LIFTING THE VEIL OF INCORPORATION IN DEBT RECOVERY

BY: PAUL OMOBHUDE, ESQ.

 

INTRODUCTION

Once a company is incorporated, in law it becomes a separate entity and possesses a distinct legal personality from the directors or shareholders of the company. The status of incorporation enables the company to own properties, secure credit for business, sue and be sued.

Likewise, the status of incorporation shields the directing minds of the company from liability in actions of the company, as such, individuals may in their ingenuity incorporate a company, obtain credit, misapply or misappropriate same without repaying in the belief that the company only should be held liable.

Hence the need to pierce the veil of incorporation, to identify those behind the veil directing the mind of the company, who must be held accountable for their indiscretion in the management of the affairs of the company.

THE CONCEPT OF INCORPORATION

Incorporation of a company refers to the legal process used in the formation, set up or creation of a corporate entity or a company. An incorporated company is a separate legal entity on its own, recognized by the law. These corporations can be identified with terms like ‘Inc’ or ‘Limited’ in their names. It becomes a corporate legal entity completely separate from its owners. The Black’s Law Dictionary defines Incorporation as the formation of a legal corporation.

When a company is incorporated, it distinguishes it from other forms of business organizations, as the company in law is seen as a separate legal entity different from the directors or shareholders of the company, by virtue of which the company has its own directing mind, can sue and be sued and can exist in perpetuity.

The dictum of Lord Denning in the English Case of Bolton {Engineering} Co. Ltd. v T.J. Graham & Sons Ltd. {1957} 1QB 159 emphatically captures the effect of incorporation of a company when the learned Justice stated that:

 “A company may in many ways be likened to a human body. It has a brain and nerve centre, which controls what it does. It also has hands, which hold the tools act in accordance with direction from the center. Some of the people in the company are mere servant and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will”

Also, in Lasisi v. Registrar of Company {1974} 7 S.C. 73 the Supreme Court of Nigeria held that:

“a company is an artificial human being and its registration is its birth and certificate of registration is its birth certificate.”

Basically, a company upon incorporation is clothed with legal personality which makes it distinct and separate from the directors or shareholders of the company. The Locus classicus on which the jurisprudence of a corporate personality is established is the case of Salomon v Salomon & Co. Ltd. {1897} AC 22 HL. 

In that case, Salomon transferred his business of boot making, initially run as a sole proprietorship, to a company (Salomon Ltd.), incorporated with members comprising of himself and his family. The price for such transfer was paid to Salomon by way of shares, and debentures having a floating charge (security against debt) on the assets of the company. Later, when the company’s business failed and it went into liquidation, Salomon’s right of recovery (secured through floating charge) against the debentures stood prior to the claims of unsecured creditors, who would, thus, have recovered nothing from the liquidation proceeds.

To avoid such alleged unjust exclusion, the liquidator, on behalf of the unsecured creditors, alleged that the company was sham, was essentially an agent of Salomon, and therefore, Salomon being the principal, was personally liable for its debt. In other words, the liquidator sought to overlook the separate personality of Salomon Ltd., distinct from its member Salomon, so as to make Salomon personally liable for the company’s debt as if he continued to conduct the business as a sole trader. The Court of Appeal, declaring the company to be a myth, reasoned that Salomon had incorporated the company contrary to the true intent of the then Companies Act, 1862, and that the latter had conducted the business as an agent of Salomon, who should, therefore, be responsible for the debt incurred in the course of such agency.

EFFECTS OF INCORPORATION

By virtue of Section 42 of the Companies and Allied Matters Act, 2020 {as amended} “CAMA 2020” the effects of incorporation or registration of a company are summarized as follows:

  1. The company becomes a body corporate by the name contained in its Memorandum of Association with effect from the date of its registration.
  2. The company assumes a separate identity from the members who comprise it; and;
  3. The company is entitled to exercise all the powers and functions of an incorporated company. These include the power to own property, the power to have a common seal and perpetual succession.

BASIC REQUIREMENT BEFORE REGISTRATION OR INCORPORATION OF A COMPANY

Before the registration or incorporation of a company, it is pertinent to consider the following:

  1. Capacity to form a Company

Every individual or promoter who intends to incorporate a company must first satisfy whether they possess the capacity to form or incorporate a company. Section 20 {1} of the Companies and Allied Matters Act, 2020 {as amended} provides that an individual shall not join in the formation of a company if he is:

  1. less than 18years of age, unless there are two other persons of full age and capacity have subscribed to the Memorandum of Association.
  2. of unsound mind, who have been so found, by a court in Nigeria or elsewhere.
  3. an undischarged bankrupt; or
  4. disqualified under sections 281 and 283 of the CAMA, 2020, from being a director of a company

2. Name of Company

Another basic requirement which must be met before a company can be incorporated or registered is that the proposed name of the company intended to be registered must not be a name prohibited under Section 852 {1} of CAMA 2020. The section prohibits the registration of any company whose name:

  1. Is identical with that by which a company in existence is already registered or so nearly resembles that name as to be calculated to deceive, except, where the company in existence is in the course of being dissolved and signifies its consent in such manner as the commission requires.
  2. Contains the words “Chamber of commerce” unless it is a company limited by guarantee; or
  3. In the opinion of the commission is capable of misleading as to the nature or extent of its activities or is undesirable, offensive or otherwise contrary to public policy; or
  4. In the opinion of the commission would violate any existing trade mark or business name registered in Nigeria, unless the consent of the owner of the trademark or business name has been obtained.
  5. Contains any word which, in the opinion of the Commission, is likely to mislead the public as to the nationality, race or religion of the persons by whom the business is wholly owned or controlled;
  6. Is in the opinion of the commission, deceptive or objectionable in that it contains a reference or suggests association with any practice, institution, personage, foreign state or government, international organization or international brand or is otherwise unsuitable or
  7. Is capable of undermining public peace and national security.

However, by Section 852 {2} of CAMA, 2020 some names are restricted save for the consent of the commission. They are:

  1. Names which include the word “Federal”, “National”, “Regional”, “State”
  2. “Government” or any other word which in the opinion of the commission suggests or is calculated to suggest that it enjoys the patronage of the Government of the Federation, the Government of a State of Nigeria, any Ministry or Department of the Government, or contains the word “Municipal” or “Chartered” or in the opinion of the commission, suggests or is calculated to suggest, connection with any municipality or other local authority.
  3. Contains the word “Co-operative” or the words “Building Society”
  4. Contains the word “Group” or “Holdings”

3. Submission of Incorporation Documents

Section 36 of CAMA 2020 provides for the following documents which must be submitted to the Commission {Corporate Affairs Commission} in an application for the registration of a company.

a. Memorandum of Association: The memorandum of association of the company regulates the affairs of the company as it relates to the transaction of business or interaction of the company with the public. By Section 27 of the CAMA, 2020the Memorandum of Association of a company shall state the following:

  1. The name of the company,
  2. The registered office of the company,
  3. Nature of business which the company is authorized to carry out {object clause},
  4. The restriction clause on the power of the company,
  5. The nature of company,
  6. The share capital of the company and
  7. The amount of the minimum share capital which must not be less than N100,000.00 in the case of a private company and N2,000,000, in the case of a public company.

The memorandum is expected to be signed by each of the subscribers and also stamped as a deed.

b. The Articles of Association of the Company: Section 32 of CAMA provides that:  A company shall have articles of association prescribing regulations for the company. The Articles of Association of the Company forms the internal regulations for the management of the company

WHEN IS A COMPANY SAID TO BE INDEBTED?

By the provisions of Section 572{a} of the Companies and Allied Matters Act, 2020 {as Amended}; A Company is deemed to be unable to pay its debts if:

“A creditor, by assignment or otherwise, to whom the company is indebted in a sum exceeding N200,000, then due, has served on the Company, by leaving it at its registered office or head office, a demand under his hand requiring the company to pay the sum due, and the Company has for three weeks thereafter neglected to pay the sum or to secure or compound for it to the reasonable satisfaction of the creditor.”

Hence, where a company is unable to pay its debt in a sum exceeding N200,000.00 within 3 weeks after demands have been made by the creditor, the Company is said to be indebted.

VEIL OF INCORPORATION

Veil of incorporation connotes the legal assumption that a corporation or company is a distinct and separate entity or that a corporation possesses a distinct legal personality such that the acts of a corporation are distinct from the acts of its shareholders, directors or managers thereby exempting them from liability for corporate actions.

Section 42 of CAMA gives statutory backing to the legality of corporate personality of registered companies. The propriety of a company’s separate legal personality was further recognized in the very formidable and celebrated case of Salomon v Salomon {supra}; which reasoning has overtime been adopted by the Courts in Nigeria. In J&J Technologies Ltd v YHQS {2015} 8 NWLR {Pt. 1460} 1 at 21 C-E, the Court was of the strong opinion that the separate personality of a registered company remains unfettered even where a director is the sole signatory to the account of a company. In NBCl v. Integrated Gas Nigeria Ltd. {1999} 8 NWLR {Pt. 613} 119 at 129 the Court held that a company must be accorded the status of recognizing the separate personality from the biological persons that run it.    

LIFTING OR PIERCING THE VEIL OF INCORPORATION

By the general principle of law, a company has a distinct legal personality different from the directors or shareholders of the company, such that a company can rightly sue to enforce its rights and conversely being sued.

However, it is pertinent to state herein that though a company possess a distinct legal personality and in fact seen as a person in law, a company nonetheless acts through its agents who are usually the directors or principal officer and shareholders of the company.

Thus, where the directors of a company use the company as a façade to perpetuate illegality or obtain loan from a bank and misapplies same, the directors would not be allowed to hide behind the veil of incorporation, rather the Court of law may lift the corporate veil of incorporation so as to render the directing minds of the company vicariously liable to the company’s creditors.

The case of Salomon v Salomon {supra} forms the basic ground on which the veil of incorporation can be pierced so as to make the directors behind the veil liable for their indiscretion in the management of the affairs of the company.

In Oyebanji v the State {2015} 14 NWLR {Pt. 1479}270 at 292B the Court stated that

“a Court may lift the corporate veil where the corporate form is abused or misused in a transaction. Directors will be personally liable for debts arising from such transactions.”

Furthermore, In Nigeriate Ltd v. Dalami {Nigeria} Ltd. 1992} 7 NWLR {Pt. 252} 288, 304, the Court stated that though a duly incorporated company cannot be disregarded even where it is a mere sham, the Court will find from the evidence that it acted not for itself but for the persons who formed it, hence the Courts may pierce the veil of the company’s incorporation to make accountable persons whose benefited from the company’s action.

STATUTORY GROUNDS FOR LIFTING THE VEIL OF INCORPORATION.

  1. Reduction in the Number of Directors: Under section 118 of the CAMA, 2020, all debts incurred by a company at any time when the number of members of the company falls below the required and continue to carry on business for more than 6 months, the directors of such a company shall become jointly and severally liable for the debts incurred within that period by the company.
  2. Misappropriation or misapplication of Companies Money or property: Section 316 of CAMA 2020 makes directors personally liable for company’s debt which arises where the company receives money or property for a specific contract or purpose but fraudulently misappropriate or misapplies same or wholly channel such money to other projects other than the specific contract for which it was meant. In the case of Eboni Finance and Securities Ltd. v Wole-Ojo Technical Services Ltd and Ors. {1996} 7 NWLR {Pt. 461} Page 464 at 478 the Court held that:
    “By virtue of section 290 of the Companies and Allied Matters Act…Every director or officer of the company shall be personally liable to the person from whom money was received”
  3. Directors’ personal liability for failure to make refunds to the company: Under the Companies and Allied Matters Act, 2020 as amended, the Directors of a company owe the company an obligation to discharge their duty with skill and in good faith. Therefore, Section 293 of CAMA provides that a director is under duty to make refunds to the company any remuneration accorded to themselves contrary to those provided in the articles of association by the shareholders or approved by the Board of Directors. Section, failure of which they become personally liable to make refunds to the company. Also, Section 309 of CAMA 2020 provides that:
    “Directors are trustees of the company’s money, properties and their powers and as such shall account for all the money over which they exercise control, refund any money improperly paid away, and shall exercise their powers honestly in the interest of the company and all the shareholders, and not in their own or sectional interests.”
  4. Declaration of Shares by Substantive Shareholders of a Company: Under Section 120 of CAMA 2020, a person who is a substantial shareholder in a public company is required to give notice in writing to the company stating his name and address and giving full particulars of the shares held by him or his nominee by virtue of which he is a substantial shareholder. Failure to comply with this requirement may warrant the lifting of the veil of incorporation such that the shareholder may be liable to such fines as the Corporate Affairs Commission may prescribe
  5. Failure to Comply with Established Business Ethics under CAMA: Section 729 of CAMA 2020requires that the name of the company shall be (a) fixed outside every office where it carries on business; (b) engrave on its common seal (c) mentioned in all Bills of Exchange, business letters, notices, advertisements and official publications. Thus, if the company’s name is not mentioned in the bills of exchange and other negotiable instruments like cheques, the office or any person issuing such instrument on behalf of the company will be personally liable for the amount thereof. This position was affirmed by the Court in the case of Nathaniel Abodun Adeniji v. The State. (1992) 4 NWLR p.248
  6. Investigation into affairs of related entities: By Section 778 of CAMA 2020, an investigator appointed by the Corporate Affairs Commission to investigate the affairs of a particular company is empowered by virtue of his appointment to further investigate any entity which has in the past or in the present associated with the company under investigation. Hence, an investigator is empowered to look beyond the company he is investigating to also investigate other companies such as subsidiaries or holding company associated with the company under investigation.
  7. Pre-incorporation contracts: Promoters of unincorporated companies are personally liable to pay all debts incurred by the unincorporated company prior to its incorporation. By the provision of Section 96{2}, Where a director contracts on behalf of an unincorporated company, he will be personally liable in the contract, except where the contract is ratified by the company upon its incorporation.

CASE LAW INSTANCES WHERE THE VEIL OF INCORPORATION IS LIFTED.

i) Where there exists a deed of personal guarantee executed by directors or shareholders of the company for a loan obtained by it: where a director or shareholder gives a personal guarantee with respect to a loan secured by a company, such directors become personally liable to pay the debt of the company if the company defaults. In Chami vs. Uba Plc {2010} 6 NWLR {Pt. 1191} Page 474 at 479 the Court held that:

“When the principal debtor fails to pay his debt, as in the instant case, the liability of the guarantor under the guarantee crystallizes. The right of the creditor is therefore not conditional as he is entitled to proceed against the guarantor without or independent of the principal debtor”  

Therefore, where directors hide behind the veil of incorporation to secure loan and misapply the benefit of the loan for other purposes, thereby defaulting in the liquidation of the debts, the Creditors are at liberty to recover the debt from the directors of the company who are guarantors of the facility.

By the authority of Chami vs. UBA Plc {Supra}, ratio 3; the Creditors can maintain an action in the recovery of debt against the directors who are also guarantors of the loan facility independently without suing the company itself.

Section 316 of CAMA 2020, also gives credence to this position that directors who misapply company’s properties or money are personally liable for their actions, as the Court will pierce the veil of incorporation to render such directors accountable for their actions.

ii) Personal Liability of Directors in the Insolvency of the Company: A company may be declared insolvent and accordingly wound up if it is deemed incapable of paying its debt. However, by section 672 of CAMA 2020, if in the course of winding up a company, it appears that any business of the company has been carried out in a reckless manner with the intent to defraud creditors, on the application of the liquidators or creditors, the Court may declare that the persons who knowingly carried on business in such a manner are personally liable without any limitation for any debt of the company.  furthermore, Section 673 specifically makes directors personally liable for the company’s debt where their indiscretion resulted in the insolvency of the Company while section 674 of the CAMA, 2020 makes both the present and past directors of the company personally liable for the companies debt if such directors have misapplied or retained the company’s money or property in an unjustifiable manner.

iii) Liability for Fraud: In Alade v. Alice (Nig) Ltd, (2010) 19 NWLR (Pt.1226) at 116-117; Galadima JSCstated that one of the occasions when the veil of incorporation of a company could be lifted by the court is when the company is liable for fraud. It is a general principle of law that a statute will not be allowed to be used as an excuse to justify illegality of fraud, hence, it is in the quest to avoid the normal consequences of the statutes which may result in grave injustice that the Court as occasion demands would look behind or pierce the corporation veil.  

Munktaka-Coomassie J.S.C in delivering his judgment stated in Alade v. Alice (Nig) Ltd, (supra)  held that:

“it must be stated unequivocally that this court as the last court of the land, will not allow a party to use his company as a cover to dupe, cheat or defraud an innocent citizen who entered into lawful contract with the company, only to be confronted with the defense of the company’s legal entity as distinct from is directors. Most companies in this country are owned and managed by an individual, while registering the members of his family as the shareholder. Such companies are nothing more than one-man-business. Thence, the tendency is there to enter into contract in such company name and later turn around to the claim that he was not a party to the agreement since the company is a legal entity”

Also in Olawepo v The Securities and Exchange Commission {2011} 16 NWLR {Pt. 1272} Pages 122, the Court held that:

“Where an offence has been committed by a company, every person who at the time the offence was committed was in charge of, and was responsible to the company for the conduct of the business of the company, as well as the company shall be deemed guilty of the offence and shall be liable to be proceeded against.”

iv) Undisclosed principal: A director who enters into a contract in his name without disclosing that he is acting for a company or disclosing the company’s name or existence, there is a risk that the director may be personally liable in the contract. In Ataguba & Co v Gura Ltd (2005) 8 NWLR (Pt 927) 429, the appellant who sold a truck to the respondent, collected the purchase price and issued a receipt in his own name, was held to be the real contracting party.

v) Negligence: A director may be personally liable for the debt of a company where his indiscretion or negligent actions in a transaction has resulted in corporate debt. This was the position of the Court in Iyere v BFFM Ltd (2008) 18 NWLR (Pt 1119) 300 at 351G-352E. However, a director may not be personally liable if he merely performs his statutory responsibilities without further. To prove negligence, it must be shown that the director owed the injured party a duty of care, the duty was breached and damage has been suffered. In Anyah v Imo Concorde Hotels Ltd (2002) 18 NWLR (Pt 799) 377 at 395H-396, a directors issued a prospectus inviting subscriptions for debentures. Contrary to the directors’ misrepresentation, the aim for raising funds was to pay off liabilities. The plaintiff, acting on a misrepresentation, advanced money. When the company became insolvent the directors were held liable for negligent misrepresentation.

vi) Deceit: A director may be liable for deceit where the director dishonestly makes a representation which is false and intended to be relied on and is in fact relied on. In GE Commercial Finance Ltd v Gee (2006) 1 Lloyds Rep 337, GE successfully claimed for damages for deceit against a company’s Chairman who had made statements on fictitious debts to GE. GE had made payments to the company based on the statements. In contrast to negligence, damages for deceit extends beyond foreseeable losses. It includes gains which the injured party would have made from the contract and the loss of opportunity to use the money in more profitable ways but for the deceit

vii) Causing loss by unlawful means/Asset stripping: Where Directors or shareholders of a company intentionally or fraudulently strip the company of its assets or money in other to frustrate its creditors or judgment creditors, the Court may lift the veil of incorporation of the company and proceed against the directors and shareholders. The English case of  Marex Financial Ltd v Carlos Sevilleja Garcia [2017] EWHC 918 indicates that English courts may hold a director personally liable where he strips a debtor-company of assets to frustrate a judgement creditor. Marex got judgment against the debtor-companies. The debtor-companies’ shadow director stripped them of assets transferring $9.5m to himself. Marex sued the shadow director for procuring the violation of Marex’s rights under the judgment and for causing loss by unlawful means. The court ruled that Marex had a good arguable case.

CONCLUSION

The veil of incorporation of company provides a formidable ground for businesses and enterprises to thrive being that it protects business owners and investors from direct corporate assault and avoidable litigation that would have arisen against the directors of the company as a result of the actions of the company.

However, the law will not permit directors to hide under the veil of incorporation or use the veil of incorporation as a façade to defraud the company or its creditors. Hence the Court will readily pierce or lift the veil of incorporation to bring to account the directors of the company acting behind the veil so as to ensure creditors recover their money directly from such directors.

 

 

 

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