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The Second Opinion: Presto! The UK Supreme Court Holds the Corporate Veil Can Disappear in Prest v. Petrodel Resources

A Commentary on Recent Legal Developments by the Opinions Group of McCarthy Tétrault LLP

Posted in The Second Opinion
Brandon Kain

The UK Supreme Court has released an important new judgment addressing the ability of judges to “pierce the corporate veil”: Prest v Petrodel Resources Ltd, [2013] UKSC 34.  The ruling in Prest follows on the heels of the same Court’s decision a few months ago in VTB Capital Plc v Nutritek International Corp, [2013] UKSC 5, which we discussed extensively in previous posts here, here and here.  In an interesting turn of events, the Court in Prest answers a question that it left open in VTB Capital, namely, whether the jurisdiction to pierce the corporate veil exists at all.  According to Prest, the corporate veil may indeed be pierced where exceptional circumstances warrant it.  The Court also sets out a new test for doing so that is likely to influence future jurisprudence in both Canada and abroad.

Background

The Prest litigation arose out of proceedings for ancillary relief following a divorce. The appellant Prest was the ex-wife of a man who owned and controlled a number of related companies, including the respondents. Her ex-husband had repeatedly failed to comply with the duty to make full disclosure of his finances, through a course of conduct which the Supreme Court “characterised by persistent obstruction, obfuscation and deceit, and a contumelious refusal to comply with rules of court and specific orders”. (para. 4)

At trial, Moylan J. made a significant award in favour of the appellant, including a £17.5 million lump sum payment and the £4 million matrimonial home.  He also ordered that three of the respondent companies controlled by the ex-husband convey various assets to her in satisfaction of the judgment.  In doing so, Moylan J. recognized that he would not ordinarily be permitted to pierce the respondents’ corporate veils, since this may only be done where the legal personality of a company has been abused for an improper purpose, which was not the case here.  Nonetheless, Moylan J. found that a wider jurisdiction to pierce the corporate veil than existed at common law was available under the Matrimonial Causes Act 1973 (U.K.).

Moylan J.’s ruling was set aside by the English Court of Appeal. The majority held that there was no greater ability to pierce the corporate veil in family law cases than in any other context.  Since there was no evidence that the legal personalities of the respondents had been abused for an improper purpose, nor a finding that they held the relevant properties on trust for the ex-husband, the respondents could not be ordered to convey the properties to the appellant.

The Prest Decision

A seven-member panel of the UK Supreme Court unanimously overturned the Court of Appeal’s judgment.  The Supreme Court agreed that the corporate veils of the respondents should not be pierced at common law, and that there was no wider jurisdiction to do so under the Matrimonial Causes Act 1973.  However, it ultimately found the respondents could be ordered to convey the properties to the appellant, since they held them on a resulting trust for the ex-husband.  In the course of its decision, the Court devoted considerable attention to the issue of piercing the corporate veil.

The leading judgment was delivered by Lord Sumption.  He began by observing that while “[t]he separate personality and property of a company is sometimes described as a fiction…the fiction is the whole foundation of English company and insolvency law”. (para. 8) Further, he noted that the expression “piercing the corporate veil” is often indiscriminately applied to a range of situations in which the law attributes the acts or property of a corporation to those who control it, but without disregarding its separate legal personality (e.g., joint liability, trust law, equitable remedies, or in certain statutory contexts).  According to Lord Sumption, “when we speak of piercing the corporate veil, we are not (or should not be) speaking of any of these situations, but only of those cases which are true exceptions to the rule in Salomon… i.e. where a person who owns and controls a company is said in certain circumstances to be identified with it in law by virtue of that ownership and control”. (para. 16)

In an important doctrinal development, Lord Sumption founded this jurisdiction to pierce the corporate veil upon the general judicial aversion to fraudulent conduct.  He gave several examples of this basic tendency, such as the vitiation of contracts or judgments founded on fraud, and the refusal of courts to permit frauds upon a statute.  He then reviewed the English corporate veil jurisprudence, and concluded that the ability to pierce the veil is “well established”, even though most of the cases which recognized this power did so in obiter, and those which applied it could have been decided on other grounds.  In Lord Sumption’s estimation, “the 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”, and “it is consistent with the general approach of English law to the problems raised by the use of legal concepts to defeat mandatory rules of law”. (para. 27)

One of the most interesting aspects of Lord Sumption’s judgment is the distinction he proceeded to draw between cases that apply what he terms 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. … (para. 28)

He then held that “the corporate veil may be pierced only to prevent the abuse of corporate legal personality”. (para. 34)  Lord Sumption defined such abuse as including attempts to “evade the law or to frustrate its enforcement” through use of the corporate personality.  It does not include cases where one “cause[s] a legal liability to be incurred by the company in the first place” or relies “upon the fact (if it is a fact) that a liability is not the controller’s because it is the company’s”, since “that is what incorporation is all about”. (Ibid) According to Lord Sumption, this explained the result in VTB Capital, where the Court held that piercing the corporate veil could not enable a company’s contractual obligations to be imposed directly upon its controlling mind, since in such a case “the principle was being invoked so as to create a new liability that would not otherwise exist”. (Ibid)

In the end, Lord Sumption proposed the following test for piercing the corporate veil:

I conclude that there is a limited principle of English law which applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. The court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller of the advantage that they would otherwise have obtained by the company’s separate legal personality. …I consider that if it is not necessary to pierce the corporate veil, it is not appropriate to do so, because on that footing there is no public policy imperative which justifies that course. … (para. 35)

Turning to the facts of Prest itself, Lord Sumption held this test was not met by the appellant.  Although the ex-husband had behaved improperly by misapplying the respondents’ assets for his own benefit, “he was neither concealing nor evading any legal obligation owed to his wife” nor “concealing or evading the law relating to the distribution of assets of a marriage upon its dissolution”. (para. 36) Further, while he used the respondents’ corporate structure to deny being an owner of the properties, that at most engaged the “concealment” principle, which meant only that the Court should ascertain the true facts (which were that the legal interest in the properties had been vested in the respondents for wealth protection and tax planning purposes long before the marriage dissolved, not to defeat the appellant’s claim).  In the result, Lord Sumption held that “the piercing of the corporate veil cannot be justified in this case by reference to any general principle of law”. (Ibid)

The remaining six members of the Court largely agreed with Lord Sumption’s treatment of the corporate veil.  However, four of the Law Lords questioned whether the jurisdiction to pierce the veil would truly be limited to instances of “evasion” in future cases.

Thus, Lady Hale and Lord Wilson doubted “whether it is possible to classify all of the cases in which the courts have been or should be prepared to disregard the separate legal personality of a company neatly into cases of either concealment or evasion”. (para. 92) In their view, “[t]hey may simply be examples of the principle that the individuals who operate limited companies should not be allowed to take unconscionable advantage of the people with whom they do business”. (Ibid)

Similarly, Lord Mance stated that it is “dangerous to seek to foreclose all possible future situations which may arise and I would not wish to do so”. (para. 100) Lord Clarke also made the following remarks:

… Lord Sumption may be right to say that it will only be done in a case of evasion, as opposed to concealment, where it is not necessary. However, this was not a distinction that was discussed in the course of the argument and, to my mind, should not be definitively adopted unless and until the court has heard detailed submissions upon it. I agree with Lord Mance that it is often dangerous to seek to foreclose all possible future situations which may arise and, like him, I would not wish to do so. … (para. 103)

Significance

Although decided in the context of a matrimonial dispute, Prest seems destined to rank among the most important corporate law judgments since Salomon v. A. Salomon & Co. Ltd., [1897] A.C. 22 (H.L.).  First, it marks the only time that the United Kingdom’s highest court has squarely recognized the jurisdiction to pierce the corporate veil.  Second, Lord Sumption articulates a clear legal test for this, which is limited to cases where piercing the veil is the only way to deprive a company or its controlling mind of an advantage they would otherwise obtain from the latter’s use of the former’s legal personality to deliberately evade or frustrate enforcement of the existing legal obligations, liabilities or restrictions of the controlling mind, as opposed to those of the company itself.  Third, Lord Sumption draws an important distinction between piercing the corporate veil to prevent such evasion, and merely looking behind the corporate veil to prevent  “concealment” of the real facts.

It is true that the concurring judgments of Lady Hale and Lords Wilson, Mance and Clarke leave room for additional exceptions to be grafted onto Lord Sumption’s test in the future.  However, their reasons also suggest that this is “likely to be very rare and that no-one should be encouraged to think that any further exception, in addition to the evasion principle, will be easy to establish”. (para. 103) In practice, future applications of the veil-piercing jurisdiction in England should largely be limited to cases which engage Lord Sumption’s evasion principle.

It is to be hoped that the  Canadian courts will follow a similar path.  In Constitution Insurance Co of Canada v. Kosmopoulos, [1987] 1 S.C.R. 2 at 10, Wilson J. famously remarked that “[t]he law on when a court may … ‘[lift] the corporate veil’ … follows no consistent principle”.  This has led Canadian courts to adopt  a number of different tests for veil-piercing, some of which are so open-ended as to amount to no test at all (e.g., where not piercing the veil would lead to a result “too flagrantly opposed to justice, convenience or the interests of the Revenue”, the approach proposed in Kosmopoulos itself).  With the articulation of the evasion test in Prest, the elusive “consistent principle” sought in Kosmopoulos may have finally emerged.

The McCarthy Tétrault Opinions Group consists of members of the firm’s litigation department whose practices focus on written advocacy and the provision of strategic advice and opinions in the context of complex business disputes and transactions.  The members of the Opinions Group are Anthony Alexander, Martin Boodman, Brandon Kain, Hovsep Afarian and Kirsten Thompson.