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opinion BANKING ON COR P OR AT E BY BRYAN HAYNES When the corporate veil should not be pierced T he "separate entities" principle established over 100 years ago by the House of Lords in Salomon v. Salomon & Co. is recognized as one of the fundamental principles of English law. It holds that a company is a distinct legal person, different altogether from its shareholders, and must be treated like any other independent person with its own rights and liabilities. The corporate veil, it was held, may only be pierced in rare and exceptional circumstances, namely, if the company was formed for an unlawful purpose or a fraud was committed. Regrettably, in the past couple of dec- ades, a "just and equitable" test has crept into the jurisprudence and been occa- sionally — but wrongly — applied in determining when to pierce the veil. The result has been uncertainty in the law and a weakening of the principle, which for more than a century has deftly served as a cornerstone of corporate law. Aron Salomon was a leather mer- chant and boot manufacturer. His sons, who worked with him, wanted a share in the business. So Mr. Salomon did what many others have done in similar circumstances; converted his business into a limited company. At the time of transfer, the business was solvent and the debts of the business had been dis- charged. Unfortunately, the company fell upon evil days with a depression in the boot trade. The company was unable to satisfy its debts and it was ordered to wind up. The trial decision, affirmed on appeal, ruled the company had a right of indemnity against Salomon on the basis the subscribers (members of his family) were mere "dummies," that the company was Salomon in disguise, and he engaged the company as his agent. The House of Lords unanimously reversed the lower court decisions, with Lord Macnaghten noting: "The company is at law a different person altogether from the subscribers to the memoran- dum, and, though it may be that after incorporation the business is precisely the same as it was before, the same per- sons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them." The origins of the just and equitable test have been traced to Justice Bertha Wilson in Kosmopoulos v. Constitution Insurance Co., where she framed the test for lifting the veil as follows: "The best that can be said is that the 'separate entities' principle is not enforced when it would yield a result 'too flagrantly opposed to justice, convenience, or the interests of the Revenue.'" In Transamerica Life Insurance Co. of Canada v. Canada Life Assurance Co., plaintiff 's counsel, relying on Kosmopoulos, creatively submitted that the corporate veil can be pierced simply when it is just and equitable to do so. This submission was sternly rejected by Justice Robert Sharpe, a decision upheld on appeal, on the basis it represented a significant departure from Salomon. Although there have been cases which have adopted variations of the just and equitable test, the preponder- ance of authoritative commercial case law (including the House of Lords' Rainham Chemical Works Ltd. v. Belvedere Fish Guano Co. Ltd., the English Court of Appeal's Adams v. Cape Industries plc, the B.C. Court of Appeal's B.G. Preeco (Pacific Coast) Ltd. v. Bon Street Holdings Ltd., and very recently in Tracy (Guardian of) v. Instaloans Financial Solutions Centres (B.C.) Ltd.) has reaffirmed the separate entities principle and applied the Salomon test for piercing the corporate veil. The introduction of a just and equit- able test into the case law is detrimental and unwarranted. The test outlined in Salomon is sound and unambiguous, the proper application of which leads to pre- dictable results. If the veil can be pierced whenever it is just and equitable to do so, we would inevitably be harking back to the days when equity was measured by the length of the chancellor's foot. We would also be straying from a coherent system of rational law characterized by the applica- tion of clear and consistent legal rules. The test is inconsistent with our cor- porate legislation which: (i) permits the creation of corporations having the cap- acity, rights, powers, and privileges of a natural person; (ii) prescribes the limited circumstances in which directors, offi- cers, and shareholders may be person- ally liable for their actions and the debts of a company; (iii) does not grant the judiciary carte blanche to pierce the veil whenever it sees fit; and (iv) sanctions the legitimacy of business owners limiting their future liability by incorporating. The object of incorporating is, and always was, to encourage enterprise and trade by facilitating borrowing and capital raising and limiting the personal liability of shareholders. Having relied on these rules to organize their affairs, business owners should naturally expect the sep- arate entities principle will be respected and the corporate veil will only be pierced in exceptional, well-understood circum- stances. The just and equitable test is indefinite and whimsical. From inception, it has been widely criticized and disregarded. It is time to abolish this vague and undeserv- ing test and reap the rewards of clarity and consistency. Bryan Haynes (haynesb@bennettjones. com) is a partner and co-chairman of the commercial transactions practice group at Bennett Jones LLP. www. C ANADIAN Law ye rmag.com NO VEMBER / DECEMBER 2009 15