An incorporated company is the most common form of business organization, and this is no truer than in the construction industry. One of the purposes of incorporation is to ensure that the liability for the business activities of the organization is solely that of the company and not that of the shareholders. But what happens when the other party to the contract with the company alleges that the company is not the real party to the contract, but rather the controlling shareholder of the company is the real party to the contract? This allegation is called “piercing the corporate veil”.
The United Kingdom Supreme Court has recently examined this issue in two decisions: VTB Capital Inc. v. Nutritek International Corp. and Prest v. Petrodel Resources Limited. These are extremely important decisions because the U.K. Supreme Court analyzed in great detail whether, and in what circumstances, contractual liability can be imposed upon an entity which has not signed a contract, namely its controlling shareholder. I have written a lengthy article on this subject with Brandon Kain: Through the Looking Glass: Recent Developments in Piercing the Corporate Veil. The article is posted on this website. I will not repeat the full contents of that article but will provide the highlights of it in the hopes that readers will turn to the article for a full analysis of these decisions.
Basically, the U.K. Supreme Court has held that the corporate veil of a corporation cannot be pierced to make another entity, the controlling shareholder of the corporation, liable on the contract unless the controlling shareholder is liable on that contract under other legal principles, such as the law of agency. The use of the corporation for “bad purposes” (my words) does not make the controlling shareholder liable on the contract. In particular, establishing a corporation so that it is responsible for the contractual obligations, and not the controlling shareholder, is not a “bad purpose.”
In the VTB Capital case, the U.K. Supreme Court held that the corporate veil of a Russian Bank which had in fact loaned money to the plaintiff could not be pierced in order to make the controlling shareholder of the bank liable on the loan facility agreement. Lord Neuberger said:
“Subject to some other rule (such as that of undisclosed principal), where B and C are the contracting parties and A is not, there is simply no justification for holding A responsible for B’s contractual liabilities simply because A controls B and has made misrepresentations about B to induce C to enter into the contract. This could not be said to result in unfairness to C: the law provides redress for C against A, in the form of a cause of action in negligent or fraudulent misrepresentation.”
This view of the law was repeated in Prest. The U.K. Court acknowledged that the controlling shareholder of a corporation may be liable for abusive conduct even if a contract is made by the corporation, and to this extent the “corporate veil” may be pierced. But the circumstances in which that can occur are limited. The court divided the “corporate veil” issue into two circumstances.
The first circumstance is one of evasion. The controlling shareholder is the real party to the original contract, and inserts the corporation in order to evade liability. For example, A is party to a non-compete agreement with B, obliging A not to compete with B in a certain area for three years. A then sets up a company, C, which then proceeds to compete during the three years. In that circumstance, A cannot evade its liability under the original contract and to this extent the corporate veil of C is pierced.
The other circumstance is concealment. For example, A is a trustee for B and A secretly sets up a company, C, to receive payments which A would be precluded from receiving as trustee. Again, A is liable and to this extent the corporate veil of C is pierced.
In both these situations the liability of A is independent of the liability of the corporation C. In these circumstances there is a “limited principle” under which the A is liable if A :
“…is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrated by interposing a company under his control.”
But if C is the original party to the contract, then A cannot be made liable on a contract to which it is not a party on the ground that reliance on the corporate existence of C is abusive. As Lord Sumption said:
“It is not an abuse to cause legal liability to be incurred by the company in the first place. It is not an abuse to rely upon the fact (if it is a fact) that a liability is not the controller’s because it is the company’s. On the contrary, that is what incorporation is all about. “
The Prest case involved a matrimonial dispute and the question was whether certain assets owned by corporations controlled by the husband should be accounted for when determining the assets and income of the husband. The U.K. Supreme Court held that this issue was largely a factual matter and could be dealt with under straight forward principles of property and corporate law without the necessity of any corporate veils being pierced.
The case law in Canada appears to assume that the corporate veil can be pierced in exceptional circumstances, and then sets out to define those circumstances. What is lacking in Canadian case law is a principled examination of why the corporate veil should be pierced at all. Only once that examination occurs can a satisfactory basis be established for the exceptions to the general rule of limited corporate liability.
It is likely that the VTB Capital and Prest decisions will spawn a further debate in Canada about what the Canadian law should be regarding piercing the corporate veil. Brandon Kain’s and my article explores the unresolved issues under Canadian law and the likely arguments that will be made when the corporate veil issue is raised once again in Canadian courts.
See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., Chapter 1, part 1(a)(i)(E).
Building Contracts – Liability – Corporations – Piercing the Corporate Veil
Thomas G. Heintzman O.C., Q.C., FCIArb October 30, 2013