David Parker
College of Law and Justice, Victoria University
‘Piercing the veil of incorporation’ is a statement which uses the metaphor of the company entity as a ‘veil’, whereby under some circumstances the courts will not recognise the separate entity of a corporation from its controllers – but will hold those controllers personally liable. The concept of ‘veiling’ presumes a legal entity exists, and that the entity is separate from its owners and operators; but what this entity actually represents is rather unsettled, both in legislation and in jurisprudence. The modern company is a concept that has evolved from the artificial entities of ancient times, basically as a result of sheer convenience and practicality. The boundaries of that entity have been subject to much criticism and perhaps mysticism as the courts have invented mythology to both create the entity, explain it, but to also constrain it by refusing its separate existence from its members should that mythology be misused.
I propose that the concept of piercing the veil, and in fact the incorporation of a company as a separate legal entity, which is then equated to that of a body with a personality, is not an appropriate analogy. I propose that the analogy of a body, the mythology that views a company as a human like ‘organic being’ obfuscates the true nature of the company, or at least a perception of what it should be. Similarly, the idea of piercing the veil is inappropriate and has been surpassed by a new reality of the company entity, or at least it should. The legal perception of a company under law has significant implications in whether a company as a humanized form must therefore display the same duties, ethics and social responsibility expected of a human citizen.
The corporate, limited liability entity is a great invention. One writer described it as equivalent to the invention of electricity! Take the statement of President Nicholas Murray of Columbia University in 1911. I weigh my words when I say that in my judgment the limited liability corporation is the greatest single discovery of modern times ....Even steam and electricity are far less important than the limited liability corporation, and they would be reduced to comparative impotence without it.1
Company law, as it relates to the creation of a company and its regulation has occurred haphazardly and incrementally in order to service each economy in which it sits, e.g. whether that be the growth of railways in the United States, or the facilitation of mining ventures in Victoria,2 or the encouragement of micro business in Australia in the last 10 years.3 In the last 140 years since the creation of companies (if we use the English legislation as a benchmark) there has been a massive creation of regulation, particularly in relation to directors and officer’s duties in the way the company must operate in keeping records, procedures etc. However, there is little in company legislation that states what essentially a company is designed to do, nor its responsibility to the community – at least in the process of its creation.
Under Australian legislation there is no statement as to what the company actually is but a rather vague reference that it is a separate entity according to law, with no further explanation of what that means, something which is then left to the courts to determine. The lack of any direction by statute means that it is difficult to determine whether the company is a human like body, or not, and in turn whether there can be a claim to citizen’s rights, and further whether such ‘privileges’ accordingly require human like ethics and responsibilities.
The corporate entity is defined in s 9 of the Corporations Act 2001 (Cth) but silent on the notion of the personality of a company, with simplistic statements that a certificate of registration is conclusive of registration.4 The company comes into existence at the beginning of the day it is registered: s 124 then states that a company has the legal capacity of an individual, as a legal person without explaining what that ‘person’ actually is. The Acts Interpretation Act 1901 (Cth) similarly gives little explanation of the term ‘person’, in s 2C the term ‘person’ includes a reference to companies, corporations or bodies corporate, thereby leaving to other sources of law to explain a company. A survey of the legislation from other common law countries demonstrates similar bland statements as to the meaning of registration, e.g. the Companies Act 1989 (UK) gives no guidance as to the separation principle with very open statements as to the essence of a company, for instance: ‘s 1(1) Any two or more persons associated for a lawful purpose may, by subscribing their names to a memorandum of association and otherwise complying with the requirements of this Act’. It is the symbology of the common law which has equated the legislated entity to that of natural person with comparisons to bodies, arms, organs and brains.
The response of the courts has been to equate the company with that of a natural person in order to give themselves extensive powers in determining the distinction between a company and its members. The courts have been forced to interpret the Corporations Act in such a way because of its complexity and gaps of the Act, particularly in relation to a lack of any stated policy within the Act.5 The Corporations Act is more of a regulatory document, remaining silent on policy issues, unlike for instance the Income Tax Assessment Act (Cth) 1997 which very clearly states policy and intention as a preamble to each chapter of the Act.
In the absence of legislative guidance it is the common law which provides the principle that companies are separate from their owners and controllers, basically starting with the celebrated Salomon case, which without stating anything in particular about corporate entities, firmly established the separateness of the corporate entity from its promoters and operators. An apt comment in a case note, attributed to Sir Frederick Pollock,7 sums up the problem: ‘Our Legislature…delivered itself on the Companies Act in its usual oracular style, leaving to the Courts the interpretation of its mystical utterances’. In a further comment, the same writer states: ‘The House of Lords has said….that the one trader and the six dummies will do, treating the statutory conditions as mere machinery’.8
Humans have always used allegory to explain their relationships, their obligations and their consequent liabilities; the law contains many examples of such ‘inventions’ in order to facilitate property holding, legal action or contractual agreements. There are two aspects to the use of the metaphors in relation to companies, the first is that the metaphor can take over and become the law itself, and secondly the use of metaphors may substitute for a real analysis of what the personhood of the company actually is.
Probably the essence of the first ‘modern’ companies (if we focus on British companies), is that the essence of incorporation was to recognize legally a company of persons, with common interests, knowledge and cooperation with each other, rather than the large corporate bodies now existing, with little interaction of its company members,9 particularly pronounced by the separation of ownership and control in a large modern company.
The idea of a legal personality is one such creation of the legal system, which begins with a recognition of humans as having a recognised legal entity, at least in modern times,10 while restricting the legal ‘abilities’ of some categories of humans e.g., children and the mentally impaired. The extension therefore of a legal personality to other artificial entities has developed out of sheer convenience in order that the entity can carry out everyday functions of holding monies, entering into contracts and appearing in court,11 albeit through human agents.
Entities similarly have certain abilities within the law, while being denied other rights which may be available to a natural (human) entity.12 Governments, corporations and even an idol13 may be deemed to have a legal personality for the purposes of law. The legal persona then operates through its agents, and in order to do this the law has therefore created a collective known as a body corporate, a created entity to which it ascribes certain legal characteristics. This body then has the right to enter into relationships that give rights to that body, while at the same time imposing liabilities and responsibilities on the creation designating that body as a legal person. To explain that body there is an expansive use of metaphor and equation of human rights (and liabilities) to entities such as companies.14 Those metaphors both create a human like persona for companies, but are also used to undo that persona, to discard the separate legal entity so presumed, in order to hold the humans behind the entity personally liable by undoing their protection in the event that they misuse the corporate form.
George Paton15 makes the observation that Greek philosophy imputed the persona as being more about the individuality of a human, ‘the rational substratum of a human being’, whereas it has been interpreted to designate a human as a ‘right and duty bearing unit’,16 a different concept altogether. Interestingly the term ‘personality’ purportedly derives from the Greek word per-sonare and persona, being an actor’s mask behind which stood the anonymous speaker.17
The Romans adopted the ideas of the Greeks and developed further the notions of corporate entities with a legal persona, whereby some bodies were recognised in law as capable of having legal rights, but also bound by certain legal duties – though not necessarily in the same strict sense as today.18 Patrick Duff’s study of Roman law demonstrates the Romans had a very unsophisticated idea of legal personality, he refers to writings with ‘hundreds of passages where homo could be substituted for persona without any apparent change in the sense’. Roman law had no particular advanced theory on artificial entities, but the barest principles were adequate enough to cope with the activities of collegia, societates publicanorum, hereditas iacens, municipalities and charities.19 The use of the corporate personality to facilitate the holding of property by these ancient peoples is interesting in that they developed the notion of a separate entity, but did not equate this with a human in terms of its rights and civil liberties.
Note that the idea of the mask has also been used in Australia, for instance Windeyer J thought that a company personifies:
[A] new legal entity, a person in the eye of the law. Perhaps it were better in some cases to say a legal persona, for the Latin work in one of its sense means a mask; Eriptur persona, manet res’.20
The metaphors range from the organic method, the idea of the company as a body with a ‘brain’ and organs that carry out the functions of the company. The metaphors, in the absence of any positive statement by the written law, have become law in itself.
Such metaphors abound in case law. One author21 identifies 25 different metaphors to describe the use and misuse of a corporate entity as amongst others as a
…mere adjunct, agent, alter ego, alter identity, arm, blind, branch, buffer, cloak, coat, corporate double, instrumentality, mouthpiece, name, nominal identity, phrase, puppet, screen, sham, simulacrum, snare, stooge, subterfuge, or tool.
In Australia and the United Kingdom, the most popular expression seems to be the use of the metaphor of the veil of incorporation. The expression of a ‘veil’ is in a sense a judgmental term and one dictionary term has it as ‘to conceal (some immaterial thing, condition, quality, etc.) from apprehension, knowledge, or perception: to hide the real nature or meaning of (something)’.22 Another term often used is that of the ‘mask’ of incorporation, which again is the use of a ‘covering’ word and particularly pertinent given that the term persona is derived from Greek theatre, whereby a mask designated a certain character to the world, while the ‘actors’ remained anonymous.23 As Paul Redmond states ‘….corporate personality is a human construct, created to solve human problems…’,24 and similarly Samuel Stoljar states that: ‘Although separate legal personality is referred to in absolute terms, it is a relative notion referring to a subject's ensemble of legal rights’.25 Professor Elvin Latty, an earlier but often quoted writer in this area,26 offers an interesting statement on the fiction of a company:
[W]e are . . . told that the corporation admits of a real personality or at least of something so like personality that we may call it by that name; that it is a real person with a body, members and will of its own; that it is an artificial person; that it is a real person because what is artificial is real; that even an individual is after all but an artificial legal person, a subject of rights and duties; that a corporation is not a thing, it is a method; that the entity is a fiction but a rational fiction, not an arbitrary or artificial fiction; that the ‘person’ is a fiction but the entity or ‘thing’ is real.27
The use of metaphors to explain the idea of corporate personality has itself been criticized, for instance Justice Cardozo in Berkey v Third Ave Ry Co28 said that: ‘Metaphors in the law are to be narrowly watched, for starting as devices to liberate thought, they end often by enslaving it’. In the same passage he described veil-piercing as an area of law which is shrouded ‘in mists of metaphor’.
Samuel Stoljar provides an Australian contribution and comments that the concept of separate legal personality is a perception that ‘responds to our anthropomorphic instincts and runs the risk of retaining, even if regarded as only a fiction, a sort of residual strength’.29 The separateness of the company detaches its members from personal liability by viewing the company as a metaphorical ‘separate personality’, ‘body’ or ‘legal person’.30 The company entity has taken on a life of its own as if the members are passive investors and the controllers work for a personified entity known as the company. Peta Spender takes up the comment by Stoljar pointing out that the concept of separate legal personality exists as both a powerful metaphor and a judicial reality’,31 and later says: ‘Unfortunately anthropomorphism has caused the separate legal personality of the family company to assume a life of its own as a persuasive metaphor. As a consequence, the law has focused upon fulfillment of the metaphor rather than the specific regulatory aims of the law in particular areas’.32 Such observations are not new; Bryant Smith33 reached a similar conclusion over 70 years ago:
It is not the part of legal personality to dictate conclusions. To insist that because it has been decided that a corporation is a legal person for some purposes . . . is to make . . . corporate personality . . . a master rather than a servant, and to decide legal questions on irrelevant considerations without inquiry into their merits. Issues do not properly turn upon a name.
The last 200 years of commercial growth and inevitable litigation has mythologized the company form. A legal arrangement has become a body, with ‘a will and mind, with organs, hands and brains’.34 Others have sought to draw back from this bald separation, for instance Buckley LJ said:
A corporation has neither body, parts nor passions. It cannot wear weapons nor serve in wars. It can be neither loyal nor disloyal. It cannot compass treason. It can be neither friend nor enemy. Apart from its corporators, it can have neither thoughts, wishes or intention, for it has no other mind than the minds of the corporators.35
Similarly Lord Chancellor Thurlow has said: ‘Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?”’36 noting that some would dispute this, by pointing to the fact that companies may have a corporate culture akin to a personality.37 In 1250 AD, Pope Innocent IV is reputed to have forbidden the practice of excommunicating a corporation convicted of a crime; he reasoned that because a corporation had no soul, it could not lose it.38
Personalising the entity of the company in modern times moves the conception of the company from a company of persons to legal person known as a company is quite a shift in perception. A comprehensive development of how the company entity should be treated is yet to come - clearly parliament can direct that that be done. The issue of how different the corporate entity is to that of a human should be determined. The challenge is to formulate some flexible definition of the corporate entity in order to accommodate those differences.
English law, including the church through canon law, began to develop the concept of a corporate entity or personae ficta and to operate as an incorporate person in what is often referred to as the corporation sole.39 Whether the fictitious body of the corporate sole was actually a separate entity or an embryonic version40 probably doesn’t matter, the practical use of separate entities was now recognised, if not embedded in law. However, the church was not the only body which embraced the use of fictional entities, Henry de Bracton, an English jurist and chancellor of Exeter Cathedral in 1264, wrote of bodies ‘politick’ and incorporate in one of the first works on English law.41 And so in the thirteenth and fourteenth centuries various corporate bodies began to develop, probably the most important being the guilds, which were descendants of the medieval guilds, originally formed to regulate the commercial activities of particular trades.42 The guilds were permitted to gain a charter (a separate entity), followed by other bodies which claimed a separate entity and these included the counties, boroughs, hundreds, manors, chantries, deans and chapters, monasteries and even societies of lawyers.43
By the 1500s to the 1600s a company could be formed in the United Kingdom by royal charter, e.g. the Mineral and Battery Company 1568,44 which was followed by a surge of unincorporated bodies claiming a type of corporate personality. In 1720 the Bubble Act (UK) was passed with the intention of preventing unincorporated joint stock bodies from claiming a corporate personality and to prevent them from trading their ‘shares’,45 a piece of reactive legislation in response to a crisis, not dissimilar to modern times. Not that it stopped the promotion of unincorporated associations, which led Lord Eldon to declare that unincorporated associations who claimed a corporate personality committed an offence under common law: Kinder v Taylor.46 This all led to the abolition of the Bubble Act in the Bubble Act Repeal Act 1825 (UK). In 1844 there was the passing of the Joint Stock Companies Act 1844 (UK), which gave the right (for the first time since the days of Republican Rome) for full, free and voluntary incorporation by mere registration rather than by charter or private act of parliament. After allowing limited liability in 1855 and 1856, parliament extended limited liability to members of registered joint stock companies (as distinct from limited companies) and a consequent increase in registrations then took place by joint stock companies. Registration as a company was taken as a right, a form of separate entity was created, but not one that was characterized as a human person.
Historical studies of Australian company law, which till the latter part of the 20th Century were essentially colonial and then state law,47 shows that Australian jurisdictions generally followed the UK model.48 Companies could be created as of right, without there being any thought as to their place in society, other than in order to facilitate a new economy that required investment and limited liability to encourage entrepreneurship, new commerce and industrialization.
Piercing by the courts usually takes place where the courts are convinced that the company entity has been misused in some way;49 particularly by shareholders improperly using the company entity to shield themselves from potential third party claims. Which is a significant withdrawal of a right, given that a prime reason for forming a company is to shield an operator or owner from liability.50 This does not discount other reasons for the creation of a company such as the need to collectively accumulate capital, to minimise tax or to have a transferability of ownership which flows from having a separate legal entity. An alternative type of piercing is reverse piercing whereby the shareholders attempt to have the courts show they are not separate entities from the company e.g., to find that the shareholders are realistically the owners of company property.51
In addition to the courts developing their own doctrines for discarding the separation of entity, there are some limited instances whereby Parliament has passed laws specifically making individuals liable for proscribed actions, irrespective of foundation entity statements in company legislation.52 Apart from some specific sections in legislation which remove the protection of the corporate entity, ‘piercing’ is basically considered to be a judicial technique whereby the courts have interpreted legislation establishing the creation of the company entity as unavailable to those who e.g., misuse the separation of entity protection, or where it is unfair to uphold the rigid separation. The fact that courts do this is interesting, in that it demonstrates a common law principle that courts are able to set aside the company entity under the universal Anglo system of law. This is a power derived by courts under the separation of powers, and in assuming the right to interpret the law they make law.
Australia’s view of veil piercing could be summarised as one - an acceptance of the Salomon principle, two- a reluctance to pierce, three – actual piercing as the need arises, and four – no predictable set of principles by which the courts will or will not pierce.
The grounds for piercing the veil in British law seems to have developed as a set of exceptions, created by different courts at different times, with some periods showing a greater propensity to pierce, but without establishing any firm grounds when a court might pierce. The body of law on piercing is therefore confusing and consists of a series of cases rather principles, though some suggest that this is a strength e.g., ‘The jurisdiction to pierce the veil of corporateness gives the courts a considerable degree of discretion and enables them to do justice and to decide individual cases in accordance with equitable considerations’.53 The downside of this is of course the unpredictability of veil piercing.
Smadar Ottolenghi54 was a writer whose work demonstrates a more flexible idea of piercing the veil and refers to a number of different possibilities, such as reaching in, or outside, of the company entity in the event that a court believes there is unfairness or inequity occurring, while attempting to preserve the ‘sanctity’ of separate entity. Ottolenghi basically refers to the idea of the corporate veil as a type of company enclosure allowing outsiders to:
Piercing as a doctrine or process has no set definition and can mean many things, just as the company format itself has various definitions and meanings. The result is that piercing is an indefinite concept, and in fact unpredictable, except perhaps where there is statutory piercing. Note there is a question as to whether statutory piercing is really piercing or in fact regulation.
Many jurisdictions of the world now recognise that it is both possible and at times necessary to pierce the veil of incorporation, but the doctrine has developed jurisprudentially as an erratic and uncertain doctrine without any real clear direction.55 An observation by Frank Easterbrook and Daniel Fischel56 suggests that:
…piercing seems to happen freakishly. Like lightning, it is rare, severe, and unprincipled. There is a consensus that the whole area of limited liability, and conversely of piercing the corporate veil, is among the most confusing in corporate law.
The whole situation of piercing is made even harder to grasp by the fact that the name of the concept and any discussion dealing with the disregard of the company entity is basically conducted in metaphors. Easterbrook and Fischel57 go on to cite with approval a quote in Phillip Blumberg58 where the legal analysis related to piercing the veil in the US was:
…jurisprudence by metaphor or epithet. It does not contribute to legal understanding because it is an intellectual construct, divorced from business realities. The metaphors are no more than conclusory terms, affording little understanding of the considerations and policies underlying the court’s actions and little help in predicting results in future cases….As a result, we are faced with hundreds of decisions that are irreconcilable and not entirely comprehensible. Few areas of the law have been so sharply criticised by commentators.
Much is therefore left to the courts to determine the whole issue of the purpose of a company, who owns the property of the company and the whole issue of the separateness of company.59 The concept of corporate entity therefore remains undefined in any conclusive way both at common law and under Australian legislation. The entity of the company has therefore been equated to that of a person for the purposes of understanding the company and its separation from its owners and controllers. This raises the question of whether a company should be considered as a unique entity and thereby removing the confusion of trying to explain the company as if it were a natural person.
A consideration of the theory of the corporation discloses a plethora of company models which explain what a company’s role, or at least what it should be, within our society, and in fact do much to explain the varied perceptions held by the observers of companies.
The most basic of theories is probably that of a contractarian model which demands the legal system uphold the primacy of the individual by creating and facilitating the company as part of contractual relationships. A good example might be Milton Friedman who wrote, ‘There is one and only one social responsibility of business-to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud’.60 Such a stance promotes economic efficiency for contracting parties such as shareholders, without considering the fall out of social costs and inequality. This is a utilitarian model which distinguishes a company as a private body and not subject to state control,61 except for its internal and external contractual relations. Variations of this stance include the perception of the company as a fiction (holding an aggregation of individuals),62 a mechanistic view of company law, and a laissez faire view without any notion of what social responsibilities such an entity should have.
At the other end of the theoretical spectrum is to hold the company as liable to all its stakeholders, a communitarian stance which means that a company has social obligations to more than just its shareholders. An extension of a social perception of the company is that the company is considered a privilege or concession by the state, and consequently must act appropriately in relation to those with whom it interacts, and that is more than just complying with contractual obligations, it means that it must act ethically, prudently and appropriately to maximize all social goals, not just economic ones.63
A company and its operators should not be permitted to operate with unsafe work practices, using phoenixing to defeat creditors64 or destroying documents to defeat legal actions.65 Consider for instance: Environmental Protection Authority v Caltex Refining Co Pty Ltd66 where Mason CJ and Toohey J cited the US case Hale v Henkel67 to justify not allowing the company the privilege against self-incrimination. Justice Brown in that case had said:
[T]he corporation is a creature of the State. It is presume to be incorporated for the public. It receives certain privileges and franchises, and holds them subject to laws of the State and the limitations of its charter. Its powers are limited by law.’
A similar theory is the realist theory which ascribes to the corporation the reality of the company as a ‘real’ person with a mind and a will, expressed through ‘organs’ of the company.68 Rather than a company being prescribed as a convenient fiction for legal activities, a company is viewed as the group of individuals who form and run the company, consequently the will and mind of the company can be formulated from the ‘will’ of the humans that make up the company. The persons bringing the company into existence act with a common purpose, their actions will make the company liable – just like any other individual.
The challenge in referring to theory is that there is no one size fits all, companies come in different sizes and are created for different purposes; each company is unique, though nevertheless the same legislation and common law applies to all.
One could argue the following:
The purpose of the doctrine of piercing is to hold those who operate under the protection of the separate entity of the company as liable for their personal actions, an action which can take place by a court disregarding the corporate entity, or where statute determines specific personal liability. Piercing the veil has occurred since legislation creating companies was first passed, it has also been refused by courts in many instances even though a refusal to pierce left an unfair situation unresolved. A refusal to pierce, even where it may have resolved an inequity, is a stance by a court to preserve the ideal of the company as a separate legal entity. The willingness or reluctance of courts to pierce has not slowed the use of companies, nor led to any particular outcry against the use of separate entity by companies, though by any stretch the growth of company regulation as an alternative means of piercing is self-evident.
The use of a doctrine such as piercing is increasingly irrelevant, particularly as companies, and their operators are becoming more and more regulated by a variety of legislation. To hold someone liable for their actions under the umbrella of the company is self-evidently demonstrated by the prolific numbers of cases litigated or prosecuted, where with or without a reference to piercing, individuals can be held liable for their actions. The mythology of piercing could be on a par with the mythology of the protection of the separate legal entity of a company.
If piercing occurs either by a court disregarding the entity of the company under common law, or by statute, this is in essence a regulation of the company, usually for the purpose of ensuring the company’s operators comply with appropriate ethical standards as determined by community and business practice. If then piercing is essentially regulation, how can this means of regulation be enhanced without resorting to the fuzzy undefined concept of piercing?
One means of ensuring appropriate behaviour by those within a company, by self-regulation for fear of prosecution, or by compliance with accepted principles of good business, is to just leave the law to develop as it has. Indeed, statute has grown incrementally, if not haphazardly, usually as a response to some crisis or disaster.71 Legislation such as the need to retain documents within an organisation, even if potentially detrimental, the Occupational Health and Safety provisions placed on management, enhancement of directors duties and consequent liabilities, all point to increasing sensitivity to operators of companies to actually ensure that the company, and they themselves comply with appropriate community standards.
Under a fuzzy law concept, the less said the less problem there is in interpreting what is actually expected from the operators of a company. It would seem however the less stated is a bit at odds with currently ‘nothing stated’. A glance at companies legislation from Australia, Canada, the UK and New Zealand shows no statement whatsoever as to the nature of a company, except for the allusion to the company as a separate entity. With one exception, i.e. s 7 (2) in the UK Companies Act there is a statement that a company must not be formed for an unlawful purpose; an interesting statement which might be the basis of bringing an action against those forming a company to facilitate phoenix activity or to promote some kind of fraud.
One means of possibly enhancing appropriate behaviour is to actually have some statement in company legislation that sets some form of benchmark as to ‘what is a company?’ and furthermore what is expected of management. This follows the idea of a company as either a privilege or a concession, granted in response to a standard of expected behaviour from management.
A legislative statement as to company might be: ‘A company is the legal representation of an individual or association of individuals, members, officers, managers and employees. That legal representation is considered under law as a legal entity as per the provisions of this legislation. The formation and operation of a company must be for a proper purpose according to community standards in addition to regulation imposed by corporate legislation. The controllers of a company are expected to operate according to appropriate social standards’. The statement targets ‘controllers’ of a company, which might in some instances be the shareholders who take on that role, whereas non-involved shareholders would not be held liable. The 18th Century companies evolved out of a particular stage in history, similarly the 21st Century companies sit in a different environmental complexity, and Australian law appears quite passive in its perception of what a company should be.