Lifting of Corporate Veil in Tort Cases in Pursuit of Justice

Limited liability has been the prevailing rule for corporations for more than a century. It creates incentives for excessive risk-taking by allowing companies to avoid the full costs of their activities. Strict application of this rule in all cases would lead to inflexibility and injustice, particularly in tort cases. Therefore, as suggested by Stephen Griffin—“in the interests of justice and to prevent subsidiary companies being used as convenient risk takers for their parent…the [corporate] veil must not become immovable.”[1] On the other hand, basing justice as the sole ground for veil lifting would undermine commercial certainty. The facts of each case should be taken into account to strike a balance between certainty and justice. This paper, focusing on the group companies context, attempts to argue for a lower threshold in veil lifting regarding tort cases to pursue justice and to introduce general principles in which court should lift the veil to ensure sufficient certainty.

Veil Lifting in Tort Cases

The Salomon principle[2]states that a company is a legal person separate from its members. In contrast, the doctrine of veil lifting refers to the possibility of looking behind the company structure to make the shareholders personally liable. It is settled in China Ocean Shipping Co v Mitrans Shipping Co Ltd[3] that using a corporate structure to evade existing legal obligations is objectionable whereas using the same to avoid the incurring of future legal obligations in the first place is not. The court held that its power to lift veil could only be exercised in the former situation. Unfortunately, strict application of this case would lead to injustice as tort liabilities almost always arise after incorporation. As a result, tort victims could never lift the veil and defendant companies are always immune to tortious liability due to the corporate structure.

In Adams v Cape Industries plc[4], in which tortious liability is involved, the court strictly applied the principle in China Ocean[5]. It held that veil is not lifted and so the parent company is not liable for the tort committed by its wholly-owned subsidiary. The tort victims in this case were left with no compensation as the subsidiary was liquidated and veil was not lifted to make the financially healthy parent company liable. Arguments for Veil Lifting in Pursuit of Justice

If the above cases are strictly followed, the effect is to shift the consequences of high risk tortious actions from the defendant companies to the innocent tort victims, which is obviously unjust.

It is worth-noting that the Salomon case[6] was decided over a century ago. At that time, it was not widespread commercial practice for large companies to operate by means of many subsidiaries and tort law was very much undeveloped compare with its form a century later. The interaction with tort law would not have been considered at all when the case was decided. Where tort and corporate law principles are in conflict, as above mentioned, courts usually resolve the matter with reference to corporate law principles. When considered in the context of contemporary public policy, it has been criticized that the deference to the Salomon principle in relation to tort liability of corporate groups appears misconceived.[7] Therefore, the Salomon principle should sometimes be disregard and veil should be lifted in tort cases due to the following reasons.

Involuntary Victims
Very often, opponents against veil lifting argue that tort victims should not receive preferential treatment over other unsecured contractual creditors. Therefore, even in tort cases, the strict approach of the China Ocean case should be applied, as in other cases involving contractual claims. However, they may have overlooked a significant difference between tort victims and contractual creditors. Tort victims are usually involuntary and innocent ones who do not possess the information or the means to safeguard themselves against risk of insolvency of the defendant company, as opposed to contractual creditors, who can always choose the parties to the contract, bargain in settling the terms with the defendant company and may also take protective steps such as gaining guarantees and security to guard against the possibility that the defendant company may be unable to meet its contractual debt. [8]

Avoidance of Excessively Risky Behaviour
The prevalence of mergers and acquisitions movement nowadays has converted many large corporations into highly leveraged firms. In order to maximize cash flow, these firms have a strong incentive for excessive risk-taking activities, which drastically increase the exposure to tort liability. Carcinogens in the workplace, environmental harms to the surrounding and hazardous products are all sources of massive tortious liability. [9] Very often, business firms would reorganize their structure to exploit limited liability to evade tort claims, such as deliberately placing hazardous activities in under-funded subsidiaries. However, business ethics is a prominent contemporary concept and issue in commercial context. In terms of public policy and public interest, it is of paramount importance to deter companies from taking excessively risky activities, which cause personal injury to innocent victims.

Tort Victims and Business on Unequal Footing
Tort victims are those who may suffer physical injury or harm. On the other hand, parent companies of its defendant subsidiaries only suffer commercial losses in the relevant tortious claims. Yet, the parent could have control over its subsidiaries and shareholders had the chance to assess the risk of the company. They also share the profit of an enterprise and so they should be subject to its loss and assume its risk as well. In allocating the burden of loss, it is necessary to balance the interests of the innocent tort victims and on the other hand, the parent companies or the shareholders. As a result, the best compromise is to allocate the risk to the parent companies as it would be unjust if they simply benefit from the excessively risky behaviour at the expense of consumer, employee, environment and society as a whole.

Guiding Principles Justifying Veil Lifting
It is neither argued that veil of every tort case must be lifted nor that justice should be the single ground for all veil lifting cases. Justice should be taken into account but the balancing should also be guided by general principles to ensure sufficient certainty, which are crucial in commercial context. Thus, there are two main grounds which justify the lifting of corporate veil in tort cases. First is the degree of control and second is the knowledge of the victims.

Control
It is suggested that using a corporate stricture capriciously, namely to evade tortious liability, together with control would be sufficient to lift the veil. [10] In any event, the Salomon Principle should never be intended to be used as a means of insulating layers of corporate group organisation from liability. In the context of group companies, the parent is not an individual shareholder, with little or no interest in the running of the subsidiary as if it were no more than a portfolio and passive shareholder. It may be unjust to hold an individual liable for action beyond their control. However, the parent is the actual manager of the subsidiary. It is a direct investor and it controls and should be, in a real business sense, responsible for that which it controls.[11]

When the tort victims are left without compensation due to the insolvency of a wholly owned subsidiary, its parent obviously satisfies the requirement of control and it makes good sense for liability to be imposed upon it.

Knowledge of Tort Victims
One may challenge that tort claimants are not always involuntary victims for they may have an existing contractual relationship with the firm prior to the injury, such as workplace injuries against employees and products liability against customers. Indeed, the result of the balancing exercise between the parent and the tort victims may well be different if the tort victims are able, prior to the injury, to assess and fully aware the risks they take in dealing with the defendant company but still voluntarily assume the risks.

Therefore, knowledge of tort victims regarding the risks in dealing with the firm become another crucial factor to determine whether veil should be lifted or not. The critical question is whether the victim can reasonably be understood to have contracted with the firm in substantial awareness of the risks of injury involved.[12] If so, the liability should be considered contractual and veil should not be lifted. Otherwise, the victims should be considered involuntary and innocent ones. The parent should not be afforded the protection of the Salomon Principle and thus, veil should be lifted in this regard.

Concluding Remarks—a Balancing Exercise
To conclude, this paper suggests that a strict application of the Salomon Principle in all cases would lead to injustice. A number of arguments for veil lifting regarding tortious claim were put forward. Although both certainty and justice are crucial to our legal system, it is impossible to achieve complete certainty and perfect justice at the same time. Sometimes, to a certain extent, justice may have to give way to certainty and vice versa. After all, it is always a balancing exercise to achieve the optimal result when more than one party is affected, as between the tort victims and the parent companies. Thereby, two factors, which are non-exhaustive, were also introduced in this paper to serve as general guidelines which may be taken into account in deciding whether to lift the veil or not, namely degree of control of the parents and the knowledge of the victims regarding the risks involved.

Bibliography

Abhinav Ashwin, “Tortious liability of company in winding up: an analysis”, Comp. Law. 2005, 26(6), 163-179

Angelo Capuano, The realist’s guide to piercing the corporate veil: Lessons from Hong Kong and Singapore, Australian Journal of Corporate Law, Vol. 23, No. 1, 2009

Henry Hansmann & Reinier Krakkman, “Towards Unlimited Shareholder Liability for Corporate Torts” 100 Yale Law Journal 1879, 1894-1909

P.T. Muchlinski, Holding multinationals to account: recent developments in English litigation and the Company Law Review, Comp. Law. 2002, 23(6), 168-179

Phillip Lipton, “Tort Liability of Corporate Groups: Grappling with the Dead Hand of Salomon”, Keeping Good Companies 57(4), 213-219, 2005

Stephen Griffin, “Holding companies and subsidiaries – the corporate veil” Comp. Law. 1991, 12(1), 16-17

Cases

Adams v Cape Industries plc [1990] Ch 433

China Ocean Shipping Co v Mitrans Shipping Co Ltd [1995] 3 HKC 123

Salomon v A Salomon & Co Ltd [1897] AC 22

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[1] Stephen Griffin, “Holding companies and subsidiaries – the corporate veil” Comp. Law. 1991, 12(1), 16-17 [2] Salomon v A Salomon & Co Ltd [1897] AC 22
[3] [1995] 3 HKC 123
[4] [1990] Ch 433
[5] [1995] 3 HKC 123

[6] [1897] AC 22
[7] Phillip Lipton, “Tort Liability of Corporate Groups: Grappling with the Dead Hand of Salomon”, Keeping Good Companies 57(4), 213-219, 2005 [8] Abhinav Ashwin, “Tortious liability of company in winding up: an analysis”, Comp. Law. 2005, 26(6), 163-179

[9] Henry Hansmann & Reinier Krakkman, “Towards Unlimited Shareholder Liability for Corporate Torts” 100 Yale Law Journal 1879, 1894-1909 [10]
Angelo Capuano, The realist’s guide to piercing the corporate veil: Lessons from Hong Kong and Singapore, Australian Journal of Corporate Law, Vol. 23, No. 1, 2009

[11]P.T. Muchlinski, Holding multinationals to account: recent developments in English litigation and the Company Law Review, Comp. Law. 2002, 23(6), 168-179 [12] Henry Hansmann & Reinier Krakkman, “Towards Unlimited Shareholder Liability for Corporate Torts” 100 Yale Law Journal 1879, 1894-1909, at p1921