Supreme Court finds that even fraud did not justify piercing the corporate veil

Even where a bank may have been induced to lend money to a company by fraudulent statements made by the company’s controller, the court will not pierce the company’s corporate veil so as to make the controller a party to the lending agreement in place of (or in addition to) the company, and hence liable to the bank in contract for a failure to repay the loan. To do so would be an unjustified and almost unprecedented extension to the circumstances and manner in which the courts are prepared to pierce the corporate veil, and would run contrary to other established principles of English law. Moreover, piercing the corporate veil was not necessary in order to provide the bank with an adequate remedy: if the bank could show that it was indeed induced to enter into the transaction by false or misleading statements made by the controller, or that the controller was part of a conspiracy to defraud the bank, the bank would be able to recover substantial damages from the controller in tort. So held the Supreme Court in a unanimous decision given on 6 February 2013 in VTB Capital plc v Nutritek International Corp and others [2012] EWCA Civ 808.

However, as this was only an interlocutory hearing, the Supreme Court declined to offer more general guidance on the questions of whether the courts can ever pierce the corporate veil and, if so, the circumstances and manner in which they will be prepared to do so. On the former question, though, the Supreme Court did note that there have been a number of cases in which the courts have been prepared to pierce the corporate veil (or assumed that it could be done), and that all the leading textbooks accept that it is possible in principle. But it is difficult to extract from the cases a clear picture of the elements needed to justify piercing the veil: possibly further guidance may be provided when the Supreme Court hears an appeal next month in a quite separate case, Petrodel Resources Limited and ors v Prest and ors. That case concerns an attempt, in the context of divorce proceedings, to pierce the corporate veil of a company used by a husband to hold the legal title to the matrimonial home and other property for wealth protection and tax reduction purposes, so that such property would form part of the husband’s assets for the purposes of the Matrimonial Causes Act 1973. What is clear, however, is that it remains perfectly legitimate for even a sole or controlling owner of a business to use a corporate structure to limit its liability, and that for the corporate veil to be lifted a claimant will almost certainly need to show more than mere impropriety: most likely, it will need to demonstrate that the company is a mere façade or sham designed to conceal the true facts.

The case

Under a facility agreement signed in 2007, VTB Capital plc, a UK bank owned by a state-controlled bank based in Moscow, lent $225 million to a newly-formed Russian company named Russagroprom LLC (RAP) to finance the acquisition by RAP of a number of Russian dairy companies from Nutritek International Corp (a BVI company). RAP defaulted on the loan and VTB is likely to recover only about $40 million from enforcing its security. VTB brought proceedings in the English courts claiming that both RAP and Nutritek were ultimately controlled Mr Konstantin Malofeev, a Russian businessman resident in Moscow, and that it had been induced to enter into the facility agreement by statements to the effect that RAP and Nutritek were not under common control and that the dairy companies were worth much more than was in fact the case. In effect, what is alleged is that Mr Malofeev and his associates concocted a scheme to extract value from the Russian dairy companies using funds fraudulently obtained from VTB.

VTB claims that the statements about the ownership of RAP and Nutritek, and the value of the dairies, were fraudulent and that Mr Malofeev and certain associates are jointly and severally liable to VTB in the torts of deceit and conspiracy. In addition, VTB sought to claim that the corporate veil of RAP should be pierced and Mr Malofeev and his associates, as its controllers, should be liable in contract for breach of the facility agreement. The Supreme Court refused to allow the contractual claim to proceed.

(By a majority of three to two, the Supreme Court also held that the English courts were not the appropriate forum to resolve VTB’s tort claims. This aspect of the decision is not discussed here.)

Reasons why the Supreme Court refused to pierce the veil

Making Mr Malofeev liable for breach of the facility agreement as if he had been a co-contracting party with the borrower, RAP, would represent a significant extension to the circumstances where it has traditionally been held that the corporate veil can be pierced. The only support for extending the principle in this way comes from the recent decision of Burton J in Antonio Gramsci Shipping Corporation v Stepanovs [2011] EWHC 333 (Comm), a case which has been much criticised. For the following reasons, the Supreme Court did not consider that the circumstances in VTB Capital justified piercing the veil in this manner:

• Even accepting that the court can pierce the corporate veil in some circumstances, the notion of making a controller jointly and severally liable with his company is inconsistent with the fundamental principles of separate corporate personality and limited liability first established in Salomon v A Salomon & Co Ltd [1897] AC 22.
• If the fraudulent misstatement claims were made out, VTB would be able to recover substantial damages in tort from the controllers. The law therefore already provides a means for the bank to obtain adequate redress.
• None of the parties concerned intended to contract with Mr Malofeev, and he did not behave as if or lead any other party to believe that he was a party to the facility agreement.
• “Quite apart from this, it seems to me that the facts relied on by VTB to justify piercing the veil of incorporation in this case do not involve RAP being used as “a façade concealing the true facts”. In my view, if the corporate veil is to be pierced, “the true facts” must mean that, in reality, it is the person behind the company, rather than the company, which is the relevant actor or recipient (as the case may be). Here, on VTB’s case, “the true facts” relate to the control, trading performance, and value of the Dairy Companies (if one considers the specific allegations against Mr Malofeev), or to the genuineness of the nature of the underlying arrangement (which involves a transfer of assets between companies in common ownership). Neither of these features can be said to involve RAP being used as a “façade to conceal the true facts”. (Lord Neuberger at paragraph 142)

Comment

Until the Supreme Court provides further guidance on the circumstances and manner in which the corporate veil can be pierced, where it appears that a corporate structure has been used “improperly” to limit or evade legal liability (whether in contract, under statute or otherwise), claimants may well continue to argue that the corporate veil should be pierced. Succeeding with such a claim will now be more difficult, though, where the law provides an alternative means of obtaining an adequate remedy against the alleged controller of the company. And it is very unlikely that the controller of a company will ever be made jointly and severally liable with the company for a contract entered into by the company alone: although Gramsci was not expressly over-ruled, its correctness must now be severely doubted.

Where the company concerned is incorporated outside the UK then, even if the English courts are the correct forum for hearing the dispute, the question of whether its corporate veil can be pierced is likely to be determined, at least in part, by reference to its domestic company law.

Of course, there are various ways in which a controller (or parent) of a company can be held liable for the acts or omissions of the company (subsidiary). These include:

• Tort: for example, as in VTB Capital, the controller will be liable for damages in tort if it makes a false or misleading statement to a third party in order to benefit the company, or if it unlawfully procures a breach of contract by the company.
• The controller may be found by the courts to have acted as a shadow or de facto director of the company.
• Under legislation relating to environmental damage, defined benefit pension schemes, bribery or tax.

For more information on how courts and legislators across Europe approach the question of when and how a parent company is liable for the acts and omissions of its subsidiary see the CMS Guide to the Liability of Holding Companies.

The VTB Capital case can be found here.