Piercing The Corporate Veil
06 Oct 2015
A corporation has a separate and distinct legal identity under Canadian law. This means that the corporation can do business, own property and have title to various assets. The general rule is that a potential claimant against a corporation cannot bring an action against the corporation’s shareholders, directors and / or officers but must confine their requests for relief as against whatever capital or assets the corporation has.
However, there are instances where a potential claimant against a corporation can bypass the corporation and seek relief as against the property or assets of the shareholders, directors and / or officers of a corporation. This process is called "piercing the corporate veil" in legalese.
Courts will "pierce the corporate veil" in situations where a single agent who has a high degree of control over a corporation uses the corporation to keep assets away from a claimant resulting in manifest unfairness to the claimant. This is controversial because there may not be fraud per se and lots of businesses use corporations to protect assets from claimants. However, two key factors that the court will use to determine whether not to "pierce the corporate veil" are (1) the nature of the wrong committed such as whether or not the corporation is a shell corporation and used as "mere sham" to keep assets out of the hands of claimants and (2) the degree of unfairness to the claimants.
Lynch v. Segal et al., 2006 CanLII 42240 (ON CA) exemplifies the above. It is a case that saw the Ontario Court of Appeal affirm the lower court decision to lay aside certain protections afforded by corporations and issue a powerful order, a vesting order, transferring ownership in property from one spouse, Mr. Segal, who tried to avoid making support payments, to Ms. Lynch, who was left to care and pay for their children by herself.
Mr. Segal was a man who would go to "extraordinary lengths" to ensure the safety of his assets by distancing himself from their apparent ownership. Mr. Segal had incorporated companies, named directors, but did not issue shares. Share certificates were prepared and executed in blank and held by a trustee. This approach allowed for great flexibility – as Mr. Segal would be able to either provide himself with the power to move around assets or foster the illusion that someone else was the owner of the corporations in question if a lawsuit was looming.
Mr. Segal had thus traveled the world setting up an elaborate web of lawyers and trustees all operating under the impression that they were employed by a group of wealthy investors who must remain unnamed.
Mr. Segal, having previously abandoned the children of his previous marriage, had shown no intention of providing the requisite child support payments. This was a crucial point for the presiding judge – as the implausibility of any support validated the extent of the relief provided.
Lynch v. Segal et al. crucially elaborates the law in two distinct areas: (a) a judge’s discretion in awarding relief in the form of vesting orders, particularly in the family law context, and (b) the extent to which the courts can "pierce the corporate veil" – effectively put aside the protections afforded by a corporation to its owners when equity calls for it.
The vesting order is an order by a court granting powers to both change title to a subject property and to convey said title to a party entitled to the property.
The appeal in Lynch v. Segal et al. found that the trial judge had not been mistaken in his decision. Mr. Segal had been vocal about his "schemes" throughout his relationship with Ms. Lynch, so there was ample evidence to support the claim that he is the beneficial owner of the corporations in question, because he enjoyed enrichment from the assets in question without holding legal title to any of the entities holding the assets.
On the question of third party investors, which would act as a bar to piercing the corporate veil in the family law context, the Court of Appeal confirmed that the trial judge had correctly noted that any unknown wealthy investors’ interests would not be affected with a finding that Mr. Segal is the beneficial owner of the corporations in question.
Mr. Segal’s attitude and determination to not allow for any support for his former spouse and children was sufficient in the trial judge’s view, as concurred by the Court of Appeal, to effect a vesting order.
It is thus the combined machinations of family law principles in terms of vesting orders and the common law on the separation between corporations and their owners that allows the court such a wide and deep power so as to move assets en masse from one spouse to another. However, a strong caveat to the above is that it is arguable that the courts would have utilized a more strict approach if the context of the case was one that was purely commercial.
Finally, it is our view that people will no doubt continue to use corporations as a means to protect the assets of the personal assets of its shareholders, directors and / officers from the risk of litigation. However, it is also important to note the limits to the use of corporations to protect personal assets as well. It is crucial for officers and directors of corporations to take certain steps to protect themselves from claims to "pierce the corporate veil." For example, the corporation should have more than an existence "on paper" and not just be there to keep personal assets out the hands of potential claimants.
The above article is for general information purposes only and does not constitute legal advice. If you have concerns with regard to the foregoing issues, please make an appointment with one of our lawyers or a qualified legal practitioner elsewhere.