me to break a contract that I have made with you, you cannot sue the servant for interference with the contract; for he is my alter ego, and I cannot be sued for inducing myself to break a contract.” This exception effectively ensures officers and directors can terminate employment contracts without fearing personal liability and also that companies can terminate contracts that may no longer be in their best interests to fulfill.

However, in McFadden v. 481782 Ontario Ltd. the exception did not apply since the Directors were acting with a view to their own interests and not those of the corporation. Accordingly they could not be said to be acting under the compulsion of a duty to the corporation. That is to say that for an officer or director to be relieved from the consequences of his act of inducement, it is because he acts under the compulsion of a duty.  Where she or he does not, for example because of a failure to act bona fide and hence outside the scope of their authority, liability to that Director will result.  The corporation in question ought to be unaffected precisely because the Directors were acting outside the scope of their authority,

Please read the Questions at pages 169-170 of the Casebook and then ask yourself the following questions:

1. What was the conduct that induced the breach in McFadden v. 481782 Ontario Ltd.?
2. Is it a sound principle that a director who fails to act in the best interests of the corporation ceases to act on behalf of the corporation? Should the fact that the Director acts in breach of their obligation to the corporation have any relevance to the rights of an employee?

Please read 369413 Alberta Ltd v. Pocklington (2000) 194 D.L.R. (4^th) 109 (Alta. C.A.) at pages 171-178 of the Casebook.

Gainers was one of Canada’s largest meat-packing companies. In acute financial distress, Gainers breached an agreement it had with the Province of Alberta. Peter Pocklington owned Pocklington Foods Inc. which held shares in Gainers.   Alberta opted to sue Gainer’s sole director, Peter Pocklington alleging that Pocklington had “induced” the breach by signing a director’s resolution transferring certain shares in another company owned by Gainers (valued in the millions) to another of his own companies, Pocklington Holdings Ltd., for $100.  Gainers had earlier agreed not to sell or dispose of its assets without the prior written consent of the Province of Alberta.

The Court awarded the Province $4.7 million in damages as against Pocklington.

Fruman J.A. set out various elements of the case as follows:

“ELEMENTS OF INDUCING BREACH OF CONTRACT

In order to find that a defendant intentionally induced a breach of contract, seven elements must be established:

1. i) the existence of a contract;
2. ii) knowledge or awareness by the defendant of the contract;

iii) a breach of the contract by a contracting party;

1. iv) the defendant induced the breach;
2. v)  the defendant, by his conduct, intended to cause the breach;
3. vi)  the defendant acted without justification; and

vii) the plaintiff suffered damages…

INTENT

The Law

…Therefore, if the breach was a reasonable or foreseeable consequence of that transfer, or alternatively, if Pocklington completed the transfer recklessly, was wilfully blind to its consequences, or was indifferent as to whether or not it caused a breach, the necessary intent element for the tort will be met.

The Evidence

…The clear implication of Ogilvie and Company’s carefully worded letter is that either the lawyers did not share their clients’ views, or they were invited to keep their legal advice to themselves. Pocklington nevertheless signed the documents to give effect to the share transfer, and retained the shares despite Alberta’s early protests and Ogilvie and Company’s apparent reservations. He had the means of knowledge, but chose to act without legal advice. Pocklington was wilfully blind to the consequences of his actions and showed clear indifference to the breach. The intent component of the tort is satisfied.

JUSTIFICATION

In some situations, a defendant’s plea of justification may avoid liability: South Wales Miners’ Federation, supra, and Quinn, supra. The defence of justification is available when the defendant caused the breach while acting under a duty imposed by law. The issue in each case is whether, upon consideration of the relative significance of all the factors, the defendant’s conduct should be tolerated despite its detrimental effect on the interests of others: Fleming, supra, at 657.

Directors of companies owe duties to the corporation; they are obliged both at common law and under Statute to act in the best interests of the company: Re Cawley & Co. (1889), 42 Ch. 209 at 233 (C.A.). For example, s. 117(1)(a) of the ABCA provides: “Every director and officer of a corporation in exercising his powers and discharging his duties shall act honestly and in good faith with a view to the best interests of the corporation [...] ”.

Therefore, when the interests of the company are best served by breaking its contractual commitments, the director’s act of inducement is justified because it is “taken as a duty”… 

But if the director is not complying with that duty, the rationale for relieving personal liability disappears…

In order to succeed under the Imperial Oil test, a plaintiff must prove that the director knew the legal rights of others would be jeopardized by the director’s actions, and intended to deprive the aggrieved party of contractual benefits… 

The concerns expressed in Imperial Oil are not misplaced. In order to protect the fine fabric of the corporate veil, courts should refrain from requiring directors to prove the legitimate corporate purpose motivating their actions. However, courts also should not condone inappropriate conduct by automatically placing a difficult onus on a plaintiff, by reason only that the defendant director owed legal duties to the company whose contract he had a hand in breaching. Some balance is required…

In this case Pocklington acquired a valuable asset for nominal consideration at the expense of Gainers’ creditors. Since Gainers was insolvent at that time, its creditors’ interests were the interests of the company. Promoting the interests of one shareholder at the expense of the creditors is not in the best interests of the company: Levy-Russell at 169. A director who pursues these objectives is not acting in furtherance of his corporate duty, and there is no justification for his deeds.

Pocklington has not demonstrated any legitimate business interest of Gainers that could have been served by the 350151 share transfer…

By transferring the 350151 shares to his own company, Pocklington was not discharging his legal duty to act honestly and in good faith with a view to the best interests of Gainers; he was acting solely in his own interests. As no legitimate interest of Gainers could possibly be served by the transaction, the court need not go on to consider whether Pocklington’s act was aimed at depriving Alberta of the benefits of its contract. Pocklington’s position as director cannot provide justification for his actions.”

(Emphasis added.)

Blog Activity 4.5

In your view is the Pocklington decision consistent with, among others, the McFadden decision? Please blog your views on this question and your reasons in less than one page under the heading “Pocklington & McFadden”.

Please read Adga Systems International Inc. v. Valcom Ltd. (1999) 43 O.R. (3d) 101 (Ont. C.A.) at pages 178-183 of the Casebook.

Note that this case represents a significant shift in the spectrum of directors’ liability/personal liability imposed on officers and directors for actions taken in the course of their duties.

The plaintiff, Adga Systems sued their competitor Valcom Ltd., as well as Valcom’s sole director in his personal capacity and two senior employees of Valcom in their personal capacity. Adga alleged that Valcom had raided its employees and caused Adga economic damage. Adga sought damages for inducing breach of contract and inducing breach of fiduciary duty. The Ontario Divisional Court dismissed the claim against the three personal defendants holding that, since the employees of Valcom Ltd. were not furthering their own interests and were pursuing their duties of employment to further the interests of their employer, no cause of action was revealed which justified a trial. The plaintiff Adga appealed to the Ontario Court of Appeal.

Adga’s appeal was allowed and the three personal defendants, being the Director of Valcom and two employees of Valcom were reinstated as defendants. Carthy J.A. focussed on the issues as follows:

“The issue that I must deal with is whether, on the assumption that the defendant Valcom committed a tort against the appellant, the sole director and employees of Valcom can be accountable for the same tort as a consequence of their personal involvement directed to the perceived best interests of the corporation…

However, where, as here, the plaintiff relies upon establishing an independent cause of action against the principals of the company, the corporate veil is not threatened and the Salomon principle remains intact…

It is my conclusion that there was no principled basis for protecting the director and employees of Valcom from liability for their alleged conduct on the basis that such conduct was in pursuance of the interests of the corporation. It may be that for policy reasons the law as to the allocation of responsibility for tortious conduct should be adjusted to provide some protection to employees, officers or directors in the limited circumstances where, for instance, they are acting in the best interests of the corporation with parties who have voluntarily chosen to accept the ambit of risk of a limited liability company. However, the creation of such a policy should not evolve from the facts of this case where the alleged conduct was intentional and the only relationship between the corporate parties was as competitors.” (Emphasis added.)

Please read Note 2 at page 183 of the Casebook: What is result if directors must choose between (1) inducing breach of contract because it is in the best interests of the company and (2) acting contrary to the company’s best interests so to avoid inducing breach?

In this regard please note the discussion on page 181 of the Casebook regarding the SCC decision in London Drugs v. Kuehne & Nagel:

“ The Supreme Court of Canada again considered the issue of an employee's liability for acts done in the course of his duties on behalf of the employer in London Drugs Ltd. v. Kuehne & Nagel International Ltd., <a href="http://www.canlii.org/en/ca/scc/doc/1992/1992canlii41/1992canlii41.html">1992 CanLII 41 (SCC)</a>, [1992] 3 S.C.R. 299, 97 D.L.R. (4th) 261. The plaintiff delivered a transformer to a warehouse company for storage. An employee of the warehouse company negligently permitted the transformer to topple over, causing extensive damage. Even though there was a contractual relationship between the company and the customer, the majority held in favour of the claim against the employee.

Iacobucci J. stated at pp. 407-08:

There is no general rule in Canada to the effect that an employee acting in the course of his or her employment and performing the "very essence" of his or her employer's contractual obligations with a customer does not owe a duty of care, whether one labels it "independent" or otherwise, to the employer's customer. . . .

…The mere fact that the employee is performing the "very essence" of a contract between the plaintiff and his or her employer does not, in itself, necessarily preclude a conclusion that a duty of care was present.”

Please read Note 6 at page 184 of the Casebook: Is there a different standard of liability of employees and directors where each acts within scope of duties?

1. Knowing Assistance in a Breach of Trust

Please read Air Canada v. M & L Travel Ltd.       [1993] 3 S.C.R. 787 at pages 184-191 of the Casebook.

M&L Travel Ltd., the directors of which were Mssrs. Martin and Valliant, was a travel agency.  It had an agreement with Air Canada under which M&L Travel Ltd. was to hold proceeds of ticket sales in trust for Air Canada.  M&L Travel Ltd. in fact did not hold the proceeds in trust as agreed but rather used them for general operating expenses as M&L found itself in financial difficulties.

Air Canada sued (1) the travel agency, and (2) both directors personally for the money owed to it for ticket sales.

Air Canada’s action succeeded against M&L Travel Ltd. but failed against the Directors Mssrs. Martin and Valliant. Accordingly Air Canada successfully appealed the decision holding the Directors not to be personally liable and judgment was entered against them as well.

The matter came before the Supreme Court of Canada. At issue was:  (1) whether the relationship between M&L Travel Ltd. and Air Canada was one of trust, or one of debtor and creditor? and (2) if of trust, under what circumstances could the directors of a corporation be held personally liable for breach of trust by the corporation - and were those circumstances present here.

Although involving a corporation, the case fell to be resolved on trust principles, and does not raise general questions of the personal liability of directors for the acts of the corporation.

(1) The Supreme Court of Canada held that there was a trust relationship between M&L Travel Ltd. and Air Canada.

(2) With respect to the personal liability of directors the Supreme Court of Canada was of the view that the imposition of personal liability on a stranger to a trust depends on whether the stranger's conscience is sufficiently affected to justify the imposition of personal liability. A stranger to the trust can be held liable as a constructive trustee for breach of trust (trustee de son tort).  The stranger, although not appointed a trustee, takes on him or herself to act as trustee and to possess and administer trust property and becomes liable if he or she commits a breach of trust while acting as a trustee. This type of liability was found to be inapplicable in the case of M&L Travel Ltd. v. Air Canada because the directors did not personally take possession of trust property or assume the office or function of trustees.

The court pointed out that strangers to a trust could also be personally liable for breach of trust if they knowingly participate in a breach of trust.  They either were acting as a trustee in receipt and chargeable with trust property (a constructive trusteeship termed "knowing receipt") or they knowingly assisted in a dishonest and fraudulent design on the part of the trustees (termed "knowing assistance").  Since the "knowing receipt" category did not apply here, the only basis upon which the directors could be held personally liable were as constructive trustees under the "knowing assistance" head of liability.  This basis of liability raises two main issues:  the nature of the breach of trust and the degree of knowledge required of the stranger.

The knowledge requirement for this "knowing assistance" type of liability is actual knowledge; recklessness or wilful blindness will suffice.  A person will be deemed to have known of the trust if it was imposed by statute.  If the trust was contractually created, then whether the stranger knew of the trust will depend on his or her familiarity or involvement with the contract.

The stranger will be liable if he or she knowingly assisted the trustee in a fraudulent and dishonest breach of trust.  Therefore, it is the corporation's actions that must be examined.  Where the trustee is a corporation, rather than an individual, the inquiry as to whether the breach of trust was dishonest and fraudulent may be more difficult to conceptualize, because the corporation can only act through human agents who are often the strangers to the trust whose liability is in issue.  The actions of the directors were relevant to the examination, given the extent to which the defendant directors controlled the travel agency.

The breach of trust by the travel agency was dishonest and fraudulent from an equitable standpoint.  The taking of a knowingly wrongful risk resulting in prejudice to the beneficiary is sufficient to ground personal liability.  As a party to the contract between itself and Mr. Martin, M&L Travel Ltd. knew that the Air Canada monies were held in trust, and were not for the general use of the travel agency.  It set up trust accounts, but never used them.  It also knew that any positive balance in its general account was subject to the Bank's demand.  By placing the trust monies in the general account that was then subject to seizure by the Bank, the travel agency took a risk to the prejudice of the rights of the beneficiary, Air Canada.  It had no right to take this risk.

It was found clearly that the appellant directors participated or assisted in the breach of trust.  There were dealing with the funds in question ‑‑ stopping payment on all cheques, opening a trust account, and attempting to withdraw the stop payment orders and to transfer the funds into a new trust account.  The breach of trust was directly caused by the conduct of the defendant directors.  Their actions in stopping payment on the cheques to protect their own interests not only prevented payment on cheques issued to Air Canada but also precipitated the seizure by the Bank of the only funds available in the unprotected general account.

Accordingly the court found that directors personally liable for breach of trust as constructive trustees.

Please read Transamerica Life Insurance Co. v. Canada Life Assurance Co. (1996), 28 O.R. (3d) 423 (Ontario Gen. Div.) at pages 192-198 of the Casebook.                  

The defendant Canada Life Mortgage Services Ltd. (“CLMS”) was a wholly owned subsidiary of the defendant Canada Life Assurance Company. CLMS was incorporated by Canada Life Assurance Company to carry on the business of mortgage correspondent and general financial agent to deal with both Canada Life Assurance Company as well as other institutional investors. CLMS had its own head office and branch offices distinct from those of the Canada Life Assurance Company.  Those offices were managed and operated independently of the Canada Life Assurance Company. The management of CLMS exercised independent discretion in conducting its business.

A number of the mortgage loans made by the plaintiff Transamerica Life Insurance Company of Canada that had been arranged by CLMS fell into default. The plaintiff Transamerica Life Insurance Company of Canada claimed that CLMS owed it a duty to do the underwriting for these loans, that it failed in that regard, and that Transamerica Life had suffered loss as a consequence. The terms of the Master Agreement that governed the relationship of the plaintiff Transamerica Life and CLMS did not specifically provide that CLMS was to perform any underwriting function on Transamerica Life’s behalf, and CLMS took the position that the agreement excluded this duty.

Transamerica Life sued CLMS for damages for breach of contract, breach of fiduciary duty, fraud, misrepresentation and negligence. Transamerica Life also sued Canada Life Assurance Company, asserting that it was liable for the wrongs of CLMS.

Canada Life Assurance Company moved for summary judgment dismissing the action against it.

It was held that the motion should be granted and the action against Canada Life Assurance Company be dismissed.

Transamerica Life relied on Kosmopoulos  in arguing that the court should lift the corporate veil whenever it was "just and equitable" to do so. Sharpe J. rejected this approach finding that lifting the corporate veil whenever it was "just and equitable" to do so  would represent a significant departure from the following principle established in Salomon:

“The company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act.” (at page 195 of the Casebook).

Sharpe J. then quotes Gower, Modern Company Law 5^th ed. (1992):

“There seem to be three circumstances only in which the courts can [pierce the veil]. These are:

1. When the court is construing a statute, contract or other document;
2. When the court is satisfied that a company is a "mere facade" concealing the true facts; and
3. When it can be established that the company is an authorized agent of its controllers or its members, corporate or human.” (At page 196 of the Casebook)

Then Sharpe J. concludes:

“... the courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct. The first element, "complete control", requires more than ownership. It must be shown that there is complete domination and that the subsidiary company does not, in fact, function independently.... The second element relates to the nature of the conduct: is there "conduct akin to fraud that would otherwise unjustly deprive claimants of their rights?” (At page197 of the Casebook)

Accordingly, Transamerica's claim against Canada Life was dismissed

TOPIC 6: THE PARTICULAR PROBLEM OF THIN CAPITALIZATION   

Please read pages 198-199 of the Casebook.

Companies have no minimum capitalization requirement in Canada. Often new corporations are created with one share valued at only $1. Thin capitalization refers to the situation where a corporation is established with high debt to equity ratio. Assuming that debt is normally secured, if something goes wrong there is no one protected except the secured creditors. In other words, in thinly capitalized companies trade creditors are very much at risk.

The question to be considered is whether thin capitalization, per se, should be a ground for lifting the corporate veil? Is it legitimate evidence where owners seek the benefit of limited liability without paying for it with adequate capital investment?

To understand what thin capitalization can look like in practical terms begin by reading the U.S. case of Walkovszky v. Carlton 18 N.Y. 2d 414 (Ct. App. 1966) at pages 199-204 of the Casebook.    

The facts are that the plaintiff Walkovszky was hit by a taxicab owned by the Seon Cab Corporation and sued. Carlton was a stockholder of ten corporations, including Seon, each of which had two cabs registered to its name and only minimal insurance. This was a rather common practice at the time in the taxicab industry.

Walkovszky claimed that although seemingly independent, the companies in fact operated as a single entity with regard to financing, supplies, repairs, employees and garaging and all of the companies are named as defendants. Walkovszky further argued that he was entitled to hold the stockholders personally liable for the damages sought because the multiple corporate structures constituted an unlawful attempt to defraud members of the general public who might be injured by the cabs.

Carlton’s motion to dismiss Walkovszky’s case was granted.

The issue in the case was whether Carlton could be held personally liable in this case and the majority of the court held that Carlton could not be held personally liable.

Fuld J. observed that incorporation of a business is permitted for the purpose of enabling its proprietors to escape personal liability. However, one can “pierce the corporate veil” when anyone uses control of the corporation to further his own rather than the corporation’s business.

That is to say that the courts will pierce the corporate veil whenever necessary in order to prevent fraud or inequity. In determining whether to lift the veil the court is to be guided by “general rules of agency.” Whenever a person uses the corporation to further his own interests as opposed to those of the corporation, he will be liable for the corporation’s acts.  This liability is not just for the corporation’s dealings, but also as regards its negligence.

Here, while the complaint alleges that the separate corporations were undercapitalized and that their assets have been intermingled, it failed to mention that the defendant Carlton and his associates were actually doing business in their individual capacities, shuttling their personal funds in and out of the corporations without regard to formality.

The majority felt that if the insurance coverage required by statute was inadequate for the protection of the public, the remedy was not with the courts but with the Legislature.

In a similar case (Mangan) it was proved that operating companies existed only for the purpose of allowing the defendant to avoid the weight of the financial responsibilities and other liabilities. “However, it is one thing to assert that a corporation is a fragment of a larger corporate combine which actually conducts the business…It is quite another to claim that the corporation is a “dummy” for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends. Either circumstance would justify treating the corporation as agent and piercing the corporate veil to reach the principal but a different result would follow in each case. In the first, only a larger corporate entity would be held financially responsible...while, in the other, the stockholder would be personally responsible…”

The majority further found that the separate corporations in this case (being Mangan) were undercapitalized and the assets intermingled, with personal funds being shuttled in and out of the corporations without formality and to suit the immediate convenience of the stockholders, then such perversions of the corporate form would justify personal liability on the stockholders.

Accordingly, a corporation is not illicit or fraudulent because it consists of other corporations.

The dissenting opinion of Keating J. went in rather a different direction:

“…From their inception these corporations were intentionally undercapitalized for the purpose of avoiding responsibility for acts which were bound to arise as a result of the operation of a large taxi fleet...”

Keating J. found that not only were the corporations intentionally undercapitalized for the purpose of avoiding liability, income was also drained from the corporations continuously for that same purpose. Keating J. did not believe that the privilege of limited liability through the use of the corporate device should be abused no matter what the cost to the public. In his view if a corporation exists without sufficient capital to pay its debts, it is inequitable that the shareholders should sustain such an organization only to escape personal liability. From this perspective attempting to do business without financial coverage is an abuse of the existence of a separate entity and should not exempt the shareholders from personal liability. Keating J. believed the policy of the law ought to be that shareholders should, in good faith, have enough capital in the business to secure the corporation. Otherwise grounds exist for denying the privilege associated with being a separate entity.

Keating J. also pointed out cases standing for other related propositions:

1. The equitable owners of a corporation are personally liable when they treat the company’s assets as their own and add or withdraw capital at will, or when they provide inadequate capital and actively participate in the corporation’s affairs.

2. The sacrifice of limited liability happens when public policy must be defended or upheld. Fraud is part of this exception. Obvious inadequacy of capital is also considered to be a reason to deny the defense of limited liability.

3. When corporate income is not sufficient to cover unexpected liabilities or extraordinary bad times, obviously the shareholders will not be held liable. However they will be when the corporation was designed solely to abuse the corporate privilege at the expense of public interest.

Please read the Notes and Questions 2 & 4 at page 204 of the Casebook.

Blog Activity 4.6

In your view: what ought to be the measure of adequate capitalization?

And..

1. At which of the following points ought adequacy to be determined?

1. As of the time of trial?

It has been widely held that “some ‘wrong’ beyond a creditor’s inability to collect” must be shown before the veil will be pierced.  Absent this, time of trial would be tantamount to a rule of unlimited liability.  Creditor typically will pursue a veil piercing theory only where corporate assets are inadequate to meet its claim.

UNIT 4 (WEEKS 4 & 5): CORPORATE PERSONHOOD – SOME SPECIFIC ISSUES AND PROBLEMS

Figure 4: “Occupy Wall Street” protest

ALT: A sign is held up during the “Occupy Wall Street” protests in New York City which began September 17, 2011. The handwritten sign says: “IF CORPORATIONS ARE PEOPLE, THEN WHY CAN’T WE PUT THEM IN JAIL?”

Source of image - <a href="http://mulevariations.com/columns/trust-me-im-doctor/occupy-mule">http://mulevariations.com/columns/trust-me-im-doctor/occupy-mule</a>

UNIT OVERVIEW:

This unit will be devoted to exploring some of the limitations and conundrums, both legal and practical, which arise out of the assignment of “personhood” to the corporation and how does the law deal with them.  What are the limits to this idea?  Can other “non-persons” have legal personhood?  Can a chimpanzee?  Can corporations commit crimes and make contracts?  Do corporations have privacy rights, or the right to free speech, or religious freedom or other constitutional protections? Can a corporation be defamed? If you are driving in the HOV lane with only a copy of your certificate of incorporation in the passenger seat, are you violating the requirement that there be two persons in the car? In what circumstances and for what purposes may the personhood of a corporation be disregarded, whether by “piercing” or, as may appeal to some of the more prurient minded among you, “lifting” the “corporate veil’?  Are these the same thing?

In the end this unit prepares you to ask in a myriad of ways, what function does “personhood” perform in the analysis of legal problems relating to the corporation?

UNIT OUTCOME:

By the end of this unit you should be able to identify the core tensions arising from corporate personhood – and the profound contradictions which arise as a result and which the law must grapple with. The most obvious of these is the tug of war between shareholder financial expectations and management prerogatives. You will also understand, starting from the seminal case of Salomon v. Salomon how tempting it is for the courts to “pierce the corporate veil” and the inevitability of the connection between corporations being separate people and the countervailing force that is the doctrine of “piercing the veil”. Finally you will appreciate that the two forces and how frustrating it is in a legal sense that these two forces working against each other have not yielded and elegant yin and yang, but rather a messy set of legal doctrines that seem more whimsical than principled.

UNIT READINGS:

Please read the following material:

Casebook pages 83-91,134-226

BCBCA sections 30, 33, 136, 142, 227

Prest v. Petrodel 2013 UKSC 34 <a href="http://www.bailii.org/uk/cases/UKSC/2013/34.html">http://www.bailii.org/uk/cases/UKSC/2013/34.html</a>

373. Todd Henderson, “Everything Old Is New Again: Lessons from Dodge v. Ford Motor Company” (2007) U of Chicago Law & Economics, Olin Working Paper No. 373: <a href="http://www.law.uchicago.edu/files/files/373.pdf">http://www.law.uchicago.edu/files/files/373.pdf</a>

TOPIC 1: CORPORATIONS AND THE CHARTER

Please read pages 83-91 of the Casebook. The extent to which corporations enjoy the protections of the Charter is considered on these pages. There is little to add.

1. v. Agat Laboratories (1998) 17 C.R. 95th) 147 (Prov.Ct.) which is found at pages 84-88 of the casebook is generally accepted as describing the proper approach. The question in issue is whether s.7 of the Canadian Charter of Rights and Freedoms applies to corporations who, after all, are not natural persons. S.7 provides:

“Life, liberty and security of person

7. Everyone has the right to life, liberty and security of the person and the right not to be deprived thereof except in accordance with the principles of fundamental justice.”

Blog Activity 4.1:

Then please consider the questions in Notes 1 and 2 on page 88 of the Casebook.

How would you answer them?  Why would you answer them that way?

Please succinctly summarize the present state of the law on the rights of corporations to use Section 7 of the Charter. Please blog your summary in no more than one page under the heading called “Corporations and the Charter”.

As you should now be able to appreciate, the fiction of corporate personhood can potentially result in some very real confusions and contortions when it comes to legal analysis. Sometimes it feels like the approach is somewhat akin to “Companies are people, except when they are not”.

Query whether such legal stretching and contorting is really necessary to accommodate the fiction of corporate personhood, or whether alternative approaches may be possible.

Blog Activity 4.2

Please consider whether s. 30 of the BC Business Corporations Act could simply be eliminated and replaced by an inclusive list of rights, powers and privileges, but without invoking any form of “personhood”. Would this be advisable or useful? Why or why not?

“Capacity and powers of company

30. A company has the capacity and the rights, powers and privileges of an individual of full capacity.”

Please blog your views on this question and your reasons in no more than one page under the heading “Eliminating Corporate Personhood?”

TOPIC 2: Some practical consequences of “personhood”        

Please read pages 134-143 of the Casebook.

We have previously identified some of the practical consequences of “personhood” – e.g., corporation is the only proper plaintiff for a wrong done to it and that an individual shareholder cannot sue for an alleged pro rata share of losses derived from those suffered by the corporation – as in the Robak case.

Now start to explore some other implications

The material on pages 134-143 of the Casebook deals with some of these. 

Please refer to the questions on page 135 of the Casebook:

Question 1:

Principal shareholder and de facto controller testifies on behalf of corporate plaintiff.  Disbelieved.  Corporation still wins.  Should the corporation be deprived of costs because “it” lied?

Question 2:

Can a corporation be held in contempt of court for failure to comply with a court order? See Northern Counties Securities v. Jackson & Seeple, [1974] 2 All ER. 625 referenced in note 2 on page 135 of the Casebook.

Question 3:

Macaura v. Northern Assurance [1925] A.C. 619 at pages 135-137 of the Casebook.

Owner of timber sold it to a company that was owned almost solely by him. He was the company's largest creditor. In his own name he insured the timber against fire. Timber was in fact destroyed by fire. Insurer denied the claim on the basis that the timber now belonged to the company and not to the previous owner or to the largest shareholder in the company.

Their argument was that the company being in law a legal entity separate from shareholders had an insurable interest but held no policy. Mr. Macaura had a policy, but no insurable interest. This left him with only a debt due by the company as a result of the fire that destroyed the timber he had sold.

The House of Lords held this way, finding that “…Neither a simple creditor nor a shareholder in a company has any insurable interest in a particular asset which a company holds.”

Does this really make policy sense?

In thinking about this question note the words of Lord Buckmaster on where the benefits and burden lie (at p.136 of the Casebook). In this case all the benefits and burdens effectively fell on Mr. Macaura.

Suppose I am convinced that a building I have no interest in beyond that of any other citizen will collapse within a year.  I contract with an insurer to pay me $50K if it does.  Isn’t this just betting – my object is to make a windfall gain not to protect against loss. That situation is clearer then the Macaura case.

Might it be suggested that Macaura was wrongly decided because it’s definition of insurable interest is too narrow?

To try and answer you will have to ask yourself what the point of “insurable interest” is?

In an early case on the subject (Lucena v. Crawford (1806) 127 E.R. 471), one judge found that an insured could recover if she suffered “factual expectation of loss”.  Unfortunately, another judge in that case required that, in addition to “factual expectation of loss”, the plaintiff must also have a “legal or equitable interest” in the property. The test of  “legal or equitable interest” in the property is the one that prevailed. Under it for example, a lender who lent money for a construction project would have no insurable interest unless he had taken out a security interest in the property.

Which bring us to the important case of Kosmopoulos v. Constitution Insurance and how the separate corporate personality doctrine can have unintended and unforeseen consequences. The decision of the Ontario C.A. is found at page 137 of the Casebook.

Mr. Kosmopoulos was the sole shareholder and director of leather goods company. He originally ran that business as a sole proprietor and the lease for its office was in the name of Mr. Kosmopoulos, as was the insurance on office. His lease for the company office was under his own name from when he originally ran the business as a sole proprietor. Even after the incorporation of his company the insurance on the office remained in his own name. The insurance agency he was dealing with knew that he was personally on the lease but carrying on business as a corporation.  A fire in a neighboring lot damaged his office.

When a claim was made insurance coverage was denied.

The trial judge found that Mr. Kosmopoulos could not recover damages as the owner of the assets as the company, and not he, owned them. However he could recover as an insured because of his insurable interest in the building.

The Ontario Court of Appeal agreed, restricting the application of the Macaura precedent to cases involving multiple shareholders.

The Supreme Court of Canada upheld the ruling of the lower courts.

Wilson J. obseved that there was no consistent principle as to when a court may disregard separate personhood by “lifting the corporate veil” and regarding the company as a mere “agent” or a “puppet” of its controlling shareholder or a parent corporation”.  Though the corporate veil would not be lifted, Mr. Kosmopoulos as sole shareholder of the company was found to be so placed with respect to the assets of the business as to have benefit from their existence and prejudice from their destruction. He had a moral certainty of advantage or benefit from those assets but for the fire. He had, therefore, an insurable interest in them capable of supporting the insurance policy and is entitled to recover under it.

McIntyre J. preferred the approach of Zuber J. in the Ontario C.A.  That is that the Macaura rule should not be accepted to compel a holding that a sole shareholder and sole director of a company could not have an insurable interest in the assets of the Company. Underlying this conclusion is that modern company law permits the creation of companies with one shareholder. The identity then between the Company and that sole shareholder (and director) is such that an insurable interest in the Company's assets may be found in the sole shareholder.

Now please consider questions 2, 3 and 4 on page 140 of the Casebook.

Please read Lee v. Lee’s Air Farming at pages 140-142 of the Casebook which helps bring some clarity to the question of how to separate different roles in a corporate structure, even where they seemingly reside within the same physical being.

Mr. Lee formed a company, held nearly all its shares, was managing director, and a pilot. Lee appointed himself the chief pilot for the company, and in this way became in effect both employer and worker. The contract of employment was between him and the company, but in effect Mr. Lee both gave orders and obeyed them.

The New Zealand Courts held that the two offices were clearly incompatible. On appeal the Privy Council reversed finding that it was the company who gave the orders, not Mr. Lee personally.

Please read Notes 1-3 on page 142 of the Casebook.

Blog Activity 4.3

Please consider the hypothetical in Note 4 on page 142 of the Casebook. What do you think? Would “x” be able to avoid liability in by “springing out” the corporation in the scenarios provided?  Please blog your views on this question and your reasons in less than one page under the heading “Ambiguities of Corporate Personality”.

TOPIC 3: QUESTIONING THE PRINCIPLE - THE CORPORATE VEIL THEORY

Please Read Pages 143-149 Of The Casebook.

It is noteworthy that clear doctrines and explanations of when “the corporate veil” will be lifted are few and far between.

Since the decision in Salomon v. Salomon a steady stream of common law decisions and legislative enactments has eroded the immutability of the separate legal entity doctrine. These decisions and enactments are conveniently seen as ways to “lift or pierce the corporate veil”. Piercing seems to happen freakishly ... rare, severe and unprincipled - almost like lightning. This lack of clarity perhaps suggests that using a fiction such as “personhood” is a poor and impractical fit. This is not just a bit of critical analysis with some normative pedagogic purpose. Rather it may be the unifying thread of virtually all aspects of this course. Because the ethical reasons underlying the principle of separate corporate personality seem to not be particularly present, know or understood, we should perhaps not be surprised at the degree of judicial flailing and uncertainty that many of the cases we are studying seem to manifest.

What Little Is Clear Is That Limited Liability Is No Longer Sacrosanct: The Principle In Salomon's Case No Longer Rules.

See the quotation from Clarkson v. Zhelka [1967] 2 O.R. 565 (H.C.) at page 144 of the casebook:

“The cases in which the Courts…have seen fit to disregard the corporate entity or personality, and instead to consider the economic realities behind the legal façade, fall within a narrow compass. The Legislature, in the fields of revenue and taxation…has made much greater departure in this respect. Such cases as there are illustrate no consistent principle. The only principle laid down is that in the leading case of Salomon v. Salomon & Co. Ltd., [1897] AC 22; and in general such principle has been rigidly applied. Briefly stated, it is that the legal persona created by incorporation is an entity distinct from its shareholders and directors and that even in the case of a one-man company, the company is not an alias for the owner.

The exception would appear to represent refusals to apply the logic of the Salomon case where it would be flagrantly opposed to justice.

…If a company is formed for the express purpose of doing a wrongful or unlawful act, or, if formed, those in control expressly direct a wrongful thing to be done, the individuals as well as the company are responsible to those to whom liability is legally owed.”

Note Welling’s critique of this part of Clarkson as obiter dicta (at page 148 of the Casebook).

Note Sharpe J. statement in Transamerica Life v. Canada Life (1996) 28 O.R. (3d) 423 at 433-434 (which can be found at the pages 144-145 of the Casebook):

“There are undoubtedly situations where justice requires that the corporate veil be lifted…[I]t will be difficult to define precisely when the corporate veil is to be lifted, but that lack of a precise test does not mean that a court is free to act as it pleases on some loosely defined ‘just and equitable” standard…

[T]he courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct. The first element “complete control”, requires more than ownership. It must be shown that there is complete domination and that the subsidiary company does not, in fact, function independently…

The second element refers to the nature of the conduct: is there “conduct akin to fraud that would otherwise unjustly deprive claimants of their rights?” (References omitted.)

Note Welling at page 149 of the Casebook:

“Courts in Canada have yet to take the final step and acknowledge that they have no inherent power to pretend that a corporation does not exist. I suspect the reason is simple. Most barristers concede the judgers has power to “pierce the corporate veil”, then argue this is not an appropriate case in which to use the power. They are conceding too much and they are ignoring the clear wording of Canadian corporate statutes. It is time for someone to stand up and say “quo warranto?”

It is clear from commentators and judges that the immense confusion around when the “corporate veil’ is to be pierced relates directly to principle of Salomon v. Salomon and the separate personality of companies. This being so it is quite curious why the fiction of “corporate personhood” does not itself draw as much attention as it might. It is at least arguable that if we chose to dispense with the fiction that corporations are “persons”, we would more easily and clearly be able to identify and define permitted corporate action strictly in terms of what is permissible.

TOPIC 4: corporate personality in practice: some problem areas              

1. Corporate Character Traits

Please read extract from Welling at page 150 of the Casebook.

Please note in particular the last three sentences:

“A fully capable corporation may well have been born yesterday. Does the law permit us to look inside of the corporation’s equivalent of a family to establish a pattern of behaviour? A cautious “yes” can be advanced, provided the principle of corporate personality is not sacrificed.”

Please read Big Bend Hotel Ltd. v. Security Mutual (1980) 19 BCLR 102 at pages 150-152 of the Casebook.

This is an example of the corporate veil being lifted to prevent improper conduct or fraud.

Vincent Kumar was the president and sole shareholder of Big Bend Hotel Ltd. Big Bend had obtained insurance from Security Mutual on the hotel, its sole asset.  The hotel burned down.

Kumar had previously been the president and sole shareholder of another corporation whose hotel had burned less than three years earlier. This fact had not been disclosed to security Mutual.

The court held that this was a material non-disclosure.  It was found to be appropriate to lift the corporate veil here because equity will not allow an individual to use a co as a shield for improper conduct or fraud.

Callaghan J. found that Kumar knew the prior loss had to be disclosed and that his failure to do so was intended to mislead or deceive the insurers who would have declined risk had they known.

In other words the fact of a separate corporate entity was not allowed to interfere with the obligation to disclose, and the veil would be pierced to put the sole shareholder corporate president to the same standard he would be held to if no company existed as a shield.

Please read Note 1 at page 152 of the Casebook:

Wasn’t it enough to decide the case to conclude that had they known, the insurer would have declined risk?

Should the insurance company have had an application form that asked for disclosure not only from the company applicant but from all its principals.

Please read Note 3 at page 152 of the Casebook:

London Computer Operators Training Ltd and others v British Broadcasting Corporation and others  [1973] 2 All ER 170 deals with how separate corporate existence can have real impact on other legal areas, such as defamation.

Two speakers on BBC radio alleged that a computer school was “a financial racket”, that their advertising was misleading, and that the founder had “woeful” business record.  The school and two of its directors bought an action for libel against BBC Radio who pleaded justification (that the statements were in fact true) and fair comment.  The founder, who was still running the school, was not joined as a plaintiff. The defendants subsequently discovered that the founder had a criminal record and sought leave to amend their particulars of justification (truth) by adding details of his convictions and sentences.  Leave to amend was granted. The court found that the words complained of were capable of the meaning that the company was being run by people of questionable honesty and background who were unfit to run a computer school.

If the company is separate from its shareholder how is the shareholders criminal record of convictions and sentencing relevant to an action involving the company only, and not the shareholder?

Read Hercules Managements Ltd. v. Ernst & Young [1997] 2 S.C.R. 165 at page 155 of the Casebook

Two companies, Northguard Acceptance Ltd (‘NGA”) and Northguard Holdings Ltd. (‘NGH”) carried on business lending and investing money on the security of real property mortgages.  Hercules Managements Ltd. was a shareholder in NGA.  Ernst & Young were hired as auditors of NGH and NGA, prepared financial statements and provided audit reports to the companies’ shareholders. NGA and NGH went into receivership and Hercules Managements Ltd. sued Ernst & Young alleging that their audit reports had been negligently prepared.

Ernst & Young sought dismissal on the ground, inter alia, that the claims asserted by the plaintiffs could only properly be brought by the corporations themselves and not by the shareholders individually. La Forest J. agreed with Ernst & Young holding that “the shareholders’ reliance on negligently prepare audit reports…will result in a wrong to the corporation for which the shareholders cannot, as individuals, recover.”

Blog Activity 4.4

What is the policy justification for this result in your view? Please blog your views on this question and your reasons in less than one page under the heading  “Justifying Ernst & Young”.

1. Corporations as Agents and Partners

Please read pages 157-158 of the Casebook.

The question is: When is it appropriate to treat a company as being the agent or partner of its controlling shareholder?

Note that the parameters of partnership can be reviewed in Unit 3.

In this regard please read Smith, Stone & Knight Ltd. v. Birmingham Corp. [1939] 4 All E.R. 116 at page 158 of the Casebook.

Birmingham Corporation expropriated premises owned by a wholly‑owned subsidiary of Smith, Stone & Knight Ltd. (“SSK”). 497 of 502 issued shares in the subsidiary were held by SSK; the other 5 shares were held for SSK.  The subsidiary had no staff and no separate accounting records. The subsidiary was effectively treated as a department of SSK.

SSK claimed compensation for loss of business as a result of the expropriation.  Birmingham Council’s response was that the loss was suffered by subsidiary ‑ a separate legal entity and for that reason SSK’s claim should fail.

It was held that compensation was indeed payable by Birmingham to SSK. The court found that the subsidiary was carrying on no business of its own, but was in fact carrying on SSK’s business as agent.

The court identified six factors to be shown before agency found and veil lifted:

• Profits of the subsidiary must be treated as profits of the holding company;
• Those conducting the subsidiary's business must be appointed by the holding company;
• The holding company must be the head and brain of the trading venture;
• The holding company must be in control of the venture and must decide what capital should be spent and what should be done;
• The profits made by the subsidiary's business must be made by the holding company's skill and direction; and
• The holding company must be in constant and effective control.

Does this make sense? Are economic realities such that a group of companies trade as a group, raise capital as a group, and are viewed as a group by those dealing with them?

Should one attach obligations and responsibilities to the group and not to individual companies?

Lifting the corporate veil on the basis of agency involves examining the relationship between two or more separate legal entities and attributing the acts of one of the entities as the acts of the other entity.

The key issue involved in the case was whether the parent had suffered any loss as a result of the council's compulsory acquisition of the property, causing disturbance to the subsidiary's business. Atkinson J. decided that the relationship between the parent and subsidiary was really an agency relationship, with the business of the subsidiary being carried on an apparent basis only. The relevant facts were:

1. The directors of the parent were also directors of the subsidiary but did not take a salary from their positions on the subsidiary’s board;
2. The business purportedly carried on by the subsidiary company was purchased by the parent and never formally assigned to the subsidiary;
3. The subsidiary had no staff apart from a manager;
4. The subsidiary's books were kept and maintained by the parent and were not the property of the subsidiary or accessible by the manager of the subsidiary;
5. The work purportedly carried out by the subsidiary was beneficially owned by the parent without any agreement to transfer the business to the subsidiary; and
6. The subsidiary was treated for accounting purposes as if it were merely a department of the parent, including, significantly, appropriating the profits of the subsidiary for payment to the parent (by direct payment rather than dividend).

Smith, Stone & Knight Ltd. v. Birmingham Corp. [1939] 4 All E.R. 116 can be seen as a poor example of lifting the corporate veil on the basis of agency.  It is preferable not to use the case for the purpose of lifting the corporate veil for two reasons:

1. Maclaine Watson & Co Ltd v. Department of Trade and Industry [1988] 3 All ER 257 at 310-311 per Kerr LJ:

“…the facts [in Smith, Stone and Knight] were so unusual that they cannot form any basis of principle"

2. See Note 4 on page 159 of the Casebook:

“Is there any reason why corporate shareholders should be made to answer for the liabilities of the corporations in which they hold shares, to a greater degree than individual shareholders?”

Read Notes 7 and 8 on pages 159-160 including excerpts from the decision in DHN Food Distributors Ltd. v Tower Hamlets London Borough Council [1976] 1 W.L.R. 852  (Eng. CA).

DHN Food Distributors Ltd. (“DHN”) owned and controlled a business of importing and distributing groceries, operating out of a warehouse owned by a subsidiary of DHN, Bronze Investments Ltd.  Vehicles used in the business were owned by yet another subsidiary of DHN. DHN held all the shares in both subsidiaries and the companies had common directors.

In 1969 the local council made a compulsory purchase order to acquire the land on which the warehouse sat.  DHN was unable to relocate and the business subsequently closed down.

The question was whether DHN was entitled to compensation for disturbance in having the business closed down. Council argued none payable since the subsidiary was not disturbed. They further argued that even if both subs were disturbed, the subsidiaries were not entitled to any compensation because they had no interest in the land. Moreover the argument continued,  DHN itself was not entitled to compensation under the provisions of a statute. The council argued that DHN was only a licensee of Bronze Investments Ltd.

The English Court of Appeal treated the companies as one economic entity and following from this, DHN could be treated as owner of the property and was thus entitled to compensation for disturbance to its business.

Lord Denning found that the corporate veil could indeed be lifted – finding that the companies were in reality a group, and should be treated as one. 

“These subsidiaries are bound hand and foot to the parent company and must do what the parent company says … virtually the same as a partnership … They should not be treated separately.”

This notion is not so easily reconcilable with other cases. Denning’s views were disapproved by the House of Lords in Woolfson v Srathclyde Regional Council, 1978 SC 90 (HL). There Lord Keith expressed doubt as to whether the decision in DHN correctly applied the principle that it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere facade concealing the true facts

TOPIC 5: CORPORATE PERSONALITY - SOME INNOVATIVE APPROACHES                  

Please read the short web article “Corporation not person in carpool lanes” which can be found at <a href="http://www.sfgate.com/bayarea/article/Corporation-not-person-in-carpool-lanes-4173366.php">http://www.sfgate.com/bayarea/article/Corporation-not-person-in-carpool-lanes-4173366.php</a>

Then please read page 160 of the Casebook:

“Judges have rarely been clear when explaining how corporate personality works. This is due in part to the facile notion that they are at liberty to disregard the separate existence of the corporate entity. There are, however, some reported cases that clearly illustrate the application of some well-known remedies, mostly in tort situations, but some from the field of equity.  Using them as examples one can formulate a principled approach that treats corporate personality as a solution rather than a problem.”

1. Inducing Breach of Contract

Please read Garbutt Business College Ltd. v. Henderson Secretarial School Ltd. [1939] 4 D.L.R. 151 (Alta. C.A.) at pages 161-162 of the Casebook. It helps illustrate yet another way that “separate” corporate personality might be manipulated in an attempt to evade responsibility.

Henderson a teacher was subject to a restrictive covenant governing employment. It specifically restrained him from engaging in or managing a rival business college for 5 years.  He resigned and started a rival college that used his name and employed him to teach.  He held all but 3 shares. His wife and daughter held those 3 shares. Garbutt Business College Ltd. lost students to new college.

The court upheld the restrictive covenant against Mr. Henderson but found there could be no corporate liability as against Henderson Secretarial School Ltd. in the contract. Any such liability must be in tort, and accordingly the court found liability against Henderson Secretarial School Ltd. in damages for interference with business relations and inducing breach of contract between Mr Henderson and Garbutt Business College Ltd.

Please note Questions 1 and 3 on pages 162-163 of the Casebook

1.This question is in effect: What if Henderson only incorporated a rival entity using his name but did not teach or manage?

3. In looking at this question consider the facts in Jones v. Lipman [1962] 1 WLR 832. In that case Mr. Lipman contracted to sell a house to Jones for £5,250. He changed his mind and refused to complete. To try and avoid specific performance, he conveyed the house for £3000 to a company formed for that purpose alone, which he alone owned and controlled. In the end specific performance against Mr. Lipman and his company was ordered: “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.”

In this regard please consider the following excerpt’s from Lord Sumption’s judgment in Prest v. Petrodel 2013 UKSC 34 (especially paragraph 30 on Jones v. Lipman) which can be found here: <a href="http://www.bailii.org/uk/cases/UKSC/2013/34.html">http://www.bailii.org/uk/cases/UKSC/2013/34.html</a>

As you will see Lord Sumpton of the United Kingdom Supreme Court had the following observations:

“27. In my view, the principle that the court may be justified in piercing the corporate veil if a company's separate legal personality is being abused for the purpose of some relevant wrongdoing is well established in the authorities….[T]he recognition of a limited power to pierce the corporate veil in carefully defined circumstances is necessary if the law is not to be disarmed in the face of abuse…

28. The difficulty is to identify what is a relevant wrongdoing. References to a "facade" or "sham" beg too many questions to provide a satisfactory answer. It seems to me that two distinct principles lie behind these protean terms, and that much confusion has been caused by failing to distinguish between them. They can conveniently be called the concealment principle and the evasion principle. The concealment principle is legally banal and does not involve piercing the corporate veil at all. It is that the interposition of a company or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming that their identity is legally relevant. In these cases the court is not disregarding the "facade", but only looking behind it to discover the facts which the corporate structure is concealing. The evasion principle is different. It is that the court may disregard the corporate veil if there is a legal right against the person in control of it which exists independently of the company's involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement. Many cases will fall into both categories, but in some circumstances the difference between them may be critical. This may be illustrated by reference to those cases in which the court has been thought, rightly or wrongly, to have pierced the corporate veil.”…
29. Jones v Lipman [1962] 1 WLR 832 was a case of very much the same kind. The facts were that Mr Lipman sold a property to the plaintiffs for £5,250 and then, thinking better of the deal, sold it to a company called Alamed Ltd for £3,000, in order to make it impossible for the plaintiffs to get specific performance. The judge, Russell J, found that company was wholly owned and controlled by Mr Lipman, who had bought it off the shelf and had procured the property to be conveyed to it "solely for the purpose of defeating the plaintiffs' rights to specific performance." About half of the purchase price payable by Alamed was funded by borrowing from a bank, and the rest was left outstanding. The judge decreed specific performance against both Mr Lipman and Alamed Ltd. As against Mr Lipman this was done on the concealment principle. Because Mr Lipman owned and controlled Alamed Ltd, he was in a position specifically to perform his obligation to the plaintiffs by exercising his powers over the company. This did not involve piercing the corporate veil, but only identifying Mr Lipman as the man in control of the company. The company, said Russell J portentously at p 836, was "a device and a sham, a mask which [Mr Lipman] holds before his face in an attempt to avoid recognition by the eye of equity." On the other hand, as against Alamed Ltd itself, the decision was justified on the evasion principle, by reference to the Court of Appeal's decision in Gilford Motor Co. The judge must have thought that in the circumstances the company should be treated as having the same obligation to convey the property to the plaintiff as Mr Lipman had, even though it was not party to the contract of sale. It should be noted that he decreed specific performance against the company notwithstanding that as a result of the transaction, the company's main creditor, namely the bank, was prejudiced by its loss of what appears from the report to have been its sole asset apart from a possible personal claim against Mr Lipman which he may or may not have been in a position to meet. This may be thought hard on the bank, but it is no harder than a finding that the company was not the beneficial owner at all. The bank could have protected itself by taking a charge or registering the contract of sale.” (Emphasis added.)

The next few cases should help you bring separate corporate personality into focus as applied to the rough and tumble of “modern” business dealings.

Please read Einhorn v. Westmount Invesments Ltd. (1969), 6 D.L.R. (3d) 71 at pages 164-166 of the Casebook.

This was an application to strike out a Statement of Claim. Accordingly the facts alleged did not have to be proven in this limited context.

Jacob Einhorn was a licensed real estate agent who provided services to Westmount Investments Ltd. a company that three brothers, Hyman, William and Samuel Belzberg, were “at all material times in complete control” of. Westmount Investments Ltd. never paid Mr. Einhorn what he was owed. It was alleged that instead the Belzberg brothers “siphoned off the assets” of Westmount Investments Ltd. to another company they controlled Regina Midtown Centre Ltd.  leaving Westmount an empty shell incapable of satisfying its contract with Mr. Einhorn.

Note that neither the Belzberg’s nor Regina Midtown Centre Ltd. induced a breach of contract (as was the case in Garbutt Business College Ltd. v. Henderson Secretarial School Ltd.), they just prevented Westmount Investments Ltd. from executing their contract with Mr. Einhorn.

The court considered whether the Belzberg brothers could be individually liable. The answer was yes, because they met the test for the tort of interference with contractual relations. This was because it appeared that the Belzberg brothers interfered with Westmount’s performance of the contract and each of the parties to a contract have a right to performance of it. There are three ingredients to the tort:

1. Interference in execution of contract: This interference is not confined to breach of contract; it extends to case where a third person prevents or hinders a party from performing the contract.
2. The interference must be deliberate.
3. The interference must be direct.

Please also read McFadden v. 481782 Ontario Ltd., (1984), 47 O.R. (2d) 134 (H.C.) at page 166 of the Casebook.

In this case two directors authorized payments to themselves as shareholders that put the corporation in a position where it could not fulfill its contractual obligations to an employee. The employee sued the directors on the basis that they induced the corporation to breach its contract with him.

It was held that the directors were liable. They acted with a view to their own interests not those of the company.

They are not protected, therefore, by the exception to the rule in Said v. Butt that they would be excused if they were acting "under the compulsion of a duty to the corporation." The court held that the directors could not fall within the exception Said v. Butt [1920] 3 K.B. 497 that: “…if a servant acting bona fide within the scope of his authority, procures or causes me to break a contract that I have made with you, you cannot sue the servant for interference with the contract; for he is my alter ego, and I cannot be sued for inducing myself to break a contract.” This exception effectively ensures officers and directors can terminate employment contracts without fearing personal liability and also that companies can terminate contracts that may no longer be in their best interests to fulfill.

However, in McFadden v. 481782 Ontario Ltd. the exception did not apply since the Directors were acting with a view to their own interests and not those of the corporation. Accordingly they could not be said to be acting under the compulsion of a duty to the corporation. That is to say that for an officer or director to be relieved from the consequences of his act of inducement, it is because he acts under the compulsion of a duty.  Where she or he does not, for example because of a failure to act bona fide and hence outside the scope of their authority, liability to that Director will result.  The corporation in question ought to be unaffected precisely because the Directors were acting outside the scope of their authority,

Please read the Questions at pages 169-170 of the Casebook and then ask yourself the following questions:

1. What was the conduct that induced the breach in McFadden v. 481782 Ontario Ltd.?
2. Is it a sound principle that a director who fails to act in the best interests of the corporation ceases to act on behalf of the corporation? Should the fact that the Director acts in breach of their obligation to the corporation have any relevance to the rights of an employee?

Please read 369413 Alberta Ltd v. Pocklington (2000) 194 D.L.R. (4^th) 109 (Alta. C.A.) at pages 171-178 of the Casebook.

Gainers was one of Canada’s largest meat-packing companies. In acute financial distress, Gainers breached an agreement it had with the Province of Alberta. Peter Pocklington owned Pocklington Foods Inc. which held shares in Gainers.   Alberta opted to sue Gainer’s sole director, Peter Pocklington alleging that Pocklington had “induced” the breach by signing a director’s resolution transferring certain shares in another company owned by Gainers (valued in the millions) to another of his own companies, Pocklington Holdings Ltd., for $100.  Gainers had earlier agreed not to sell or dispose of its assets without the prior written consent of the Province of Alberta.

The Court awarded the Province $4.7 million in damages as against Pocklington.

Fruman J.A. set out various elements of the case as follows:

“ELEMENTS OF INDUCING BREACH OF CONTRACT

In order to find that a defendant intentionally induced a breach of contract, seven elements must be established:

1. i) the existence of a contract;
2. ii) knowledge or awareness by the defendant of the contract;

iii) a breach of the contract by a contracting party;

1. iv) the defendant induced the breach;
2. v)  the defendant, by his conduct, intended to cause the breach;
3. vi)  the defendant acted without justification; and

vii) the plaintiff suffered damages…

INTENT

The Law

…Therefore, if the breach was a reasonable or foreseeable consequence of that transfer, or alternatively, if Pocklington completed the transfer recklessly, was wilfully blind to its consequences, or was indifferent as to whether or not it caused a breach, the necessary intent element for the tort will be met.

The Evidence

…The clear implication of Ogilvie and Company’s carefully worded letter is that either the lawyers did not share their clients’ views, or they were invited to keep their legal advice to themselves. Pocklington nevertheless signed the documents to give effect to the share transfer, and retained the shares despite Alberta’s early protests and Ogilvie and Company’s apparent reservations. He had the means of knowledge, but chose to act without legal advice. Pocklington was wilfully blind to the consequences of his actions and showed clear indifference to the breach. The intent component of the tort is satisfied.

JUSTIFICATION

In some situations, a defendant’s plea of justification may avoid liability: South Wales Miners’ Federation, supra, and Quinn, supra. The defence of justification is available when the defendant caused the breach while acting under a duty imposed by law. The issue in each case is whether, upon consideration of the relative significance of all the factors, the defendant’s conduct should be tolerated despite its detrimental effect on the interests of others: Fleming, supra, at 657.

Directors of companies owe duties to the corporation; they are obliged both at common law and under Statute to act in the best interests of the company: Re Cawley & Co. (1889), 42 Ch. 209 at 233 (C.A.). For example, s. 117(1)(a) of the ABCA provides: “Every director and officer of a corporation in exercising his powers and discharging his duties shall act honestly and in good faith with a view to the best interests of the corporation [...] ”.

Therefore, when the interests of the company are best served by breaking its contractual commitments, the director’s act of inducement is justified because it is “taken as a duty”… 

But if the director is not complying with that duty, the rationale for relieving personal liability disappears…

In order to succeed under the Imperial Oil test, a plaintiff must prove that the director knew the legal rights of others would be jeopardized by the director’s actions, and intended to deprive the aggrieved party of contractual benefits… 

The concerns expressed in Imperial Oil are not misplaced. In order to protect the fine fabric of the corporate veil, courts should refrain from requiring directors to prove the legitimate corporate purpose motivating their actions. However, courts also should not condone inappropriate conduct by automatically placing a difficult onus on a plaintiff, by reason only that the defendant director owed legal duties to the company whose contract he had a hand in breaching. Some balance is required…

In this case Pocklington acquired a valuable asset for nominal consideration at the expense of Gainers’ creditors. Since Gainers was insolvent at that time, its creditors’ interests were the interests of the company. Promoting the interests of one shareholder at the expense of the creditors is not in the best interests of the company: Levy-Russell at 169. A director who pursues these objectives is not acting in furtherance of his corporate duty, and there is no justification for his deeds.

Pocklington has not demonstrated any legitimate business interest of Gainers that could have been served by the 350151 share transfer…

By transferring the 350151 shares to his own company, Pocklington was not discharging his legal duty to act honestly and in good faith with a view to the best interests of Gainers; he was acting solely in his own interests. As no legitimate interest of Gainers could possibly be served by the transaction, the court need not go on to consider whether Pocklington’s act was aimed at depriving Alberta of the benefits of its contract. Pocklington’s position as director cannot provide justification for his actions.”

(Emphasis added.)

Blog Activity 4.5

In your view is the Pocklington decision consistent with, among others, the McFadden decision? Please blog your views on this question and your reasons in less than one page under the heading “Pocklington & McFadden”.

Please read Adga Systems International Inc. v. Valcom Ltd. (1999) 43 O.R. (3d) 101 (Ont. C.A.) at pages 178-183 of the Casebook.

Note that this case represents a significant shift in the spectrum of directors’ liability/personal liability imposed on officers and directors for actions taken in the course of their duties.

The plaintiff, Adga Systems sued their competitor Valcom Ltd., as well as Valcom’s sole director in his personal capacity and two senior employees of Valcom in their personal capacity. Adga alleged that Valcom had raided its employees and caused Adga economic damage. Adga sought damages for inducing breach of contract and inducing breach of fiduciary duty. The Ontario Divisional Court dismissed the claim against the three personal defendants holding that, since the employees of Valcom Ltd. were not furthering their own interests and were pursuing their duties of employment to further the interests of their employer, no cause of action was revealed which justified a trial. The plaintiff Adga appealed to the Ontario Court of Appeal.

Adga’s appeal was allowed and the three personal defendants, being the Director of Valcom and two employees of Valcom were reinstated as defendants. Carthy J.A. focussed on the issues as follows:

“The issue that I must deal with is whether, on the assumption that the defendant Valcom committed a tort against the appellant, the sole director and employees of Valcom can be accountable for the same tort as a consequence of their personal involvement directed to the perceived best interests of the corporation…

However, where, as here, the plaintiff relies upon establishing an independent cause of action against the principals of the company, the corporate veil is not threatened and the Salomon principle remains intact…

It is my conclusion that there was no principled basis for protecting the director and employees of Valcom from liability for their alleged conduct on the basis that such conduct was in pursuance of the interests of the corporation. It may be that for policy reasons the law as to the allocation of responsibility for tortious conduct should be adjusted to provide some protection to employees, officers or directors in the limited circumstances where, for instance, they are acting in the best interests of the corporation with parties who have voluntarily chosen to accept the ambit of risk of a limited liability company. However, the creation of such a policy should not evolve from the facts of this case where the alleged conduct was intentional and the only relationship between the corporate parties was as competitors.” (Emphasis added.)

Please read Note 2 at page 183 of the Casebook: What is result if directors must choose between (1) inducing breach of contract because it is in the best interests of the company and (2) acting contrary to the company’s best interests so to avoid inducing breach?

In this regard please note the discussion on page 181 of the Casebook regarding the SCC decision in London Drugs v. Kuehne & Nagel:

“ The Supreme Court of Canada again considered the issue of an employee's liability for acts done in the course of his duties on behalf of the employer in London Drugs Ltd. v. Kuehne & Nagel International Ltd., <a href="http://www.canlii.org/en/ca/scc/doc/1992/1992canlii41/1992canlii41.html">1992 CanLII 41 (SCC)</a>, [1992] 3 S.C.R. 299, 97 D.L.R. (4th) 261. The plaintiff delivered a transformer to a warehouse company for storage. An employee of the warehouse company negligently permitted the transformer to topple over, causing extensive damage. Even though there was a contractual relationship between the company and the customer, the majority held in favour of the claim against the employee.

Iacobucci J. stated at pp. 407-08:

There is no general rule in Canada to the effect that an employee acting in the course of his or her employment and performing the "very essence" of his or her employer's contractual obligations with a customer does not owe a duty of care, whether one labels it "independent" or otherwise, to the employer's customer. . . .

…The mere fact that the employee is performing the "very essence" of a contract between the plaintiff and his or her employer does not, in itself, necessarily preclude a conclusion that a duty of care was present.”

Please read Note 6 at page 184 of the Casebook: Is there a different standard of liability of employees and directors where each acts within scope of duties?

1. Knowing Assistance in a Breach of Trust

Please read Air Canada v. M & L Travel Ltd.       [1993] 3 S.C.R. 787 at pages 184-191 of the Casebook.

M&L Travel Ltd., the directors of which were Mssrs. Martin and Valliant, was a travel agency.  It had an agreement with Air Canada under which M&L Travel Ltd. was to hold proceeds of ticket sales in trust for Air Canada.  M&L Travel Ltd. in fact did not hold the proceeds in trust as agreed but rather used them for general operating expenses as M&L found itself in financial difficulties.

Air Canada sued (1) the travel agency, and (2) both directors personally for the money owed to it for ticket sales.

Air Canada’s action succeeded against M&L Travel Ltd. but failed against the Directors Mssrs. Martin and Valliant. Accordingly Air Canada successfully appealed the decision holding the Directors not to be personally liable and judgment was entered against them as well.

The matter came before the Supreme Court of Canada. At issue was:  (1) whether the relationship between M&L Travel Ltd. and Air Canada was one of trust, or one of debtor and creditor? and (2) if of trust, under what circumstances could the directors of a corporation be held personally liable for breach of trust by the corporation - and were those circumstances present here.

Although involving a corporation, the case fell to be resolved on trust principles, and does not raise general questions of the personal liability of directors for the acts of the corporation.

(1) The Supreme Court of Canada held that there was a trust relationship between M&L Travel Ltd. and Air Canada.

(2) With respect to the personal liability of directors the Supreme Court of Canada was of the view that the imposition of personal liability on a stranger to a trust depends on whether the stranger's conscience is sufficiently affected to justify the imposition of personal liability. A stranger to the trust can be held liable as a constructive trustee for breach of trust (trustee de son tort).  The stranger, although not appointed a trustee, takes on him or herself to act as trustee and to possess and administer trust property and becomes liable if he or she commits a breach of trust while acting as a trustee. This type of liability was found to be inapplicable in the case of M&L Travel Ltd. v. Air Canada because the directors did not personally take possession of trust property or assume the office or function of trustees.

The court pointed out that strangers to a trust could also be personally liable for breach of trust if they knowingly participate in a breach of trust.  They either were acting as a trustee in receipt and chargeable with trust property (a constructive trusteeship termed "knowing receipt") or they knowingly assisted in a dishonest and fraudulent design on the part of the trustees (termed "knowing assistance").  Since the "knowing receipt" category did not apply here, the only basis upon which the directors could be held personally liable were as constructive trustees under the "knowing assistance" head of liability.  This basis of liability raises two main issues:  the nature of the breach of trust and the degree of knowledge required of the stranger.

The knowledge requirement for this "knowing assistance" type of liability is actual knowledge; recklessness or wilful blindness will suffice.  A person will be deemed to have known of the trust if it was imposed by statute.  If the trust was contractually created, then whether the stranger knew of the trust will depend on his or her familiarity or involvement with the contract.

The stranger will be liable if he or she knowingly assisted the trustee in a fraudulent and dishonest breach of trust.  Therefore, it is the corporation's actions that must be examined.  Where the trustee is a corporation, rather than an individual, the inquiry as to whether the breach of trust was dishonest and fraudulent may be more difficult to conceptualize, because the corporation can only act through human agents who are often the strangers to the trust whose liability is in issue.  The actions of the directors were relevant to the examination, given the extent to which the defendant directors controlled the travel agency.

The breach of trust by the travel agency was dishonest and fraudulent from an equitable standpoint.  The taking of a knowingly wrongful risk resulting in prejudice to the beneficiary is sufficient to ground personal liability.  As a party to the contract between itself and Mr. Martin, M&L Travel Ltd. knew that the Air Canada monies were held in trust, and were not for the general use of the travel agency.  It set up trust accounts, but never used them.  It also knew that any positive balance in its general account was subject to the Bank's demand.  By placing the trust monies in the general account that was then subject to seizure by the Bank, the travel agency took a risk to the prejudice of the rights of the beneficiary, Air Canada.  It had no right to take this risk.

It was found clearly that the appellant directors participated or assisted in the breach of trust.  There were dealing with the funds in question ‑‑ stopping payment on all cheques, opening a trust account, and attempting to withdraw the stop payment orders and to transfer the funds into a new trust account.  The breach of trust was directly caused by the conduct of the defendant directors.  Their actions in stopping payment on the cheques to protect their own interests not only prevented payment on cheques issued to Air Canada but also precipitated the seizure by the Bank of the only funds available in the unprotected general account.

Accordingly the court found that directors personally liable for breach of trust as constructive trustees.

Please read Transamerica Life Insurance Co. v. Canada Life Assurance Co. (1996), 28 O.R. (3d) 423 (Ontario Gen. Div.) at pages 192-198 of the Casebook.                  

The defendant Canada Life Mortgage Services Ltd. (“CLMS”) was a wholly owned subsidiary of the defendant Canada Life Assurance Company. CLMS was incorporated by Canada Life Assurance Company to carry on the business of mortgage correspondent and general financial agent to deal with both Canada Life Assurance Company as well as other institutional investors. CLMS had its own head office and branch offices distinct from those of the Canada Life Assurance Company.  Those offices were managed and operated independently of the Canada Life Assurance Company. The management of CLMS exercised independent discretion in conducting its business.

A number of the mortgage loans made by the plaintiff Transamerica Life Insurance Company of Canada that had been arranged by CLMS fell into default. The plaintiff Transamerica Life Insurance Company of Canada claimed that CLMS owed it a duty to do the underwriting for these loans, that it failed in that regard, and that Transamerica Life had suffered loss as a consequence. The terms of the Master Agreement that governed the relationship of the plaintiff Transamerica Life and CLMS did not specifically provide that CLMS was to perform any underwriting function on Transamerica Life’s behalf, and CLMS took the position that the agreement excluded this duty.

Transamerica Life sued CLMS for damages for breach of contract, breach of fiduciary duty, fraud, misrepresentation and negligence. Transamerica Life also sued Canada Life Assurance Company, asserting that it was liable for the wrongs of CLMS.

Canada Life Assurance Company moved for summary judgment dismissing the action against it.

It was held that the motion should be granted and the action against Canada Life Assurance Company be dismissed.

Transamerica Life relied on Kosmopoulos  in arguing that the court should lift the corporate veil whenever it was "just and equitable" to do so. Sharpe J. rejected this approach finding that lifting the corporate veil whenever it was "just and equitable" to do so  would represent a significant departure from the following principle established in Salomon:

“The company is at law a different person altogether from the subscribers to the memorandum; and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act.” (at page 195 of the Casebook).

Sharpe J. then quotes Gower, Modern Company Law 5^th ed. (1992):

“There seem to be three circumstances only in which the courts can [pierce the veil]. These are:

1. When the court is construing a statute, contract or other document;
2. When the court is satisfied that a company is a "mere facade" concealing the true facts; and
3. When it can be established that the company is an authorized agent of its controllers or its members, corporate or human.” (At page 196 of the Casebook)

Then Sharpe J. concludes:

“... the courts will disregard the separate legal personality of a corporate entity where it is completely dominated and controlled and being used as a shield for fraudulent or improper conduct. The first element, "complete control", requires more than ownership. It must be shown that there is complete domination and that the subsidiary company does not, in fact, function independently.... The second element relates to the nature of the conduct: is there "conduct akin to fraud that would otherwise unjustly deprive claimants of their rights?” (At page197 of the Casebook)

Accordingly, Transamerica's claim against Canada Life was dismissed

TOPIC 6: THE PARTICULAR PROBLEM OF THIN CAPITALIZATION   

Please read pages 198-199 of the Casebook.

Companies have no minimum capitalization requirement in Canada. Often new corporations are created with one share valued at only $1. Thin capitalization refers to the situation where a corporation is established with high debt to equity ratio. Assuming that debt is normally secured, if something goes wrong there is no one protected except the secured creditors. In other words, in thinly capitalized companies trade creditors are very much at risk.

The question to be considered is whether thin capitalization, per se, should be a ground for lifting the corporate veil? Is it legitimate evidence where owners seek the benefit of limited liability without paying for it with adequate capital investment?

To understand what thin capitalization can look like in practical terms begin by reading the U.S. case of Walkovszky v. Carlton 18 N.Y. 2d 414 (Ct. App. 1966) at pages 199-204 of the Casebook.    

The facts are that the plaintiff Walkovszky was hit by a taxicab owned by the Seon Cab Corporation and sued. Carlton was a stockholder of ten corporations, including Seon, each of which had two cabs registered to its name and only minimal insurance. This was a rather common practice at the time in the taxicab industry.

Walkovszky claimed that although seemingly independent, the companies in fact operated as a single entity with regard to financing, supplies, repairs, employees and garaging and all of the companies are named as defendants. Walkovszky further argued that he was entitled to hold the stockholders personally liable for the damages sought because the multiple corporate structures constituted an unlawful attempt to defraud members of the general public who might be injured by the cabs.

Carlton’s motion to dismiss Walkovszky’s case was granted.

The issue in the case was whether Carlton could be held personally liable in this case and the majority of the court held that Carlton could not be held personally liable.

Fuld J. observed that incorporation of a business is permitted for the purpose of enabling its proprietors to escape personal liability. However, one can “pierce the corporate veil” when anyone uses control of the corporation to further his own rather than the corporation’s business.

That is to say that the courts will pierce the corporate veil whenever necessary in order to prevent fraud or inequity. In determining whether to lift the veil the court is to be guided by “general rules of agency.” Whenever a person uses the corporation to further his own interests as opposed to those of the corporation, he will be liable for the corporation’s acts.  This liability is not just for the corporation’s dealings, but also as regards its negligence.

Here, while the complaint alleges that the separate corporations were undercapitalized and that their assets have been intermingled, it failed to mention that the defendant Carlton and his associates were actually doing business in their individual capacities, shuttling their personal funds in and out of the corporations without regard to formality.

The majority felt that if the insurance coverage required by statute was inadequate for the protection of the public, the remedy was not with the courts but with the Legislature.

In a similar case (Mangan) it was proved that operating companies existed only for the purpose of allowing the defendant to avoid the weight of the financial responsibilities and other liabilities. “However, it is one thing to assert that a corporation is a fragment of a larger corporate combine which actually conducts the business…It is quite another to claim that the corporation is a “dummy” for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends. Either circumstance would justify treating the corporation as agent and piercing the corporate veil to reach the principal but a different result would follow in each case. In the first, only a larger corporate entity would be held financially responsible...while, in the other, the stockholder would be personally responsible…”

The majority further found that the separate corporations in this case (being Mangan) were undercapitalized and the assets intermingled, with personal funds being shuttled in and out of the corporations without formality and to suit the immediate convenience of the stockholders, then such perversions of the corporate form would justify personal liability on the stockholders.

Accordingly, a corporation is not illicit or fraudulent because it consists of other corporations.

The dissenting opinion of Keating J. went in rather a different direction:

“…From their inception these corporations were intentionally undercapitalized for the purpose of avoiding responsibility for acts which were bound to arise as a result of the operation of a large taxi fleet...”

Keating J. found that not only were the corporations intentionally undercapitalized for the purpose of avoiding liability, income was also drained from the corporations continuously for that same purpose. Keating J. did not believe that the privilege of limited liability through the use of the corporate device should be abused no matter what the cost to the public. In his view if a corporation exists without sufficient capital to pay its debts, it is inequitable that the shareholders should sustain such an organization only to escape personal liability. From this perspective attempting to do business without financial coverage is an abuse of the existence of a separate entity and should not exempt the shareholders from personal liability. Keating J. believed the policy of the law ought to be that shareholders should, in good faith, have enough capital in the business to secure the corporation. Otherwise grounds exist for denying the privilege associated with being a separate entity.

Keating J. also pointed out cases standing for other related propositions:

1. The equitable owners of a corporation are personally liable when they treat the company’s assets as their own and add or withdraw capital at will, or when they provide inadequate capital and actively participate in the corporation’s affairs.

2. The sacrifice of limited liability happens when public policy must be defended or upheld. Fraud is part of this exception. Obvious inadequacy of capital is also considered to be a reason to deny the defense of limited liability.

3. When corporate income is not sufficient to cover unexpected liabilities or extraordinary bad times, obviously the shareholders will not be held liable. However they will be when the corporation was designed solely to abuse the corporate privilege at the expense of public interest.

Please read the Notes and Questions 2 & 4 at page 204 of the Casebook.

Blog Activity 4.6

In your view: what ought to be the measure of adequate capitalization?

And..

1. At which of the following points ought adequacy to be determined?

1. As of the time of trial?

It has been widely held that “some ‘wrong’ beyond a creditor’s inability to collect” must be shown before the veil will be pierced.  Absent this, time of trial would be tantamount to a rule of unlimited liability.  Creditor typically will pursue a veil piercing theory only where corporate assets are inadequate to meet its claim.

1.   At the time of incorporation?