Lifting the corporate veil Essay Example

  • Category:
    Law
  • Document type:
    Assignment
  • Level:
    Undergraduate
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    5
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    3123

City and State Where Institution is Located

Introduction

A company is covered by the veil of incorporation and this veil remains in place except in exceptional circumstances. For example, a director of a company that is wound up because it is insolvent can be made personally liable for such of its debts as the court sees fit, if there has been wrongful trading or fraudulent trading. This essay discusses the directors’ potential personal liabilities for acts of fraud and mismanagement under both UAE and UK’s company laws. In so doing, reference is made to various legal provisions under both the jurisdictions for instance the UK insolvency act of 1986 and the new UAE Commercial Company Law, 2015. The essay starts with a brief definition of what the meaning of lifting the corporate veil is. The essay also discusses in detail the issue of wrongful trading and fraudulent trading and how the directors may be accused of wrongful and fraudulent trading thus resulting in lifting of the corporate veil. The essay will also compare laws regarding wrongful and fraudulent trading under the English system and the UAE system. In so doing, the essay is expected to shed light on lifting of corporate veil with regard to wrongful and fraudulent trading.

The corporate veil

At times, courts have to deal with the issue of whether a company is an independent legal entity in cases where parties try to recover from opponents and it has been discovered that the contracting party has been used as a brass plate company with no assets but part of a bigger profitable group (Taylorwessing, 2016). The courts usually apply the strict principle of independent corporate existence as held in Salomon v Salomon Co LTD (1982) AC 22 and hence courts regard companies as being separate from its members and hence the veil is not pierced. Thus, the doctrine of corporate veil. Thus, corporate veil implies that on a strict application of the law, the shareholders of a limited liability company cannot be held liable for the acts or omissions of the entity in which they hold shares beyond their shareholding. Furthermore, the directors cannot be held personally liable for their actions as company directors. Both under UAE and UK jurisdictions, the concept of the corporate veil holds that a company has separate legal personality implying that its assets and liabilities are separate from the assets and liabilities of the shareholders. However, the veil may be lifted or pierced where the separation of the personality of a company and its shareholders is not maintained. For instance, the corporate veil may be lifted in case of wrongful trading or fraudulent trading when the company faces liquidation. However even then, certain legal provisions have to be adhered to as will be discussed below.

Wrongful trading and fraudulent trading

As stated above, the corporate veil may be lifted in circumstances where an insolvent company is guilty of either wrongful trading or fraudulent trading. A company which has already been served with a winding up petition will for instance be at increased risk of being accused of wrongful trading where the company continues to carry on business while insolvent. This is in line with the provisions of articles 214 of the UK’s insolvency act of 1986 which terms wrongful trading as the act of a company continuing to carry on their daily business operations even when insolvent or unable to pay its debts as they fall due. This may be when the directors may continue trading thinking that things will improve although the company continues to perform poorly (icaew.com, 2016). Thus, in such a case of wrongful trading, there may be no intention to defraud the company’s creditors but it is a case of poor judgement or the directors failing to carry out their responsibilities and thus the corporate veil may be lifted in this case to hold the directors responsible for wrongful trading. On the other hand, a company will be liable for fraudulent trading based on section 213 of UK’s insolvency act where the directors knowingly carry on the company’s normal business affairs though they have no intention to pay their debts. In such circumstances, the court will find them guilty of fraudulent trading as their intention was to defraud the creditors. In such a circumstances, the court will lift the corporate veil to find the directors guilty of fraudulent trading. It is worth noting that in the case of wrongful trading, there is no intent to defraud unlike in the case of fraudulent trading and hence in this case, there is a burden of proof on the party claiming to have been defrauded. When the company is winding up and its assets are being liquidated, the liquidator may report a finding of wrongful trading to the court even before accusing the directors of fraudulent trading.

It is worth noting that in bringing a successful wrongful trading claim, there are three things that must be established. The first test is the date when the director/ directors knew or ought to have made a conclusion that an insolvent liquidation was unavoidable. If this date has not been set out and established to the satisfaction of the court, then the claim for wrongful trading is unlikely to succeed as held in Re Sherborne Associates Limited (1995) BCC 40. Liquidators will in practice identify more than a single date. The second test is the state of mind of the director. The court in looking at the mental state of mind of the director will assess whether the director knew or ought to have known that the company was insolvent and the steps he/she ought to have taken. In so doing, the court will consider what a reasonable director would have done with regard to the general knowledge and experience that may be reasonably expected of a person carrying out the same functions as the director carried them out. The general skills, knowledge and experience of the director will also be considered. As such, a director with no accountancy qualifications may not be expected to have an accountant’s expertise. The third test is whether every step was taken. S214 (3) of the solvency act provides that a director be not held liable under wrongful trading act if after the insolvency point he/she took every step with a view to preventing future loss. In Re Robin Hood Centre Plc (in liquidation) (2015) EWHC 2289 (ch), the court held that in minimizing future loss, it means to mitigate future loss to the creditors as a whole and not to just certain creditors. The burden of proof here if that of proving that the director took every step to minimize future loss and lies with the director. Another test is with regard to the loss suffered as the result of wrongful trading which lies with the liquidator. It must also be established that the loss resulted from the director’s behavior as held in Re Continental Assurance Co of London plc (in liquidation)(No 4) [2007] 2 BCLC 287, [2001] All ER (D) 229 (Apr) at [297]).

S213 of insolvency act 1986 provides that where in the course of winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the court may on application of the liquidator declare that any persons who were knowingly parties on the carrying on of the business in the fraudulent manner liable to make such contribution to the company’s assets as the court may deem fit. As such, it is clear that the corporate veil will be lifted to uncover the fraud and make the people responsible to pay. However, this is subject to some tests as stated above. However, while the above test are essential for a claim for fraudulent trading, dishonesty is the most essential ingredient for the claim. If it proved that the directors acted dishonestly and fraudulently by incurring debts with no intention to repay especially knowing that the company was facing imminent liquidation, then the director will be liable for fraudulent trading. However, the onus is on the liquidator to prove this. The intent to defraud should thus be proved as held in Morris & Ors v State Bank of India. It is also important to prove that the mischief was fraudulent trading generally not just as far as it affects the company’s creditors as held in Morphitis v Bernasconi[2003]EWCA Civ 289. As such, a claim will be brought against the directors if fraudulent trading has taken place whether it affects creditors or customers. Furthermore, the offence must have been aimed at carrying on a business but can be constituted by a single transaction as was held in Re Gerald Cooper Chemicals Ltd
[1978] Ch 262, [1978] 2 All ER 49 («Cooper«). The act of fraudulent trading must have been committed only by persons who exercise some kind of control or managerial function within the company such as the directors as was held in Grantham and R v Miles (1992) Crim LR 657 (miles).

How the directors may be accused of wrongful and fraudulent trading

Legally, company directors are charged with the responsibility of the day to day running of their organizations. As such, a director of a company that is insolvent which continues trading may be made personally liable for such of the company’s debts as the court deems fit where there has been wrongful trading or wrong trading. According to s213 and 214 of the insolvency act of 1986, it is the responsibility of the liquidator to bring a claim against such directors for action against their wrongful trading or fraudulent trading. The liquidator hence brings application by way of an application notice under rule 7.3 of insolvency rules 1986. The application sets out the nature of the relief sought and the fact that the liquidator is making the application under insolvency act 1986, s213 or 214. Such a relief sought will typically be a declaration that the director engaged in wrongful or fraudulent trading and that the director should be required to compensate for the loss that occurred as a result. There will be need to file a witness statement in support of the application and this should be served on the director together with relevant supporting evidence.

The witness statement in support of the application ought to address a number of issues. It should give the full details of the company including the place of incorporation, its registered office address, objects and its nature of trade. It should give full details of the company’s liquidation and how the liquidator was appointed. The statement ought to also detail out the date when the director in question knew or ought to have known that the company’s insolvent liquidation was unavoidable. It should state the fact that the respondent was a director of the company at the time of the wrongful trading or fraudulent trading and his/her involvement in the wrongful trading of fraudulent trading. The steps or actions that a reasonably competent director would have taken and the steps the director should have taken should also be outlined. The statement should also make clear that the respondent failed to take every step to minimize future losses for the company (howespercival.com, 2016). The statement should also detail out the increase in the net deficiency between the insolvency date and the date of liquidation that was caused by the director continued trade. The statement should also detail out the order sought. In the case of fraudulent trading, the statement ought to detail out evidence of dishonesty or intention to defraud the creditors perpetrated by the director. The evidence of the loss suffered should also be attached. In addition, all the documents relating to the claim should also be attached. Depending on the evidence produced in the court, the court will decide either positively or negatively regarding the order sought. However, it is worth noting that if the evidence is sufficient, then the director will be held liable for the loss as stated above.

If the application is successful, the court will make a declaration that wrongful trading or fraudulent trading has taken place and hence make an order that the director contribute to the company’s assets for the loss caused in accordance to s213 or 214. Any payments that the director is ordered to pay will be for the benefit of all of the company’s creditors and not just a particular creditor that may have been directly identified to have been directly affected by the wrongful or fraudulent trading as held in Re Purpoint Limited. Where the liquidator has successfully brought an action for wrongful trading or fraudulent trading claim against more than one directors, the liability for the loss suffered by the company as well as its creditors will be joint and several as between the director respondents. The court can however make declarations regarding the amount that each of the directors ought to pay. This was the case in Re Produce Marketing Consortium Limited (No 2) [1989] BCLC 520 where the court held that the senior director indemnify the junior director $50,000 out of the $75,000 the directors were to pay. Furthermore, the court held that the two directors pay interest on the sum they were offered to pay even where they had not taken anything out of the company. The court held that the purpose of the insolvency act of 1986 s 213 and 214 is to compensate creditors for something that should not have happened.

Director’s insolvency liability in UAE

The above discussion has mainly concentrated on both wrongful trading and fraudulent trading under the English system under insolvency act 1986 articles 213 and 214. However, these situations when directors may be held personally liable do not exist per se under UAE laws (Taylorwessing, 2016). However, the new UAE commercial company laws 2015 does notionally incorporate both Wrongful trading and fraudulent trading. Under UAE regulations, directors will be held liable to the company, the shareholders as well as third parties such as creditors for deception, fraudulent acts, violation of law, misuse of authority and any losses that may arise from maladministration of the company including gross error.

S84 of the CCL states that directors will be liable for fraudulent acts by them and they will also be liable for any losses or expenses incurred out of improper use of the power or the contravention of the provision of any relevant laws, the company’s memorandum of association or the director’s appointment contract or for any gross error by him. On the other hand, s162 of CCL provides that the directors and their chairman may be jointly liable to indemnify the company, shareholders and third parties for any damage arising from their acts of fraud, misusing power as well as violations of the provisions of CCL or the company’s articles of association or any error in management. If we read the two articles jointly, we can infer that directors have a number of duties whose breach may result in directors’ personal liability. For instance, the director is expected to act honestly and in the best interest of the company and its shareholders as opposed to such act as fraudulent trading as provided by the UK’s insolvency act. A director who engages in fraudulent trading will thus be considered to have flouted the provisions of CCL since he is expected to act honestly and not fraudulently. In the same way, engaging in wrongful trading may also be in violation of this act since it does not show honesty given that directors are aware of the company’s situation. Furthermore, they may also be held liable for gross error or maladministration and hence be required to pay for the loss arising therefrom (Malik, 2016). To this extent therefore, both the UK’s insolvency act and UAE’s CCL are similar in that they provide for lifting the corporate veil in the situations of wrongful trading and fraudulent trading in insolvency.

It is to be noted that under section 162 of UAE’s CCL, directors will be held jointly liable to the company, its shareholders and third parties for their wrongful acts such as wrongful trading and fraudulent trading that result from their unanimous decision as a board. This is in line with the provision of the insolvency act s213 and 214 in the UK. It is however worth noting that where a director has recorded his objection to a wrongful decision taken by the board in the minutes during the directors meeting, such a director will not share responsibility for the decision (Dean, 2016). A director’s absence from the meeting in which a wrongful decision is taken will however not relieve the director from the responsibility unless he has not been informed of the decision or if though being aware of the decision, he was unable to object or if he objected to the decision when he became aware of it.

Conclusion

This essay has looked at the issue of lifting of corporate veil in detail with regard to UK’s insolvency law and UAE’s commercial companies’ law. It has been established that although the company is a separate legal entity from its shareholders or directors, there are circumstances under which the veil may be lifted to make the shareholders or directors personally liable for their wrongful acts. Such circumstances include when acts of wrongful trading or fraudulent trading on the part of shareholders or directors have been established. The differences between wrongful trading and fraudulent trading have also been discussed at length as well as the factors that courts will consider for a successful action against either. The UAE’s new commercial company law of 2015 has also been compared with UK’s 1986 insolvency act with regard to fraudulent trading and wrongful trading. It has been concluded that although UAE does not have a law that expressly deals with wrongful trading and fraudulent trading, articles 84 and 162 does indirectly address the two issues thus justifying the lifting of corporate veil under situations of wrongful trading and fraudulent trading.

References:

Taylorwessing, 2016, Directors and insolvency, Retrieved on 7th November 2016, from;

https://united-kingdom.taylorwessing.com/synapse/duties_directors_insolvency.html

icaew.com, 2016, Case law: When directors can be personally liable on company insolvency, Retrieved on 7th November 2016, from;

http://www.icaew.com/en/archive/library/subject-gateways/law/insolvency/legal- alert/when-directors-can-be-personally-liable-on-company-insolvency

howespercival.com, 2016, Insolvency litigation: No questions asked a valid defense to fraudulent trading? Retrieved on 7th November 2016, from;

http://www.howespercival.com/resources-and-events/case-studies/insolvency-litigation- no-questions-asked-a-valid-defence-to-fraudulent-trading

Malik, S2016, Piercing the corporate veil, Retrieved on 7th November 2016, from;

https://www.linkedin.com/pulse/piercing-corporate-veil-sarah-malik

Taylorwessing, 2016, Piercing the corporate veil and director’s liability, Retrieved on 7th November 2016, from;

https://united-arab-emirates.taylorwessing.com/en/piercing-the-corporate-veil-directors- liability

Dean, P2016, The corporate veil: when will it be pierced? Retrieved on 7th November 2016, from;

http://www.hfw.com/Piercing-the-Corporate-Veil-Dec-2012