Lalmibl01 International Business Law- Civil Assessment Answers

International Comparative Corporate Law (Regulation)

Mr White is the owner and principal director of a limited liability company, White Manufacturing LLC, incorporated in the state of Delaware USA. White Manufacturing was initially set up, in 1991, with a share capital of US$20,000, with each share having a par value of US$1. Mr White is the majority shareholder with 15,001 shares, the remaining shares owned by Mr Pink (1000 shares), Mr Brown (1000 shares), the balance of the shares (2,999) were, in 1995, transferred by the original owner, Mr Green, to Mr White’s daughter Clarissa. White Manufacturing produces high volume plastic products for the small gifts market.

The company grew rapidly initially and Mr White set up subsidiary companies in Germany (White Holdings GmbH) and the UK (White Manufacturing (UK) Ltd.) with a view to expanding into the European market. The German company maintains an office in Hamburg, with five employees but there is no manufacturing operation in Germany. The UK company owns a small factory in Corby with 16 employees (which produces high precision plastic products).

In 2005, White Manufacturing acquired, for US$20,000,000, a defunct but still operational plastics factory in New Jersey, USA in a bid to greatly expand its operations and output. It financed the acquisition with loans from Capital Finance Partners Inc. (US$10,000,000) and two loans equivalent to US$5,000,000 each from Schneider Investment (a limited liability partnership registered in Germany) and Development Holdings (an investment company based in the UK).

The new factory was recommissioned and commenced production again in early 2006. Initially all went well such that in 2007 the factory reported a small operating profit with a healthy order book. However, by the end of 2008, the financial crash had resulted in a huge fall-off in orders in the last two quarters and the company reported a serious financial loss for that financial year.

Mr White and the other shareholders held a board meeting and discussed whether they should cut their losses and liquidate the company. All the shareholders apart from Mr White agreed that this should happen as soon as possible (even Mr White’s daughter). Mr White however, used his majority holding to defeat the motion as he believed he could convince a Chinese buyer who would buyer to buy the factory as a going concern. It transpired later that Mr White had in fact already commenced negotiation with the Chinese buyer without informing the board. Moreover, Mr White had seriously undervalued the New Jersey operation in order to sweeten the deal for the company. The Chinese buyer, after five months, pulled out of the deal by which time the New Jersey operation had losses amounting to $25,000,000.

Mr White then held another board meeting and informed the board of the failure of the Chinese deal. He also revealed that White Manufacturing itself was in financial trouble and, with the help of his daughter, persuaded the other shareholders to dissolve the company. Accordingly a certificate of cancellation was filed in Delaware terminating White Manufacturing’s existence.

It transpired however, that White Manufacturing was terminated with debts amounting to some $50,000,000 dollars, including the balance of the loans to Capital Finance Partners ($5,700,000 still owed), Schneider Investment and Development Holdings ($1,997,000 each). It also transpired that Mr White has engaged in capital transfers of funds (in the amount of $30,000,000 in total) to the two subsidiaries in the UK and Germany, with the connivance of the company’s accountants but without informing the board. As if that were not enough, there is evidence that Mr White had been using the assets of his foreign subsidiaries to finance the purchase of a villa in the Dordogne region of France, to fund (as tax-deductible ‘business trips’) family-and-friends excursions to the villa (by private jet; none of the friends seems ever to have had any business dealings with any of White’s companies) and to fund a lavish playboy lifestyle in the casinos of Monte Carlo.

Consider the possible approach in each of the three possible jurisdictions to the question of piercing the corporate veil to recover debts.

Answer

Introduction

The purpose of writing this report is to explain the application of corporate veil in the corporate legal environment. It is one of the controversial areas. The concept of corporate veil is applicable to the public companies which say that the legal person is different from its company. There are many consideration which are regarded while determining the factors whether the Court can lift up the corporate veil. Solomon vs. Solomon is a famous case for determining the case for lifting up the corporate veil. Nowadays the above principle is used when there is unjust to the third parties. Most of the limited companies apply this rule to separate personality. If the corporate veil is lifted then the limited liability is lost and the Court may impose personal fines and penalty on the directors and the management of the companies.

Different approaches to piercing the corporate veil in each of the relevant jurisdictions

Piercing the corporate veil or lifting the corporate veil is a concept where the legal decision is taken on both the rights as well as the duties of the companies as well as its shareholders. A company or a Corporation is treated as a separate legal person, and they are responsible for the debts that are incurred and is the sole beneficiary of the credit it is owed. As per the common law, the companies uphold this principle of separate legal entity except in the exceptional situations may "pierce" or "lift" the corporate veil.

Taking a example where the businessman, who was the director has left his position as a director and signed an agreement where the company will has just left for a period of time. He set up a company which was competing with the former company,, technically it would be the company and not the person competing. The Court said that the new company is a sham which would still allow the old company to sue the man for breach of the contract.

Justification for the different jurisdictional approaches</h3

Common Law System

A country which follows the common law system is typically known to the former British colonies or protectorates, including the United States.

Features that common law system include:

• There is no such written constitution or particular codified laws;
• The decision made by the Judicial are binding – the decisions are of the highest court which can generally be overturned by the same court or through the legislation;
• There is extensive freedom of the contract – There are few provisions that are implied into the contract by law
• It is seen that everything that is included is not expressly prohibited by law.

A common law system is less of the descriptive or less prescriptive than that of the civil law system.Thus the Government may enshrine the protection to the citizens for particular legislation related to the infrastructure program being contemplated. They may wish to prohibit the service provider from cutting off the water or electricity supply of bad payers or may require that documents related to the transaction be disclosed under a freedom of information act. There may also be legal requirements to imply into a contract in equal bargaining provisions where one party is in a much stronger bargaining position than the other.

There are very provisions that can be implied into a contract under the common law system – it is therefore important to set out all the terms governing the relationship between the parties to a contract in the contract itself. This results in a contract which is longer in a civil law country.

Civil Law System

The Countries that follow the civil law system mainly belong from French, Dutch, German, Spanish or Portuguese colonies or protectorates, including much of Central and South America. There are many people who follow the Central and Eastern European and East Asian countries’ civil law structure.

The civil law system is a codified system of law. It takes its origins from Roman law. Features of a civil law system include:

• There is a written constitution which is based on the specific codes (e.g., civil code, codes covering corporate law, administrative law, tax law and constitutional law) the enshrining basic rights and the duties; administrative law is something which is however less codified and the administrative court judges which tend to behave more like the common law judges;
• Only the legislative enactments which are considered as binding to the all. There is a little scope for the judge or the law in civil, criminal and commercial courts, although in practice judges which tend to follow the previous judicial decisions; constitutional and administrative courts that can nullify the laws and regulations and their decisions in such cases are binding for all.
• The Courts have specific to that of the underlying codes – there are usually separate constitutional court, administrative court and civil court systems that opine on consistency of legislation and administrative acts with and interpret that specific code;
• Less freedom of the contract – There are many provisions which are implied into a contract by the law and parties which cannot be contract out of the certain provisions.

A civil law system is generally more prescriptive than a common law system. However, a government will still need to consider whether specific legislation is required to either limit the scope of a certain restriction to allow a successful infrastructure project, or may require specific legislation for a sector. There are a number of provisions implied into a contract under the civil law system.This will often result in a contract being shorter than one in a common law country.

Advantages and disadvantages of the different approaches in the case study analysis

Germany

German corporate law developed a number of theories in the early 1920s for lifting the corporate veil on the basis of "domination" by a parent company over a subsidiary. Today, shareholders can be held liable in the case of an interference destroying the corporation. The corporation is entitled to a minimum of equitable funds. If these are taken away by the shareholder the corporation may claim compensation, even in an insolvency proceeding.

United Kingdom

The corporate veil in UK company law is pierced very rarely. After a series of attempts by the Court of Appeal during the late 1960s and early 1970s to establish a theory of economic reality, and a doctrine of control for lifting the veil, the House of Lords reasserted an orthodox approach. According to a 1990 case at the Court of Appeal, Adams v Cape Industries plc, the only true "veil piercing" may take place when a company is set up for fraudulent purposes, or where it is established to avoid an existing obligation. The veil is also often ignored in the process of interpreting a statute, and as a matter of tort law it is open as a matter of authority that a direct duty of care may be owed by the managers of a parent company to accident victims of a subsidiary. There are also significant statements still among the judiciary in support of a broader veil lifting approach in the interests of "justice”. The issue is discussed at length in a 2013 UK Supreme Court case, Prest v Petrodel Resources Ltd.

It is an axiomatic principle that a company is an entity separate and distinct from its members, who are liable only to the extent that they have contributed to the company's capital: Salomon v Salomon [1897]. The effect of this rule is that the individual subsidiaries within a conglomerate will be treated as separate entities and the parent cannot be made liable for the subsidiaries' debts on insolvency. Furthermore, it can create subsidiaries with inadequate capitalization and secure loans to the subsidiaries with fixed charges over their assets, despite the fact that this is "not necessarily the most honest way of trading”. The rule also applies in Scotland.

While the secondary literature refers to different means of "lifting" or "piercing" the veil judicial dicta supporting the view that the rule in Salomon is subject to exceptions are thin on the ground. The theory of the "single economic unit" - wherein the court examined the overall business operation as an economic unit, rather than strict legal form - in DHN Food Distributors v Tower Hamlets. However this has largely been repudiated and has been treated with caution in subsequent judgments.

United States

In the United States, corporate veil piercing is the most litigated issue in corporate law. Although courts are reluctant to hold an active shareholder liable for actions that are legally the responsibility of the corporation, even if the corporation has a single shareholder, they will often do so if the corporation was markedly noncompliant with corporate formalities, to prevent fraud, or to achieve equity in certain cases of undercapitalization

In most jurisdictions, the ruling is based on common law precedents. In the United States, different theories, most important "alter ego" or "instrumentality rule", attempted to create a piercing standard. Mostly, they rest upon three basic prongs

• "Unity of interest and ownership": the separate personalities of the shareholder and corporation cease to exist,
• "Wrongful conduct": wrongful action taken by the corporation, and
• "Proximate cause": as a reasonably foreseeable result of the wrongful action, harm was caused to the party that is seeking to pierce the corporate veil.

However, the theories failed to articulate a real-world approach which courts could directly apply to their cases. Thus, courts struggle with the proof of each prong and rather analyze all given factors. This is known as "totality of circumstances"

There is also the matter of what jurisdiction the corporation is incorporated in if the corporation is authorized to do business in more than one state. All corporations have one specific state (their "home" state) to which they are incorporated as a home company and if they operate in other states, they would apply for authority to do business in those other states as a foreign company. In determining whether or not the corporate veil may be pierced, the courts are required to use the laws of the corporation's home state. This issue can be significant; for example, the rules for allowing a corporate veil to be pierced are much more liberal than. Thus, the owner(s) of a corporation operating in California would be subject to different potential for the corporation's veil to be pierced if the corporation was to be sued, depending on whether the corporation was a California domestic corporation or was a Nevada foreign corporation operating in California.

Relevant regulatory environment and applicable case law in each jurisdiction

In Woolfson v Strathclyde BC, the House of Lords held that it was a decision to be confined to its facts (the question in DHN had been whether the subsidiary of the plaintiff, the former owning the premises on which the parent carried out its business, could receive compensation for loss of business under this notwithstanding that under the rule in Salomon, it was the parent and not the subsidiary that had lost the business). Likewise, in Bank of Tokyo v Karoon, Lord Goff, who had concurred in the result in DHN, held that the legal conception of the corporate structure was entirely distinct from the economic realities.

The "single economic unit" theory was likewise rejected by the CA in Adams v Cape Industries, where it was held held that cases where the rule in Salomon had been circumvented were merely instances where they didn't know what to do. The view expressed at first instance by HHJ Southwell QC in Creasey v Breachwood that English law "definitely" recognised the principle that the corporate veil could be lifted was described as a heresy by Hobhouse LJ in Ord v Bellhaven, and these doubts were shared by Moritt V-C in the corporate veil cannot be lifted merely because justice requires it. Despite the rejection of the "justice of the case" test, it is observed from judicial reasoning in veil piercing cases that the courts employ "equitable discretion" guided by general principles such as male fides to test whether the corporate structure has been used as a mere device.

Generally, the plaintiff has to prove that the incorporation was merely a formality and that the corporation neglected corporate formalities and protocols, such as voting to approve the companies in the context of a duly authorized corporate meeting. This is quite often the case when a corporation facing legal liability transfers its assets and business to another corporation with the same management and shareholders. It also happens with single person corporations that are managed in a haphazard manner. As such, the veil can be pierced in both civil cases and where regulatory proceedings are taken against a shell corporation.

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