DriveTech plc is engaged in the business of designing and manufacturing high-performance racing cars. It wishes to build a racetrack upon which it can test its prototype models, and to that end, it creates a subsidiary company called TrackBuild Ltd. A suitable piece of land on which to build the testing track is located and TrackBuild purchases it using capital borrowed from DriveTech. However, shortly thereafter, the directors of TrackBuild (all of whom are also directors of DriveTech) discover that the land does not have planning permission and so TrackBuild agrees to sell the land to BuildCorp Ltd, a local construction company. However, several days later, a member of the local council indicates to the directors of TrackBuild that, should it apply for planning permission, it would certainly be granted. Accordingly, before sale of the land to BuildCorp is completed, TrackBuild transfers ownership of the land to DriveTech, and argues that the contract with BuildCorp is no longer valid as it no longer owns the land. TrackBuild successfully applies for planning permission. DriveTech decides that it wishes to expand into the consumer car market and, to this end, it created another subsidiary called GearShift Ltd. The articles of GearShift provide that only directors nominated by DriveTech may sit on its board and, accordingly, all the directors of GearShift are either persons nominated by DriveTech, or are actually also directors of DriveTech. GearShift engages in research and development on a new car and this is funded exclusively by issuing shares that are purchased by DriveTech (with the result that GearShift becomes a wholly-owned subsidiary). However, more capital is required, but the directors of DriveTech refuse to provide GearShift with any more capital and instead order the board of GearShift to cut back on its research and development. Accordingly, the directors of GearShift agree to cut back on research into the car’s safety features. GearShift completes designing a new car and it is manufactured and sold to the public. However, the car turns out to be unsafe due to a defect in the car’s brakes and numerous accidents occur. Those who suffered injury and loss due to the defective cars initiate proceedings against GearShift but, by this time, GearShift has entered insolvent liquidation, and has insufficient funds to meet any liability. Advise the parties above of any potential liability they might face.

Introduction

• This problem question requires you to discuss whether or not the corporate veil will be pierced, or whether liability can be imposed upon DriveTech by some other means. Problem questions in this area are reasonably common, so you will want to be aware of those instances when the courts will pierce the veil. Unfortunately, this area of the law is not overly structured and academics disagree in terms of those instances when the veil will be pierced. You may want to point out that the courts will not lightly case aside a company’s corporate personality – indeed, the recent case of Petrodel Resources Ltd v Prest [2013] has confirmed that, currently, there is only one instances in which the courts will pierce the veil.

Purchase of land

• The first issue to discuss is TrackBuild’s purchasing of a piece of land, and its attempts to avoid selling the land to BuildCorp.
• The courts have stated repeatedly that where a company is a sham, or is used to perpetrate a fraud or evade a contractual obligation, then that company’s corporate personality will be set aside. Prest has confirmed this by stating that the only instances in which the courts can pierce the veil is where ‘a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control.’
• TrackBuild has agreed to sell the land to BuildCorp, but then changes its mind and decides to renege on the sale. TrackBuild attempts to avoid an existing legal obligation by selling the land to DriveBuild, and argues that it cannot complete the sale to BuildCorp as it no longer owns the land.
• Clearly, TrackBuild is attempting to use its corporate personality (and that of its parent) to avoid a contractual obligation (i.e. it is interposing DriveBuild in order to frustrate the enforcement of the contract). The facts of this case are very similar to the case of Jones v Lipman [1962]. Normally, in problem questions, it is not necessary to provide the facts of cases, but if a case’s facts closely mirror those of the facts of a problem, or if there is a key difference that you wish to highlight, then feel free to provide a brief recap of the facts. Note, however, it should be brief and should focus on material facts only – you will not be awarded marks for remembering unnecessary or irrelevant facts.
• Accordingly, it is likely that if BuildCorp wish to commence proceedings that the corporate personality of TrackBuild will be ignored and DriveTech will be compelled to sell the land to BuildCorp in accordance with the terms of the original contract of sale.
• However, it should be noted that in Prest, the Supreme Court stated that the veil will be pierced only if other more conventional remedies have proved to be of no assistance.

Defective brakes

• The second issue to discuss is who (if anyone) will bear liability for the injuries caused by the defective brakes. State at the outset that, as GearShift has entered insolvent liquidation, there is little point in issuing proceedings against GearShift.
• However, it may be possible to initiate proceedings against DriveTech. When a subsidiary has become insolvent, creditors of that subsidiary may attempt to obtain satisfaction of their debt by commencing proceedings against the subsidiary’s parent.
• One way of imposing liability upon the parent is by piercing the corporate veil of the subsidiary, so that the parent is liable for the subsidiary’s debts and liabilities. However, as noted above, there is now only one instance in which the veil will be pierced (namely where where ‘a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control’) and the issue of the defective brakes does not appear to fit into this instance.
• Accordingly, you will need to discuss other company law-related grounds[1] in which to impose liability. This could involve a discussion of those instances that were, until the Supreme Court decision in Prest, considered valid grounds for piercing the veil.

Agency

• It could be argued that GearShift is an agent for DriveTech. The general rule is that a principal is liable for the authorized acts of its agent. Accordingly, if GearShift were acting as DriveTech’s agent, DriveTech could be liable for GearShift’s actions.
• Unfortunately, establishing a relationship of agency in such cases is extremely difficult and it is not clear in what circumstances such a relationship will be established. The House of Lords in Salomon v A Salomon & Co Ltd [1987] did state that owning shares in a company (even owning all the shares) will not be enough per se to establish a relationship of agency.
• You may wish to discuss some cases to demonstrate what type of facts could give rise to a relationship of agency (e.g. Smith, Stone and Knight Ltd v Birmingham Corporation [1939]; Re FG Films Ltd [1953]).
• It should be noted that, historically, cases involving a relationship of agency between parent and subsidiary could result in the subsidiary’s corporate personality being ignored and liability being placed on the parent. Following Prest, this would no longer be regarded as a piercing of the veil and would simply be regarded as an application of agency principles.

Single economic unit

• The injured parties may try to argue that GearShift and DriveTech should be regarded as one single economic unit, thereby allowing their separate personalities to be ignored. The general rule is that, in a corporate group, the separate corporate personalities of the companies involved will be respected.
• The case of DHN Food Distributors Ltd v Tower Hamlets LBC [1976] complicated matters. In that case, the three companies in a corporate group were regarded as one entity. In DHN, Denning MR focused on the fact that the parent had complete control over its subsidiaries (as appears to be the case in our problem) and subsequent cases have hinted that this area of the law might develop.
• However, in general, DHN has been strongly criticized by future courts (e.g. the Court of Appeal in Adams v Cape Industries plc [1990] and the House of Lords in Woolfson v Strathclyde Regional Council (1978)), and is therefore likely to be regarded as questionable authority. Indeed, following Prest, DHN must now be regarded as not providing a sufficient justification for piercing the veil.

[1] Liability could be established in negligence, but you would likely not be expected to discuss this in a company law assessment.