Piercing the Corporate Veil in Latin American Jurisprudence

A comparison with the Anglo-American method

Jose Maria Lezcano

• Publisher: Routledge
• Year: 2015
• ISBN:
  9781317555476
• Edition: 1
• Topic: Law
• Subtopic: Financial Law
• Index: Law

This book is a comparative law study exploring the piercing of the corporate veil in Latin America within the context of the Anglo-American method.

The piercing of the corporate veil is a remedy applied, in exceptional circumstances, to prevent and punish an inappropriate use of the corporate personality. The application of this remedy and the issues it involves has been widely researched in Anglo-American jurisdictions and, until recently, little attention has been given to this subject in Latin America. This region has been through internal political conflicts that undermined economic development. However, rise of democratic governments has created the political stability necessary for investment and economic development meaning that the corporate personality is now more commonly used in Latin America. Consequently, corporate personality issues have become a subject of study in this region.

Drawing on case studies from Mexico, Colombia, Brazil and Argentina, Piercing the Corporate Veil in Latin American Jurisprudence examines the ingenuity of Latin American jurisdictions to deal with corporate personality issues and compares this method with the Anglo-American framework. Focusing in particular on the influence of two key factors- legal tradition and the uniqueness of each legal system- the author highlights both similarities and differences in the way in which the piercing of the corporate veil is applied in Latin American and Anglo-American jurisdictions.

This book will be of great interest to scholars of company and comparative law, and business studies in general.

II
Piercing the corporate veil in an Anglo-American context

As pointed out in the first chapter, the contemporary business entity is an English ingenuity that was adopted and more extensively developed by the US Seeing that the UK and the US are the first to exercise such entity, they are also the first to experience any problems relating to it.

In order to study the piercing of the corporate veil in Latin America, the origins of this legal phenomenon should be understood. Certainly, in the first chapter the general aspects of this subject were established. However, for comparative purposes this has to be addressed to a greater extent in an Anglo-American context. The rationale of this chapter is based on the need for a template from which to draw a comparison. The US is the jurisdiction that has been adopted as such a template. This jurisdiction has not only dealt more with the corporate personality but it has also developed a doctrinal approach to deal with corporate entity issues. This has been the subject of interest for academics in other jurisdictions.

It has to be mentioned that England has been included as the subject of study in this chapter. Moreover, this chapter begins with the piercing of the corporate veil in England. This jurisdiction has been reluctant to pierce the corporate veil. Furthermore, it has not born heavy influence on the development of the Latin American mechanisms to deal with the corporate personality. However, England has been included to supplement this comparative study because of her role in the development of the contemporary business entity and her tendency to protect the business entity.

This chapter starts with the piercing of the corporate veil in England. The English doctrinal and statutory approaches are explored. Following this, the US piercing of the corporate veil is addressed, where the generalities of this subject and the doctrines of instrumentality and alter-ego are studied. In addition, the role of US federal law regarding the piercing of the corporate veil is analyzed in context. Finally, this chapter closes with a reflection over the factors that have made the US and England take different paths regarding the piercing of the corporate veil.

1. Piercing the corporate veil in England

Disregard of the legal entity has been a controversial subject in English company law. The English judiciary has been characterized for being less willing to pierce the corporate veil than has the US.¹ The perception of England as a jurisdiction willing to preserve the corporate personality can be attributed to the fact that less direct approaches to deal with corporate veil issues have been applied by English courts. However, before addressing the methods used by the English judiciary to deal with corporate veil issues, I will proceed to address the case of Salomon v Salomon Co. Ltd,² which can be considered the precedent that created the foundation of the current position of the English courts with regard to the piercing of the corporate veil.

1.1 The case of Salomon

English company law authors regard the case of Salomon v Salomon Co. Ltd as the landmark in the preservation of the corporate entity’s integrity and autonomy.³ This precedent created the foundations of the current position of the English judiciary in regard to the corporate personality.

This case presented an early, and I dare to say simple, scenario, compared to the modern corporate structures. Mr Aron Salomon was a boot maker, who carried out his business as a sole trader. One day, he decided to enjoy the benefits of limited liability and created a company called “ A Salomon & Co Ltd ”, to execute the bootmaking business. The members of the company were his wife, his daughter, four sons and himself. Each subscriber took a £1 share. Mr Salomon sold his boot making business to the company for £39,000. Part of the purchase price was used by Mr Salomon to subscribe for a further 20,000 £1 shares in the company. However, £10,000 of the purchase price was not paid by the company; rather this was given to Mr Salomon in a series of debentures, which in turn gave Mr Salomon a guarantee for the debt. In other words, he had preference over other creditors in case the company defaulted, which is indeed what happened. The business of A Salomon & Co Ltd failed, and the company went into liquidation. As a creditor with preference, Mr Salomon claimed for his credit. However, this payment would have left the company without enough assets to cover debts to other creditors. Consequently, Mr Salomon’s claim was challenged by the company’s liquidator, who claimed that Mr Salomon should answer for the debts of the company. The plaintiff argued that the company had conducted the business as an agent of Mr Salomon and consequently he was responsible for the debts incurred in the course of the agency. The first instance court decided in favor of the plaintiff. Therefore Mr Salomon appealed. Although Salomon & Co was properly incorporated, the Court of Appeal considered this fact not to be relevant.⁴ Instead, the Court of Appeal focused on whether the sale of Mr Salomon’s business to Salomon & Co was valid. Should this transaction be supported to enable Mr Salomon to defeat the creditors and under the debentures appropriate the assets to himself?⁵

Based on the facts of there not being a valuation of stock, account of profits and non-influential members of the company (shareholders were considered as dummies used by Mr Salomon to comply with a statutory requirement), the Court of Appeal decided that Salomon & Co was a sham created by Mr Salomon to defeat creditors.⁶ Therefore, the remedy provided by the Court of Appeal consisted of two options: (1) Mr Salomon had to indemnify the company against the debts and costs, or (2) the Court declared the sale of the business as invalid, set aside the agreement and debentures and ordered Mr Salomon to repay the money of the sale.⁷ Undeniably, both options were aimed at setting aside the corporation’s legal personality and made Mr Salomon liable for the debts of the company.

The House of Lords, however, rejected the decisions made by the first instance court and the Court of Appeal. The existence of Salomon & Co Ltd ’s personality was preserved. Their Lordships held that there was nothing in the Companies Act that prohibited what Mr Salomon had done. Lord Macnaghten, Lord Halsbury and Lord Herschell went on to say:

“It is not contrary to the true intent and meaning of the Companies Act 1862 for a trader, in order to limit his liability and obtain the preference of a debenture-holder over other creditors, to sell his business to a limited company consisting only of himself and six members of his own family, the business being then solvent, all the terms of sale being known to and approved by the shareholders, and all the requirements of the Act being complied with.”⁸

The decision made by the House of Lords in the case of Salomon most definitely affected the corporate entity.⁹ It was established that the mere wish to trade using the corporate entity in order to get the benefits of limited liability is not to be regarded as fraud.¹⁰ The whole purpose of incorporating a business is for its member[s] to avoid incurring further personal liability.¹¹ To presume the creation of a company as fraudulent would defeat the whole notion of the separate existence of the company and make it impossible for small private companies to function in a different way to partnerships. However, it was clear from the decision regarding Salomon that had there been evidence of fraud their Lordships would not have recognized the company as a separate entity.

Additionally, it was clarified in the Salomon case that being a controller member of a company does not in itself make the company an agent of that member (although the sole objective of the company is to benefit the member(s)).¹² Consequently, the creditors that accept trading with a corporate entity also accept the risk that, should the company default, they would not reach the shareholders’ assets. Therefore, creditors have the obligation to establish adequate protections in order to have a higher probability of recovering their credit in case of default.¹³

1.2 The effects of the Salomon precedent

Based on the precedent of Salomon, the English judiciary has established that the only condition to enjoy the benefits of the corporate entity is that the company be properly created by registration. The Companies Act 2006 gives the registrar power to refuse to register a company not created for a lawful purpose. In principle, the English judiciary will not allow the use of the corporate entity for fraudulent purposes. However, the piercing of the corporate veil is not common in this jurisdiction. I personally consider that the English approach to corporate personality cases involves an extension of liability rather than piercing the corporate veil. As will be shown throughout this section, the English judiciary has opted for not affecting the integrity of the corporate personality.

Certainly, since the decision on the Salomon case English authorities have crafted exceptions to the corporate personality. These main exceptions have been developed under the concepts of “sham”, “agency” and “single economic unit”. However, although these exceptions are currently valid and applicable, none of them have been widely applied.

1.2.1 Sham exception

The Case Gilford Motors v Horne,¹⁴ is an early corporate personality case on which the obligations of a natural person were extended to a corporate entity. It was justified through an argument based on the concept of sham. In this case, the defendant was accused of using a company called “JM Horne & Co Ltd” to avoid the effects of a covenant in order not to compete with his ex-employer. The defendant did not hold shares or a position in the company. Instead, his wife and an employee held shares and were the directors of the company. However, the defendant had a strong influence over the management of the company. Therefore, based on the fact that Mr Horne sought to avoid the covenant through a company (that he indirectly controlled) the court considered the company to be a “mere cloak or sham”.¹⁵ It was believed that even if a company was properly incorporated, its legitimacy would be doubted if it were suspected of being a device to conceal an illegitimate purpose. However, the outcome of this case was not the piercing of the corporate veil. Rather the effects of the covenant were extended from Mr Horne to the company JM Horne & Co Ltd, and the integrity of the corporate personality was preserved.

The precedent established in Gilford Motors v Horne created the basis for the concept of sham to become an available argument against wrongdoers who sought cover behind the corporate personality. In the case Jones v Lipman,¹⁶ the argument of sham established in Gilford Motors v Horne was again used to deal with the fraudulent use of corporate personality. In this case, the defendant agreed to sell some land but later decided not to complete the sale. The defendant instead chose to transfer the property to a company, of which he and his lawyer were the shareholders and directors. The court regarded this company as “the creature of the defendant, a device, a sham”.¹⁷ However, rather than piercing the corporate veil, the court decided to make the company a second defendant. Furthermore, both defendants were obligated to complete the agreement between the claimant and the first defendant.

Although the outcome of the cited cases did not result in the piercing of the corporate veil, it can be considered that the relevance of both precedents derived from the fact that the scope of the sham exception was defined. Indeed, from this point the judiciary started to consider that the use of the corporate entity as an instrument to escape contractual obligations is a justification to set aside the corporate personality. However, the concept of sham derived from Gilford Motors v Horne can be regarded as an incomplete approach because there is not a system...