Liability Of An Individual Taken In The Garb Of A Company

The Given Issue and Background

Question:

Discus about the Garb of a Company Chu and Computers Pty Ltd.

The given issue here refers to the question of the liability of an individual taken in the garb of a company, or in short, the issue here refers to the piercing of the corporate veil of a company. As per the given facts of the problem, Chu retires from Computers Pty Ltd and enters into an agreement with them not to compete against Computers Pty Ltd for a period of two years from the date of his retirement. Such an agreement between Chu and the company was important because Chu, due to his experience, position and seniority, knew many important details regarding the preferences and the identity and the specifications each client had with regard to the products that the company offered. To ensure that such knowledge is not misused or exploited by Chu to Computers Pty Ltd, such an agreement was necessary. Chu had retired on March, 2014 and the agreement between Chu and Computers Pty Ltd was to have effect till March 2016. In April 2016, i.e. just a month after Chu’s retirement the company Systems Pty Ltd was created and it had, as its sole director, Chu’s wife who also held all the issued capital of Systems Pty Ltd. this company dealt with the selling of market hardware and software on a retail basis. Till such juncture, the matter was, per se, not in conflict with law. Systems Pty Ltd actively markets its products to the existing customers of Computers Pty Ltd. it is from this juncture that things may be said to get complicated. Further information of the case tell us that after the exit of Chu from Computers Pty Ltd, the company changed its structure in such a manner that the whole of its retail wing relating to hardware and software products were now to be controlled by Software Pty Ltd. Incidentally the management and directorial set up of both Computers Pty Ltd and Software Pty Ltd were the same. In reality Software Pty Ltd was a wholly owned subsidiary of Computers Pty Ltd. Such scheme of operation between Computers Pty Ltd and Software Pty Ltd took effect from the 1st of July, 2014, 4 months from the retirement of Chu from Computers Pty Ltd.

The pressing issue now is whether Computers Pty Ltd is entitled to any legal right or remedy or not and if it is entitled to any remedy, what should such remedy be. On the face of it, Systems Pty Ltd is not in the breach of any law, because the name of Chu is in no way involved with that company, therefore the company is well within its rights to solicit customers from Computers’ customer base, keeping in mind the considerations of competition and a free market economy. However, at the same time doubt lingers regarding the authenticity of the Systems Pty Ltd because the company has got only one director who happens to be Chu’s wife, she also holds all the issued capital of the company. Again the company actively solicits Computers’ customers and Chu, using his knowledge and experience regarding Computers’ customers’ tastes and preferences and their identity is very likely to help his wife in getting a good customer base for her company. So, question is definitely very likely to arise whether Systems Pty Ltd is being used by Chu and his wife as a corporate veil to pull customers away from Computers’ and subsequently increase the customer base of Systems Pty Ltd

Legal Right or Remedy for Computers Pty Ltd

It is for the sake of corporate convenience and legal expediency that the concept of corporate veil came into being. Once a company comes into being it has to undertake myriad activities. Such activities have obviously to be taken in the company’s name and the consequences of such activities have to be borne by the company too[1]. In essence, a company is not a living being, it does not have any power to act of itself. Whatever activity is done by a company is actually done by individuals entrusted with the management of the company’s affairs. A corporate veil effectively insulates the individuals involved in the management of the company from the consequences of the decisions taken.[2] Question may arise, why such a veil is needed in the first place. Such a veil may be said to give a tacit encouragement to criminal minded individuals to use the garb of the company to commit illegal acts, therefore, such a veil should be effectively discouraged[3].

The answer to this question has many layers. Corporate veil is necessary for many reasons, but mainly because to encourage individuals involved in the management of the company to take risks, because whatever action they take in their capacity as management of a company, is taken in the name of the company itself, thus such people can take risks for the company without worrying to be personally liable and/or answerable for each and every actions, because it goes without saying that the activities of a company come with their share of unavoidable risks. If an individual is made personally liable for such activities, they would be averse to undertaking any risk. Therefore, this concept has arisen to ensure some protection to individuals involved in the management of a company and allow and in fact encourage them to take calculated and well thought risks[4].

However, as noble or beneficial as the scheme of corporate veil may seem to be, this scheme is not protected from misuse or abuse, as it happens with any other provision intended for the benefit of the public[5]. Many unscrupulous individuals use the protection offered by the corporate veil for their own benefit or to hide their illegal activities under the corporate personality of a company; there have, in fact, been many such cases where the corporate personality of a company has been misused for illegal purposes[6]. It is during such activities that the courts have to resort to the phenomenon of “lifting of the corporate veil” or the “piercing of the corporate veil”[7].  The case given may be said to be an appropriate case where the doctrine of piercing or lifting of the corporate veil may be applied.

In the case of Dennis Willcox Pty Ltd v Federal Commissioner of Taxation[8] it was clearly held by the Court that the corporate personality of a company is to be ignored when it is rather evident that the corporate personality is used merely as a façade or a sham to further some illegal or questionable cause or to evade a legal duty or responsibility[9]. Many a time it may happen that a company has been incorporated simply for the purpose of hiding an inherently and patently illegal activity[10]. According to the Australian jurisprudence, the following broad factors may be decisive in the issue whether the corporate veil of a company is to be pierced or not:

1. When the question is of agent principal relation;
2. When the question is of fraudulent transactions;

• When the question is of unearthing a sham or a fake company;

1. In case of group enterprises;
2. In any case of inherent unfairness or injustice[11].

However, the list cannot be said to be exhaustive, because as is the nature of law, this list too is open to change and growth in the future[12].

Conclusion

In our given problem, the principle of agency may be said to apply in this case, because as is given in the problem, the new company was not created by Chu but by his wife who was the sole director and held the issued capital, therefore, it may be well be reasonably presumed that the company was effectively run by Chu through the agency of his wife.

However, at the same time Computers Pty Ltd floated a subsidiary company and outsourced all its transactions relating to software was to be conducted and supervised by Software Pty Ltd which is a wholly owned subsidiary of Computers Pty Ltd. so in such a scenario it can be very well assumed that Software Pty Ltd was in reality an extension of Computers Pty Ltd and acted as its agent, as its main aim was the furtherance of the goals o f Computers Pty Ltd. The work that was previously done by Computers Pty Ltd itself is now done through Software Pty Ltd which is a wholly owned subsidiary of the parent company, Computers Pty Ltd. Thus, Software Pty Ltd was an extension of Computers Pty Ltd.

Therefore, the action by Systems Pty Ltd directly hurts Software Pty Ltd and through Software Pty Ltd, it tacitly hurts Computers Pty Ltd. The action is done by Chu and is in dirct breach of Chu’s agreement with Computers Pty Ltd, because Chu is soliciting customers of Computers Pty Ltd, within two years of his retirement. Chu again is not doing this directly, but he is doing it through Systems Pty Ltd which is in fact a shell company owned by Chu’s wife to help Chu gain the market.

Davies, P., Worthington, S. and Gower, L., 1979. Gower and Davies' Principles of Modern Company Law. 1st ed. p.37.

Karapanço, A. and Karapanço, I., 2013. The Piercing of the Corporate Veil Doctrine: A Comparative Approach to the Piercing of the Corporate Veil in European Union and Albania. Academic Journal of Interdisciplinary Studies.

Tricker, B., 2011. Re-inventing the Limited Liability Company. Corporate Governance: An International Review, 19(4), pp.384-393.

ibid

Moerman, L. and van der Laan, S., 2015. Exploring Shadow Accountability: The Case of James Hardie and Asbestos. Social and Environmental Accountability Journal, 35(1), pp.32-48.

Supra note 2

Dennis Willcox Pty Ltd v Federal Commissioner of Taxation (1988) 79 ALR 267 (FC, Woodward, Jenkinson and Foster JJ).

Zindoga, w., 2015. Piercing of the corporate veil in terms of gore: section 20(9) of the new companies act 17 of 2008. Llm. University of cape town.