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Difficulty in Lifting the Corporate Veil

2010-04-01

The recent Court of Appeal case of Horace Yao Yee Cheong & Ors v Pearl Oriental Innovation Limited [2010] HKCU 800 has shown the Court’s reluctance to pierce the corporate veil and hold a parent company liable for the debts of its subsidiary.

Dransfield Holdings Ltd (“DHL”) was a company incorporated in the Cayman Islands in October 1992 and listed on the Hong Kong Stock Exchange.  In around 2004, the Plaintiffs issued a writ against DHL for money owed to the Plaintiffs.  The Plaintiffs obtained judgment in their favour in June 2005.  In September 2005, DHL was wound up upon a petition filed by the Plaintiffs.  

Background

In around 2002, due to grave financial difficulties, DHL entered into a subscription agreement with DiChain Systems Limited, which provided for the setting up of a new company into which the subscribers would invest more than $53 million; and there would be a Scheme of Arrangement whereby the existing DHL shares would be cancelled and new shares issued.  The existing shareholders of DHL would receive new shares in the new company.  Since the Scheme of Arrangement was completed in August 2002, DHL became a wholly owned subsidiary of the Defendant and was controlled fully by the Defendant as an intermediate investment holding company.  

Court of First Instance (“CFI”)

The CFI judge concluded that the Defendant had stripped DHL of its assets in a wrongful manner by referring to 2 instances of asset stripping: -  

1.            In 2004, DHL’s investment in DF China Technology Inc was realized generating approximately HK$16 million (which was still well below the liabilities owed by DHL to its creditors).  While it was alleged by the Defendant that the proceeds may have been utilized to repay part of the bank loans DHL had obtained, there was no documentary evidence to substantiate that.

2.            In 2003, after the Defendant had acquired DHL, the shares of Good Value Holdings Ltd (“Good Value”), a wholly owned subsidiary of DHL, was transferred to China Merchants DiChain (Asia) Investment Holdings Ltd, a wholly owned subsidiary of the Defendant for a consideration of US$7.00.  At the time, Good Value was holding a valuable bonded warehouse in Futian.  

The CFI judge found that there had been a deliberate and systematic stripping of assets of DHL by the Defendant after its acquisition by the Defendant.  The assets of DHL had been stripped away without proper or sufficient value given and at the same time the existing liabilities of DHL were not met and the creditors were left high and dry.  The motive for the improper asset stripping of DHL was to put it beyond reach of the other creditors of DHL (including the Plaintiffs) since from the outset, the Defendant had no intention of paying off even the existing liabilities of DHL other than to the banks.  Further, the judge found that there was concealment from the public eye such asset stripping of DHL by the Defendant.  For reasons above, the judge held that it was appropriate to lift and pierce the corporate veil and treat the Defendant as being the same entity as DHL.  

Lifting/Piercing the Corporate Veil

On the facts of the case, the Court of Appeal (“CA”) found that there had been no asset stripping of DHL by the Defendant and no concealment from the public.  Therefore, the factual basis on which the CFI judge proceeded to consider lifting or piercing the corporate veil were not made out.   

Further, the CA was of the view that even if the Defendant had stripped the assets of DHL to detriment of DHL’s creditors, that would not in itself be sufficient grounds for the Court to pierce the corporate veil and give judgment against the Defendant.  

The following sets out the circumstances in which the corporate view will be pierced or circumvented so as to treat the rights and liabilities of a company and its parent as one for any purpose: -  

(1)          where the construction of a statute, contract or other document requires such an approach;

(2)          where the company is a mere façade for some fraud or improper purpose;

(3)          where the company is an authorized agent of its parent or other members.

The CA considered that only one of those circumstances could have applied to the present case, namely, where DHL is a mere façade for some fraud or improper purpose.  If that is the case then DHL itself would have been the sham or façade.  However, this simply cannot be the case as it was the Plaintiff’s case that DHL was the party wronged.

Cause of Action

The CA also observed that lifting or piercing the corporate veil does not give rise to a cause of action in itself.  It is a relief or remedy which can be granted when there is an underlying cause of action.

Therefore, even if the Defendant had “stripped” DHL of its assets and had acted improperly, that does not give rise to a cause of action that may be brought by the Plaintiff.  The alleged wrongs were done to DHL.  There may be causes of action which DHL could rely upon (e.g. a claim for a declaration that it was the beneficial owner of shares of Good Value if there was no genuine transfer, or avoid the disposition as having been made to defraud creditor pursuant to section 60 of the Conveyancing and Property Ordinance).  However, that would be a remedy brought by DHL or its liquidator for the benefit of the company and the creditors as a whole.  It does not give rise to any right of action on the part of an individual creditor (i.e. the Plaintiffs).


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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.
Published by ONC Lawyers © 2010

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